Standard Costing Meaning, Objectives, VariationS, Limitations, Etc.

Imagine a factory where every rupee counts. Standard costing helps predict, monitor, and control expenses, making it a cornerstone for strategic financial planning. Standard costing will help predict, monitor and control expenses; it is the base for strategy planning and means that not only it is practically purposive but also a widely adopted technique in management accounting. It provides a metric by which performance can be accessed and assessed in manufacturing and service firms.Then comparing actual costs to these standards to identify and address variances. This approach is particularly useful in firms where production and costs are a marked portion of total costs, and efficiency gains can be achieved through cost reduction. Standard costing and variance analysis goes hand in hand.The application of standard costing in management accounting supports long-term strategic goals

Standard costing is asked a lot in UGC NET Commerce Examination and so the readers are advised to go through the articles properly.

In this article, we will understand the following:

• What is standard costing
• Standard Costing Formula
• Variances in Standard Costing
• Key Elements of Standard Costing
• Objectives of standard costing
• Different types of standard costing you should know
• Advantages of standard costing
• Limitations of standard costing
• Standard Costing vs Budgetary Control

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What is Standard Costing?

Standard costing meaning can be learnt as a cost accounting system that uses set costs to assess a firm's actual costs. This budgetary control tool system sets a standard cost for each product or service by looking at the expected costs for materials, labor, and overhead. The use of standard costing in management accounting provides a consistent framework for cost comparison.

The standard costing system creates a model by setting a standard for expected costs for a product or service. Comparing actual production costs with these models is then done to detect deviations.

Standard Costing Formula

The standard costing formula simplifies cost planning and control. The standard cost formula has been stated below for better understanding of the topic.

Variances in Standard Costing

In the field of standard costing, variances are the differentiations of predetermined (standard) costs with actual costs incurred for production. Variances essentially assist companies in performance reviews, identify inefficiencies, and corrective actions towards improved cost control and better decision-making.

Material Variance

Material variances are caused by price changes or changes in material usage.

A. Material Price Variance (MPV)

Formula:

MPV = (Standard Price – Actual Price) × Actual Quantity

Example:
Standard price = ₹10/kg
Actual price = ₹12/kg
Actual quantity = 1000 kg

MPV = (10 – 12) × 1000 = ₹(-2000) → ₹2000 Unfavourable

B. Material Usage Variance (MUV)

Formula:

MUV = (Standard Quantity – Actual Quantity) × Standard Price

Example:
Standard quantity = 900 kg
Actual quantity = 1000 kg
Standard price = ₹10

MUV = (900 – 1000) × 10 = ₹(-1000) → ₹1000 Unfavourable

Labour Variance

Labour variances arise from wage rate differences or efficiency in working hours.

A. Labour Rate Variance (LRV)

Formula:

LRV = (Standard Rate – Actual Rate) × Actual Hours

Example:
Standard rate = ₹20/hour
Actual rate = ₹22/hour
Actual hours = 100

LRV = (20 – 22) × 100 = ₹(-200) → ₹200 Unfavourable

B. Labour Efficiency Variance (LEV)

Formula:

LEV = (Standard Hours – Actual Hours) × Standard Rate

Example:
Standard hours = 80
Actual hours = 100
Standard rate = ₹20

LEV = (80 – 100) × 20 = ₹(-400) → ₹400 Unfavourable

Overhead Variance

Overhead variances cover both variable and fixed costs in production processes.

A. Variable Overhead Spending Variance

Formula:

(Standard VO Rate – Actual VO Rate) × Actual Hours

B. Variable Overhead Efficiency Variance

Formula:

(Standard Hours – Actual Hours) × Standard VO Rate

C. Fixed Overhead Spending Variance

Formula:

Actual Fixed Overhead – Budgeted Fixed Overhead

D. Fixed Overhead Volume Variance

Formula:

(Standard Hours × FO Rate) – Budgeted Fixed Overhead

Example (Volume Variance):
Budgeted Fixed Overhead = ₹12,000
Standard production = 1200 units
Actual production = 1000 units
Fixed OH Rate = ₹10/unit

Volume Variance = (1000 × 10) – 12,000 = ₹10,000 – 12,000 = ₹(-2,000) → ₹2000 Unfavourable

Standard costing relies on four primary components to track, analyze, and control costs. These elements provide a structured approach to setting expected costs and analyzing variances for better decision-making.

Standard Direct Material Cost

This represents the estimated cost of raw materials required to produce one unit of output under normal conditions.

• How it's determined:
  • Standard quantity of material per unit × Standard price per unit of material.
• Purpose: To act as a benchmark for material consumption and cost control.
• Example: If the standard material required is 5 kg per unit and the standard price is ₹10/kg,
  → Standard Direct Material Cost = 5 × ₹10 = ₹50/unit

Standard Direct Labour Cost

This refers to the expected wages and time needed for the labor required to produce one unit.

• How it's determined:
  • Standard hours of labor per unit × Standard wage rate per hour.
• Purpose: To assess labor efficiency and cost-effectiveness.
• Example: If standard labor hours per unit = 2 hours, and wage rate = ₹20/hour,
  → Standard Direct Labour Cost = 2 × ₹20 = ₹40/unit

Standard Overhead Cost

This includes both variable and fixed overheads estimated per unit.

• How it's determined:
  • Variable Overhead: Based on machine hours or labor hours × overhead rate.
  • Fixed Overhead: Budgeted fixed overhead / Expected production volume.
• Purpose: Helps distribute overheads accurately and track deviations in cost allocation.
• Example:If overhead rate = ₹5 per labor hour and 2 hours are needed:
  → Standard Overhead Cost = 2 × ₹5 = ₹10/unit

Standard Cost Variance Analysis

Variance analysis typically varies with actual and standard costs, and these differences indicate where performance deviates from expectations. For example, variance analysis can indicate performances deviating favorably or unfavorably from expectations.

Purpose: Corrective action, improvement in the precision of budgeting, and better cost control are enabled.

Types of Deviations :

• Material Deviation
• Labor Deviation
• Overhead Deviation

Objectives of Standard Costing

The most vital purpose of standard costing is an essential managerial cost control mechanism. Such costing is used by business as inevitable parameters for effective performance of many important, financially and operationally efficient, objectives.

Budgeting and Planning

One primary goal of the system of standard costing may be said to be the enhancement of the budgeting process. The object of standard costing is paramount to a business in the pursuit of cost control and performance measurement. With the establishment of standard costs based on historical data and future estimates, businesses create their budgets and financial plans with a great deal of accuracy. This accuracy in allocation makes certain that resources earnestly earn the set financial goals, thereby increasing personal goals within the budgeting process in totality.

Performance Measurement

Starring budgeting, another one of the main objectives of standard costing is performance reporting. One of the most significant objectives of standard costing is to measure actual results against standards. The other main objective of standard costing is for measuring performance. the standard serves as a measure against which actual performance is compared; this enables a straightforward discovery of deviations and inefficiencies in operation by the management. Through this variance analysis, organizations find areas that need considering and improvement hence creating a culture of continuous performance improvement and accountability.

Cost Control

The next major aim of standard costing is based on cost control. In fact, controlling costs, is the ultimate objective of standard costing. The management is effectively able to monitor and control actual costs by comparing them with standard costs. The analysis of variances aids in identifying cost overruns and inefficiencies at an early enough stage for the accurate and timely decision to correct any anomaly. Thus, by controlling the bastards with a zeal found in no other, one ensures that production costs and operating costs are also tightly controlled.

Pricing Strategies

Pricing accuracy is among the underrated yet vital objectives of standard costing. To make the pricing strategies better is another objective. Standard costing gives a clear knowledge of the cost structure associated with producing goods or services. This detailed cost data is invaluable in setting competitive and profitable pricing. By finding out the exact cost implications, firms can make more calculated pricing decisions that improves profitability while remaining competitive in the market.

Motivating Employees

It is making objectives that motivate employees and managers. Performance targets can be provided from standard costs, hence giving working employees and managers something clear to strive about. When those standards are set realistically, it enhances efficacious higher productivity and efficiency.. Achieving these targets can lead to rewards and recognition, thereby motivation in the workforce to maintain high performance levels.Each objective of standard costing supports decision-making and financial discipline.

Different Types of Standard Costing You Should Know

Various forms of standard costing are deployed, with specific operational needs and natural conditions in mind. Standard costing is generally classified according to varying techniques and the nature of standards set. Some of the major types of standard costing include:

Ideal Standards

Among different types of standard costing, ideal standards are the ones with the most efficiency goals, depending on the given circumstances. Also referred to as perfection or theoretical standards, the ideal standards operate upon the assumption of theoretically perfect settings where there are no losses or inefficiencies. To set the highest possible benchmark for maximum efficiency. It is often used as a motivational tool, but it is unrealistic and may lead to employee dissatisfaction if the targets are always considered unachievable..

Attainable Standards

Operational efficiency standards set for normal wastage levels in downtime and other eventualities. A realistic possible acceptable level that the employee can aspire to achieve. Thus usually used in practice balance motivation with realism and encourages continual improvement without overly demanding goals.

Current Standards

These are based on current operating conditions, reflecting the latest data on costs, processes, and efficiencies. To align standards closely with existing performance levels. It is useful for short-term planning and performance evaluation as they provide a basis for comparison with actual performance under current conditions.

Basic Standards

Basic standards means that they are long-term standards which stay the same over a period of time unless there are visible changes in the production process or the business environment. To gives a consistent benchmark for long-term output evaluation. It is good for spotting trends and long-term progress but are actually outdated and less relevant for day-to-day operations.

Normal Standards

It is based on average performance across periods and is inclusive of both favorable and unfavorable variances. To give a fair picture of expected performance under average conditions. It will set realistic expectations and help in long-term budget and planning activity.

Expected Standards

Standards set based on expected future conditions, accounting for anticipated changes and improvements in the production process. To incorporate future expectations into current planning and control processes. It is useful for strategic planning and forecasting. They take into consideration the likely future developments.Understanding these types of standard costing helps businesses select the most suitable method for control

Advantages of Standard Costing

Standard costing is used as a budgetary control technique which has setting predetermined costs for products or services, that serves as a benchmark for calculating actual performance.Overall, standard costing improves cost efficiency and performance management. Here are five key advantages of standard costing:

Improved Cost Control

The standard cost system here lays out a definition of production costs. Valleys created thus make obvious differences from the standard costs, making corrections easy to establish. Management would then be able to impose proper control over costs, aside from implementing measures for cost reduction. Standard costs, then, are those predetermined costs set on the basis of efficient operations, along with data from the past. Actual costs can be compared with the standards so that deviations are identified for corrective action.

Simplified Performance Measurement

By checking actual costs against standard costs, firms can gauge the efficiency and effectiveness of their operations. It helps in straightforward performance evaluation and drives accountability among managers and staff. Standard costing has set predetermined costs (standard costs) for production activities. These standards help in identifying as benchmarks to compare against actual performance, helping in straightforward and clear assessment of efficiency and effectiveness.

Efficient Budgeting and Planning

Standard costs is considered as a reliable basis for financial forecasting and budgeting, ensuring more accurate and realistic financial planning. It helps in the precision of budgeting processes and helps in overlapping of financial plans with firm’s goals. Standard costing gives a systematic and consistent approach to setting the expected costs of products or services. These set costs serve as a foundation for preparing budgets and financial plans.

Enhanced Decision Making

Standard costing in management accounting gives managers the tools needed for pricing and production strategies. Consistent cost standards provide valuable insights into cost behavior and profitability, aiding better business decisions related to pricing strategies, production, and resource allocation. It supports informed decision-making process by offering a clear understanding of cost dynamics and potential financial impact. Standard costing provides a reliable and consistent framework for comparing actual costs against predetermined standards. This comparison yields valuable data that can inform various aspects of business strategy and operations.

Focus on Efficiency Improvement

Variance analysis highlights areas where actual performance deviates from standards, prompting investigations into inefficiencies and process improvements. It drives continuous process improvements and operational efficiency by identifying and addressing underlying issues. It encourages Kaizen Costing initiatives and operational efficiencies by identifying and addressing inefficiencies. Thus, the role of standard costing in management accounting cannot be overstated—it drives insight-based planning

Limitation of Standard Costing

Despite fulfilling major objectives of standard costing, it does come with certain limitations.Here are five detailed limitations of standard costing, presented in a paragraph form with bullet points for clarity:

Rigidity in a Dynamic Environment

Standard costing has difficulty withstanding the rapid changes in business environment. Market conditions, technology, and consumer preferences may change in a short time resulting in the foregone standards becoming obsolete. Inflexibility leads to benchmarks that are inaccurate, causing poor decision-making since the data does not reflect the present scenario.

Resource Intensive Setting and Maintenance

Setting and updating standard costs can drain resources. It requires intensive analysis and frequent reviews in order to be accurate. This ongoing evaluation and readjustment often monopolizes otherwise valuable resource spending and can be quite costly to keep a part of the organization busy on something other than critical business activities.

May Discourage Innovation

Because standard costing focuses heavily on adherence to predetermined costs, it may stifle creativity and innovation. Employees may feel pressured to meet standards rather than seek out more efficient or innovative methods, potentially hindering improvements and the adoption of new technologies or processes.

Variance Analysis Complexity

One essential element of standard costing is variance analysis, which helps firms control budget deviations. While variance analysis is a key aspect of standard costing, the process can be complex and sometimes misleading. Not all variances are indicative of inefficiencies; some may arise from valid operational changes or strategic decision making. Misinterpreting these variances can lead to inappropriate corrective actions, which may harm the business.

Potential Negative Impact on Employee Morale

When standards are unrealistically high or believed to be unattainable, they can have negative impacts on employees' morale. Workers fall short of these standards, which demotivates them and eventually leads to lowered productivity and possibly higher turnover rates. Therefore, management needs to find a balance between setting challenging standards and making them achievable if they want a motivated workforce.

Standard Costing vs Budgetary Control

Standard Costing and Budgetary Control are essential tools in cost accounting and financial planning. While both aim to manage costs, they differ in focus, scope, and how often they're updated to reflect operational realities.

Category	Standard Costing	Budgetary Control
Focus	Cost per unit	Total cost
Timeframe	Short-term	Can be long-term
Variance Analysis	Yes	Sometimes
Adjustment Mechanism	Regular updates	Annual/biennial review

Conclusion

Standard costing is a widely used management accounting tool. It allows firms to set predetermined product or service costs. Standard cost is the cost a firm estimates for producing goods or services. It aids management in planning future production. Also, increasing efficiency and assessing actual costs. Nevertheless, choosing the standard cost of production is a challenging task. It demands technical expertise and effort from the responsible person.Implementing standard costing can drastically improve a firm’s cost structure and financial transparency. Thus, the objectives of standard costing directly impact strategic financial management

Standard costing is a critical topic as per several competitive exams. It would help if you learned other similar topics with the Testbook App.

Major Takeaways for UGC NET Aspirants:- What is Standard Costing? Standard costing is a cost accounting system where predetermined costs are used to compare with actual expenses to evaluate a firm's financial efficiency. Advantages of Standard Costing: Standard costing improves cost control, makes performance evaluation easier, aids in budgeting, supports better decision-making, and promotes operational efficiency. Objectives of Standard Costing: The primary objectives of standard costing include effective budgeting, performance measurement, cost regulation, strategic pricing, and motivating employee productivity. Limitations of Standard Costing:  Standard costing has limitations such as inflexibility in changing environments, high setup and maintenance costs, reduced innovation, complexity in variance analysis, and possible negative effects on staff morale. Types of Standard Costing:  The main types of standard costing include ideal, attainable, current, basic, normal, and expected standards, each serving a different planning or control purpose.

Standard Costing Previous Year Questions

1. Kruger Corporation has recently implemented a standard cost obtained the following information for variance analysis:

(a) Standard cost information:

Direct materials = Rs. 5 per kg.

Quantity allowed per unit = 100 kg per unit

Direct labour rate = Rs. 20 per hour

Hours allowed per unit = 2 hours per unit

Fixed overhead budget = Rs. 12,000 per month

Normal level of production = 1200 units

Fixed overhead application rate = Rs. 10 per unit

Variable overhead applicable rate = Rs. 2 per unit

Total overhead applicable rate = Rs. 12 per unit

(b) Actual cost information:

Cost of material purchased and consumed = Rs. 4,68,000

Quantity of material purchased and consumed = Rs. 1,04,000 kg

Cost of direct labour = Rs. 46,480

Hours of direct labour = 2240 Hrs.

Cost of variable overhead = Rs. 2,352

Cost of fixed overhead = Rs. 12,850

Volume of production = 1000 units

Question:

What is the overhead volume variance?

• Rs. 4,600 favourable
• Rs. 2,200 unfavourable
• Rs. 4,000 unfavourable
• Rs. 2,000 unfavorable