Standard costs are the scientifically pre-determined costs of manufacturing a single unit or a number of units of product or of rendering a service during a specified future period. The Chartered Institute of Management Accountants, London, defines standard cost as “a standard expressed in money. It is built up from an assessment of the value of cost elements. Its main uses are providing bases for performance measurement, control by exception reporting, valuing stock and establishing selling prices.”
What is evident from the above definition is that standard costs are planned costs of a product under current or anticipated operating conditions. The dictionary meaning of the word ‘standard’ is that it is a “thing serving as a basis for comparison”, “thing recognized as model for imitation”. But it should be noted ‘standard’ is a relative term. Admittedly, what is standard for one may be substandard for another and vice versa. However, what is significant is that within an organization, it serves as a desirable target.
The term ‘standard cost’ consists of two parts, viz., ‘standard’ and ‘cost’. ‘Standards’ can be established in respect of quantities and qualities like materials and labour. Cost involves the expression of the standard so established in values.
CIMA defines standard costing as “a control technique which compares standard costs and revenues with actual results to obtain variances which are used to stimulate improved performance”. The technique of standard costing may be summarized as follows:
- Pre-determination of technical data related to production, i.e. details of materials and labour operations required for each product, the quantum of losses, level of activity, etc.
- Pre-determination of standard costs, in full details for each element of cost viz. material, labour and overhead.
- Comparison of the actual performances and costs with the standards and working out the variances i.e., the difference between the actuals and the standards.
- Analysis of the variances in order to determine the reasons for deviations of actuals from the standards, and
- Presentation of information to the appropriate level of management for suitable action.