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.
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.