Purpose and Stages of Standard Costing

Purpose of Standard Costing

Standard Costing is a tool that assists in controlling and planning operations within an organisation.
It provides a benchmark or ‘standard’ against which actual performance can be compared and analysed.
It is useful for setting budgets and understanding the full picture of a business’s costs. This enables effective financial planning and forecasting.
By identifying deviations between projected and actual costs, standard costing facilitates cost control and reduction. It assists in streamlining processes and implementing cost savings measures.
Standard costing helps in identifying inefficiencies in production processes. By bringing attention to areas that exceed set standards, corrective actions can be undertaken.
It simplifies product cost calculations and inventory valuations improving the accuracy and reliability of financial statements.
Standard costing is used in determining the selling price of products. Pricing strategies can be effectively developed with the help of accurate cost information.

Setting Standards: This involves determining the ‘standard’ or expected cost for different aspects of business operations. It includes standard material cost, labour cost, and overhead cost. Standards set should be both achievable and realistic.
Recording standard costs: Standard costs are recorded for future comparison. These costs should be periodically reviewed and updated to ensure their relevance with current market conditions.
Comparing actual costs with standard costs: Actual costs incurred are systematically compared with standard costs. This comparison reveals the variances, which can either be favourable, if actual cost is less than standard cost or adverse/unfavourable if actual cost exceeds standard cost.
Analysing Variances: Variances are carefully analysed to determine the reasons behind them. This variance analysis sheds light on operational efficiency and effectiveness.
Taking Corrective Action: Based on variance analysis, corrective measures are implemented. If variances are due to inefficiencies, management may take steps to improve operations. Conversely, if variances are due to unrealistic standards, the standards may be revised.
Reviewing Standards: Standards set should be reviewed on a regular basis. Changing market conditions, technological advancements, operational modifications and many other factors can necessitate changes in standards. Regular review ensures that the standards are relevant and practical.