Standard costing methods classify standards based on their accuracy and intended application. These include ideal, basic, normal, current, and expected standards, each serving a specific role in cost control and performance evaluation.
(i) Ideal Standards
Ideal standards represent the level of performance achievable under the most favorable conditions. These conditions include optimal material and labor prices, maximum output with superior equipment and layout, and the highest efficiency in resource utilization, leading to minimal costs. In essence, ideal standards calculate the lowest possible cost of a product under perfect conditions.
Ideal standards are typically used to set ambitious performance goals and highlight areas for improvement. However, they face criticism on several grounds:
- Unattainability: Due to their unrealistic nature, employees may not take them seriously.
- Variance Misinterpretation: The variances derived from ideal standards do not indicate how much could have been reasonably avoided.
- Variance Disposal: There is no systematic method to allocate these variances effectively.
(ii) Basic or Bogey Standards
Basic standards remain unchanged over extended periods and serve as a reference point for comparisons across different time frames. Similar to statistical price indices, a base year is selected for comparison purposes. Since basic standards do not represent current attainable goals, businesses should establish current standards alongside them.
Basic standards are particularly suitable for businesses with a limited product range and long production runs. These standards are seldom revised, and variances are not typically calculated. Instead, actual costs are expressed as a percentage of basic costs, allowing comparison with current costs to assess deviations from the standard.
Application: Basic standards are useful for long-term performance evaluation and trend analysis.
(iii) Normal Standards
Normal standards represent the cost levels achievable under typical operating conditions. This method involves using predetermined standard costs for materials, labor, and overhead while recording actual costs separately. The differences between the two are analyzed to identify inefficiencies and areas for improvement.
Normal activity is defined as “the number of standard hours required to produce sufficient goods at normal efficiency to meet average sales demand over several years.”
Difference between Standard Costing and Normal Costing:
- Normal Costing: Applies actual direct costs and a standard overhead rate to a product.
- Standard Costing: Uses expected costs instead of actual costs.
Criticism of Normal Standards:
- Difficult to Set: Establishing normal standards requires a degree of forecasting, making them challenging to determine accurately.
- Large Variances: If actual performance significantly deviates from the standard, substantial variances may arise, necessitating revisions.
(iv) Current Standards
Application: Current standards are used for short-term cost control, performance evaluation, and variance analysis.
Current standards reflect management’s expectations of actual costs for a given period. These costs account for anticipated prices of goods and services, as well as planned resource usage to achieve production targets. Variances from these standards indicate the efficiency of production factors, fluctuations in material and service costs, and differences in production volume.
(v) Expected or Practical Standards
Expected or practical standards are based on projected operating performance, incorporating reasonable allowances for unavoidable losses. These standards are designed to be attainable and realistic, making them a practical benchmark for performance evaluation.
By understanding and applying these different types of standard costing, businesses can enhance cost control, optimize efficiency, and improve overall financial performance.
Related Posts:
