Establishment of System of Standard Costing, Cost Management B Com Notes | EduRev

Cost Management

B Com : Establishment of System of Standard Costing, Cost Management B Com Notes | EduRev

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Preliminaries of Establishment of Standard Cost System:

The following four points are usually considered for setting up a standard cost system in a business:

1) Setting up cost center

2) Classification of Accounts   

3) Types of Standards

4) Settings the Standards.

1) Setting up Cost Center:  Introducing Standard Cost System is requires first of all to establish cost centers with their well‐designed ambit of work. In the process there should be no ambiguity about the responsibility of each cost center so that their responsibility may be identified.
A cost center is a location; people or item of equipments for cost may be ascertained and used for the purpose of cost control.

2) Classification of Accounts: Accounts are classified in order to assist collection and analysis. To use the system of standard costing effectively, all accounts have to be classified on the basis of their functions, items of revenue nature, assets and liabilities, etc. Codes are given for each item and each account along with elements of cost with this end in view, codes may be used. A code is a symbolic representation of any particular item of information.

For example,  

Direct Material 01-19
Direct Labour 20-29
Direct Expense 30-39
Indirect Expense 40-49
Indirect Labour 50-59
Indirect Expense 60-69

 

3) Types of Standards: Basically, there are two types of standard:

(a) Current Standard
(b) Basic Standard

(a) Current Standard: It is established for the use over a diminutive period of time and is related to current circumstances. Such a standard remains in operation for a limited period and belongs to the current conditions. These standards are revised at regular intervals. Current standard are of three types like (1) Ideal standards, (2) Expected standards, and (3) Normal standards.

(1) Ideal standards: This is a hypothetical standard which is rather not practicable to attain. This ideal is clearly unrealistic and unattainable. It pre‐ supposes that the performance of men, materials and machines is perfect and thus makes no allowance for the loss of time, accident, wastage of materials and any other type of waste of materials and any other type of waste or loss. Such standards have the advantage of establishing a goal which, however, is not always attainable in practice. As such it is having a little practical value.
The standard which can be attained under the most favourable condition possible.‐ I.C.M.A

(2) Expected or practical standards: Such standards are likely to be expected or utilized in the future period. Such standards are based on expected performance after making a reasonable allowance for unavoidable losses and other inevitable lapses from perfect efficiency. So it is most generally used standard and is best suited for cost control.
This standard can be anticipated as well as attained in future in  sync with the specified budget. ‐ I.C.M.A

(3) Normal standards: It is also known as ‘Past Performance Standard’ because it is based on the average performance in the past. It should be attainable and it provides a challenge to the staff. The aim of such a standard is to eliminate the variations in the cost which arise out of trade cycle. The average standard can be anticipated as well as attained in a future period of time.
Preferably, it should be long enough to cover one trade‐ cycle. ‐ I.C.M.A

(B) Basic standards: This is a standard which is established for use unaltered for an indefinite time. It is similar to an index number against which all results are measured. Variances from basic standards show trends of deviations of the actual cost. However, basic standards are of no practical utility from the point of view of cost control and cost ascertainment. This standard is set on a long‐term basis and seldom revised.   
It is an underlying standard from which current standard can bedeveloped.‐ I.C.M.A

4) Setting the Standard: The process of setting standard is a valuable activity in itself. The success of standard costing system depends on the reliability, accuracy and acceptance of the standards. If standards have been properly set and maintained, they are a sound basis for determining cost for various purposes. While setting the standards, the following points should be taken into consideration: duration of use of standard, reasonable standard of performance, level of activity. For the given units standard sets for the following items are (i) direct material cost, (ii) direct wage cost,(iii) direct expense,(iv) factory variable overhead cost,(v) selling and distribution variable cost,(vi) selling price and sales margin.

  • Standards for Material: It includes
    (1) Determination of standard quantity of material required, and
    (2) Determination of standard price per unit of material.
  • Material Quantities: After establishing the standard quality of material, it is more important and necessary to establish the standard regarding quantity of each material. Generally, quantities are expressed in terms of kilograms, feet, units and so forth.
  • Standards for Labour: This standard is determined with regard to the current rate of pay and any anticipated variations. It should be fixed for each grade of labour and for each operation involved. The standard hours are fixed for all categories of labour i.e., for skilled and unskilled labour. In these standards, number of hours and workers are established.
  • Material Prices: This is a forecast of the average prices of material during the future period. This standard is quite difficult   to establish because prices are regulated more by the external factors than by the company management. While setting standard prices, the past experiences, existing prices and anticipations should closely examine. Price of material in the past, current prices and fluctuating trends are the base for determining standard of price.
  • Setting for Overheads: Setting standard for overheads is more complex than the development of material and labour standards. It is estimated for variable overheads and fixed overheads. 
    • Variable Overheads: It may be recalled that variable overhead has been defined as a cost which tends to vary directly with the volume of output. It is assumed that the overhead rate per unit is invariable, irrespective of the quantity produced, so it is necessary to calculate only a standard cost per unit or per hour.   
    • Fixed Overheads: Fixed overhead tends to be unaffected by variations in the volume of output. Therefore it is required to determine total fixed overhead for the period and budgeted production in units.
  • Standard Hour: Production is usually articulated in physical units such as tons, pounds, gallons, numbers, kilograms, liters, etc. When a company is manufacturing different types of products, it is almost impossible to increase the production, which cannot be expressed in the same unit. Standard hour means a hypothetical hour, which represents the amount of work that should be performed in one hour under standard conditions.
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