Meaning of Standard Cost Accounting
Standard Cost Accounting is a technique of Cost Accounting in which the actual costs incurred are compared with predetermined or standard costs. The comparison is made with the help of Variance Analysis, which identifies the difference between the actual cost and the standard cost. The main objective of this method is to measure cost performance, identify deviations from planned costs, and help management take corrective action.
In simple words, Standard Cost Accounting establishes a standard cost before production begins and then compares it with the actual cost incurred during production.
Exam Point: Standard Cost Accounting compares Actual Cost with Standard Cost using Variance Analysis.
Standard Cost
A Standard Cost is a pre-determined or estimated cost fixed in advance for producing a product or providing a service under normal operating conditions. It acts as a benchmark against which actual performance is measured.
Standard costs are prepared before production starts and help management in planning, budgeting, cost control, and performance evaluation.
Objectives of Standard Cost Accounting
The main objective of Standard Cost Accounting is to identify whether actual costs are higher or lower than planned costs. By comparing actual and standard costs, management can analyse the reasons for differences and take suitable corrective measures.
This technique also helps in controlling manufacturing costs, improving operational efficiency, evaluating employee performance, and supporting managerial decision-making.
Working of Standard Cost Accounting
Under Standard Cost Accounting, fixed costs incurred during an accounting period are allocated to the goods produced during that period. As a result, the full cost of production, including both fixed and variable costs, is assigned to each unit produced.
If some products remain unsold at the end of the accounting period, their full production cost is recorded as Inventory in the Balance Sheet. These inventory costs are then carried forward to the next accounting period. According to the provided content, this treatment is consistent with the principles of Generally Accepted Accounting Principles (GAAP).
The use of standard costs also enables managers to focus mainly on the standard cost of production, while fixed costs are allocated systematically across all units produced.
Example of Standard Costing
Suppose a railway coach manufacturing company normally produces 40 railway coaches in a month. The fixed cost is $1,000 per month, while the variable cost is $300 per coach.
The fixed cost allocated to each coach will be:
Fixed Cost per Coach = $1,000 ÷ 40 = $25
Therefore,
Total Standard Cost per Coach = Variable Cost + Fixed Cost
= $300 + $25 = $325 per coach
Thus, under normal production conditions, the standard cost of each railway coach becomes $325.
Effect of Change in Production Volume
The allocation of fixed cost per unit changes when production volume changes.
If the company produces 100 coaches in one month, the fixed cost per coach becomes:
$1,000 ÷ 100 = $10
Therefore,
Total Cost per Coach = $300 + $10 = $310
If production falls to 50 coaches, the fixed cost per coach becomes:
$1,000 ÷ 50 = $20
Therefore,
Total Cost per Coach = $300 + $20 = $320
This shows that as production increases, the fixed cost per unit decreases, and as production decreases, the fixed cost per unit increases.
According to the provided content, this variation is relatively small in mass-production industries that manufacture a single product and have comparatively low fixed costs.
| Number of Coaches Produced | Fixed Cost per Coach | Total Cost per Coach |
|---|---|---|
| 40 | $25 | $325 |
| 50 | $20 | $320 |
| 100 | $10 | $310 |
Exam Point: Increasing production reduces fixed cost per unit, while decreasing production increases fixed cost per unit.
Variance Analysis
Variance Analysis is an important part of Standard Cost Accounting. It is the process of analysing the difference between Actual Cost and Standard Cost.
The purpose of Variance Analysis is to identify the reasons why actual costs differ from planned or standard costs so that management can take corrective action.
According to the provided content, the difference between actual cost and standard cost may be analysed into several components, such as:
- Material Cost Variance
- Labour Cost Variance
- Volume Variance
By analysing these variances separately, management can determine the exact reason for cost differences and improve future performance.
Exam Point: Variance Analysis helps management identify the causes of differences between Actual Cost and Standard Cost.
Advantages of Standard Cost Accounting
Standard Cost Accounting helps management control costs by comparing actual performance with predetermined standards. It provides useful information for planning, budgeting, performance evaluation, and cost control. It also helps in identifying inefficiencies and enables timely corrective action. According to the provided content, it allows managers to focus on the standard cost of products while fixed costs are allocated systematically among the units produced.
Limitations of Standard Cost Accounting
According to the provided content, Standard Costing may slightly distort the unit cost because fixed costs per unit change with the level of production. However, in mass-production industries producing a single product with relatively low fixed costs, this distortion is generally very small.
Key Points
Standard Cost Accounting is a Cost Accounting technique that compares Actual Cost with Standard Cost. A Standard Cost is a predetermined cost fixed before production begins. The comparison between actual and standard costs is made through Variance Analysis. Under this method, fixed costs are allocated to all units produced during an accounting period, and the full production cost of unsold goods is recorded as Inventory in the Balance Sheet in accordance with GAAP. As production volume increases, the fixed cost per unit decreases, while a decrease in production increases the fixed cost per unit. Important variances mentioned in the provided content include Material Cost Variance, Labour Cost Variance, and Volume Variance.
Quick Revision Summary
Standard Cost Accounting compares Actual Cost with Standard Cost using Variance Analysis. A standard cost is determined before production and serves as a benchmark for performance evaluation. Fixed costs are allocated to the units produced, and unsold goods are recorded as Inventory in the Balance Sheet. Variance Analysis identifies differences such as Material Cost Variance, Labour Cost Variance, and Volume Variance, enabling management to understand cost deviations and take corrective action.