STANDARD COSTING

In business, standards serve as a measure of acceptable performances established by

management as a guide in making economic decisions. Standard-cost systems are used to help
managers control the cost of operations. The system has three components namely: standard costs,
actual costs, and the difference between the two figures (termed as variance).

Standard costs are carefully predetermined costs established by management in producing

a unit of product. They are developed for each input factor of production (materials, direct labor and
overhead). Standard costs are composed of the standard quantity of each input factor that should
be used to make a unit of product (for example, 2 yards of cloth and 90 minutes to make one t-shirt)
and the standard price or rate which is the amount that the company should pay for one unit of input
factor. For example, P21 per yard of cloth, P35 per hour of direct labor, P7.50 factory overhead per
direct labor hour.

After the actual operation, a report is generated showing the actual costs incurred, the costs
that should have been incurred for the actual level of activity (planned costs or standard costs), and
the related variances. The management usually establishes a control limit (tolerance level) to serve
as a guide in determining which variances are tolerable and which are not. The manager then
examines the variance column to ascertain which variances require attention. Following up on
significant variances only is called management by exception. It is used so managers can focus their
efforts and used their limited time where they are most needed.
Purposes and Benefits of Standard Costs

Standard costs are used for reporting, monitoring and controlling business
activities. When such are established carefully and used
widely the following benefits may be derived from standard costing:
1. Cost Control
2. Pricing Decisions
3. Motivation and Performance Appraisal
4. Cost Awareness and Reduction
5. Preparation of Budgets
6. Management by Exception

Setting Standards

As mentioned previously, standard costs include two factors, price and quantity.
Setting price and quantity standards ideally combine the
expertise of everyone who has responsibilityfor purchasing and using inputs.
This will include the accounting, purchasing, engineering and production
departments.

Standards should be designed to encourage efficient future operations, so even though

past records of purchase prices and input usage may be helpful in setting standards, other
variables that may affect future operations, such as expected changes in
technology, the production process, inflation, and other similar factors, should be included.
Managers also use task analysis to focus on how much a product should cost
(like time and motion studies). Standards tend to fall into two categories, either ideal
standards or practical standards.

Ideal (Theoretical or Perfection) Standards