Friday, August 15, 2014

Management Accounting - Introduction of Standard Costing

Essentials or Preliminaries before Setting Standard:
While setting standard cost for operations, process or product, the following Preliminaries must be gone through:
a.      There must be Standard Committee, similar to Budget Committee, in which Purchase Manager, Personnel Manger, and Production Manager are represented. The Cost Accountant coordinates the functions of the Standard Committee.

b.      Study the existing costing system, cost records and forms in use. If necessary, review the existing system.

c.       A technical survey of the existing methods of production should be undertaken so that accurate and reliable standards can be established.

d.      Determine the type of standard to be used.

e.       Fix standard for each element of cost.

f.        Determine standard costs for each product.

g.      Fix the responsibility for setting standards.

h.      Classify the accounts properly so that variances may be accounted for in the manner desired.

i.        Comparison of actual costs with pre-determined standards to ascertain the deviations.

j.        Action to be taken by management to ensure that adverse variances are not repeated.

Introduction of Standard Costing System in an Establishment
Introducing standard costing in any establishment requires the fulfillment of following preliminaries:
a.      Establishment of cost centers;
b.      Classification and codification of accounts;
c.       Determining the types of standards and their basis;
d.      Determining the expected level of activity;
e.       Setting standards

a)      Establishment of cost centers: A cost centre is a location, person or item of equipment for which costs may be ascertained and used for the purpose of cost control. The cost centers divide an entire organisation into convenient parts for costing purpose. The nature of production and operations, the organisational structure, etc. influence the process of establishing cost centres. No hard and fast rule can be laid down in this regard. Establishment of the cost centres is essential for pin pointing responsibility for variances.

b)      Classification and codification of accounts: The need for quick collection and analysis of cost information necessitates classification and codification. Accounts are to be classified according to different items of expenses under suitable headings. Each of the headings is to be given a separate code number. The codes and symbols used in the process facilitate introduction of computerization.

c)       Determining the types of standards and their basis: Standards can be classified into two broad categories on the basis of the length of use:
i.       Current standards: These are standards which are related to current conditions, particularly of the budget period. They are for short-term use and are more suitable for control purpose. They are also more amenable for combining with budgeting.
ii.      Basic standards: These are long-term standards; some of them intended to be in use for even decades. They are helpful for planning long-term operations and growth.

Basic standards: There can be significant difference in the standards set depending on the base used for them. The following are the different bases for setting standard, whether they are current standards for short-term or basic standards for long-term use.
Ø  Ideal standards: These standards reflect the best performance in every aspect. They are like 100 marks in a paper for students taking up examinations. What is possible under ideal circumstances in all aspects is reflected in these standards. They are impractical and unattainable in practice. There utility for control purpose is negligible.

Ø  Past performance based standards: The actual performance attained in the past may be taken as basis and the same may be retained as standard. Such standards do not provide any incentive or challenge to the employees. They are too easy to attain. Their value from cost control point of view is minimal.

Ø  Normal standard: It is defined as “the average standard which, it is anticipated can be attained over a future period of time, preferably long enough to cover one trade cycle”. They are average standard reflecting the average performance over a complete trade cycle which may take three to five years. For a specific period, say a budget period, their relevance is negligible.

Ø  Attainable high performance standards: They are based on what can be achieved with reasonable hard work and efforts. They are based on the current conditions and capability of the workers. These standards are considered to be of great practical value because they provide sufficient incentive and challenge to the workers to attain them. Any variances from such standard are really significant because the standard which is attainable with effort is not attained.

d)      Determining the expected level of activity: Capacity of operation or level of activity expected over a future period is vital in fixing current or short-term standards. When the activity level is decided on the basis of sales or production, whichever is the limiting factor; all standard can be developed with the activity level as the focal point. The purchase of material, usage of material, labour hours to be worked, etc. are solely governed by the planned level of activity.

e)      Setting standards: Standards may be either too strict or too liberal because they may be based on theoretical maximum efficiency attainable good performance or average past performance. Setting standards may also be called developing standards or establishment of standard cost because as a consequence of setting standards for various aspects, standard cost can be computed.

Material quantity standards: The following procedure is usually followed for setting material quantity standards.
(a)   Standardization of products: Detailed specifications, blueprints, norms for normal wastage etc., of products along with their designs are settled.
(b)   Product classification: Detailed classified list of products to be manufactured are prepared.
(c)    Standardization of material: Specifications, quality, etc., of materials to be used in the standard products are settled.
(d)   Preparation of bill of materials: A bill of material for each product or part showing description and quantity of each material to be used is prepared.
(e)    Test runs: Sample or test runs under regulated conditions may be useful in setting quantity standards in a precise manner.

Labour quantity standards: The following are the steps involved in setting labour quantity standards:
(a)   Standardization of products: Detailed specifications, blueprints, norms for normal wastage etc., of products along with their designs are settled.
(b)   Product classification: Detailed classified list of products to be manufactured are prepared.
(c)    Standardization of methods: Selection of proper machines to use proper sequence and method of operations.
(d)   Manufacturing layout: A plan of operation for each product listing the operations to be performed is prepared.
(e)    Time and motion study is conducted for selecting the best way of completing the job.

(f)     The operator is given training to perform the job or operations in the best possible manner.