Standard Costing Principles and Practice
Standard Costs
Cost Basics
Real Costs
Real Costs are historical costs that have been incurred in a prior period.
Default Costs
Default Costs represent a system in which costs are determined before the start of production activities for identification, classification, and control. They are classified as:
Estimated Costs
Estimated Costs represent the amount which the company anticipates a product or a process operation will actually cost for a certain period.
Standard Costs Defined
Standard Costs are scientifically and technically determined default costs that serve as a basis for measuring actual performance.
Establishing Standard Costs
The difference between the actual cost and the standard is called a Variation.
Variations indicate the extent to which a certain level of established performance has been reached.
Variations can be grouped by department, cost, or cost element.
Advantages of Standard Costs
- Is an important tool for performance evaluation.
- Variations from standards lead the company to implement cost reduction programs, focusing on areas that are out of control.
- They are useful for decision-making.
- Standard Costs are useful because they allow the company to plan, assign responsibilities, and establish policies and methods of performance evaluation.
- In a large company, the standard cost system simplifies operations and internal cost reporting.
Drawbacks of Standard Costs
- They are most applicable for companies whose production plant is rationally organized.
- They are not easily adoptable to every type of business.
- They may not be advisable for small businesses.
- Requires a relationship with short-term inventory stocks in the manufacturing process.
- Some workers may become upset because they feel under pressure to try to achieve the standards.
- A standard cost system is generally applicable to industries that produce large volumes or in series, where production is repetitive and there is uniformity in the process.
- They are not recommended for small orders or operations that do not occur again.
Analyzing Cost Variations
The difference between the actual cost and standard cost of materials used is reflected in two variations:
- Material Price Variation
- Material Usage Variation
Determining Material Variations
The standard cost of raw materials consists of two elements: Quantity and Price.
Quantity
This must consider all types of raw materials and materials used. Catalogs or lists of all materials and raw materials that make each product are necessary.
Price
This requires materials planning and control procedures (aiming for low prices).
When the actual price of raw materials is greater than the standard cost, there is an adverse material price variation.
Although the material price variation may not always be controllable, it provides management with important information for planning and decision-making.
Material Usage Variation
The Material Usage Variation reflects whether the quantity of materials used was greater or lesser than contemplated by the established standards.
The material usage variation may be due to several factors, such as using smaller quantities, theft, poor workmanship, etc.
Labor Variations
The standard cost of labor has two elements: the standard production rate per hour and the standard wage rate per hour.
Standard Production per Hour
Time and motion studies are often used here. Some companies use test runs as the basis for determining standard labor time.
Standard Wage Rate per Hour
This is determined to understand the quality of workmanship and the wages involved, often based on union contracts or wage tables (TAB).
The Labor Rate Variation is the difference between the actual and standard wage rate set.
Indirect Cost Standards
Setting standards for direct materials and direct labor is theoretically easier than determining standards for manufacturing overhead.
In general, variable overhead items consist of suitable elements (e.g., public utilities) for which standards can be determined based on a given amount of production.
Types of Standards
When setting standards, we consider:
- Actual Standards
- Basic Standards
- Regular Standards
- Achievable Standards