Standard Costing

How are the standard costs useful in a manufacturing firm? What are their limitations? (2019)

Meaning of Standard Costing:

Standard costing is a cost accounting method whereby an estimated predetermined (standard) costs are assigned to materials, labor, and overheads Then actual costs are compared with such predetermined standard costs for the purpose of finding variance. The purpose is to control costs, improve efficiency, and aid in decision-making towards the business.

In simple terms, standard costing helps a business know what costs should be, and then checks if actual costs are higher or lower—so that management can take corrective actions.

Example:
If the standard cost to produce one unit is ₹100 and the actual cost is ₹110, the variance is ₹10 (unfavorable), indicating inefficiency or increased expenses.

Standard Costs in a Manufacturing Firm – Usefulness and Limitations

Usefulness of Standard Costs:

1. Cost Control:
   Cost is controlled with the Help of comparing actual costs with standard (expected) costs.
2. Budgeting:
   Serves as a foundation for preparing budgets, helping in setting realistic cost expectations.
3. Performance Evaluation:
   Assists in evaluating employee and departmental performance by analyzing variances.
4. Decision Making:
   With the help of standard costing reliable information about the costs are collected. Due to which decision making can be made regarding product mix, setting pricing for product.
5. Motivation:
   Acts as a performance target that can motivate workers and managers to achieve efficiency.
6. Inventory Valuation:
   Standard costs are also helpful for inventory costing valuation. Because the volume of inventory is also considered as the standard volume of material and actual material used.

Limitations of Standard Costs:

1. Outdated Standards:
   If not regularly updated, standard costs may become inaccurate due to inflation, technology changes, or process modifications.
2. Time and Cost:
   Setting up and maintaining a standard costing system can be expensive and time-consuming.
3. Inflexibility:
   May not suit dynamic production environments where products and processes change frequently.
4. Employee Resistance:
   Workers may feel pressured or demotivated if they consistently fail to meet rigid standards.
5. Focus on Cost Over Quality:
   Emphasis on cost reduction may lead to a compromise in product quality.
6. Not Suitable for Custom Production:
   In job-order or highly customized production settings, standard costing may not be practical.

Conclusion of Standard Costing:

Standard costing is a valuable method for cost controlling in cost accounting that helps businesses plan, control, and analyze costs effectively. By comparing standard costs with actual costs, it identifies variances after comparing standard costs with the Actual costs and so it enables management to take corrective actions. This method improves cost control, supports budgeting, and enhances decision-making.

However, for it to remain effective, standards must be regularly updated and tailored to the business environment. Despite its limitations, standard costing continues to be a widely used technique in manufacturing and other cost-driven industries.
While standard costs are powerful tools for cost control and operational efficiency in manufacturing firms, they must be regularly reviewed and carefully implemented to avoid misleading results or resistance. You can check your syllabus for cost Accounting on the university site Gndu.

Important questions of Cost Accounting

1. CVP Analysis
2. Contract Account Costing Treatment. Give its performa.