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Determination of Standards Costing


The following preliminary steps are to be taken into account before setting standards for different elements of costs :

(i)                 Establishment of cost centre

(ii)               Classification and codification of accounts

(iii)             Types of standards or period of use

(iv)             Setting the standards


I. Establishment of Cost Centre

Setting of cost centres is the very first step required before setting of standards. According to The Chartered Institute of Management Accountants, London cost centre is defined as “a location, person or item of equipment (or group of these) for which cost may be ascertained and used for the purpose of cost control”. When the organisation establishes the cost centre, the standards are fixed and the variances are analysed. Cost centre is necessary because fixing of responsibility and defining the lines of authority becomes easier.


II. Classification and Codification of Accounts

In a business organisation various kinds of expenses are incurred. However, the actual expenses are classified under suitable heads for the purpose of establishment of codes and symbols. Coding is useful for speedy collection, analysis of cost information and mechanical devices.


III. Period of Use

After the classifying and coding of accounts, the next step for the establishment of standard cost is the length of the operating period for which standards are to be used. The different types of standards are normally taken into account while determining the standards.

(a)    Basic Standards. ICMA, London defines basic standard as “an underlying standard from which a current standard can be developed”. Basic standard is set up for some base year and is not changed as material prices and labour rate change.

(b)   Ideal Standard. Ideal standard is set up under ideal conditions. ICMA defines it as “the standard which can be attained under the most favourable condition possible”. It indicates the higher level efficiency of the manufacturing process in the organisation.

(c)    Current Standard. ICMA, London, defines it as “a standard which is established for use over a short period of time and is related to current conditions”. Current standard is a short term standard as it is modified at regular intervals.

(d)   Expected Standard. Expected standard is otherwise termed as practical standard. ICMA defines the expected standard as “the standard which is anticipated, can be attained during a future specified budget period”. Whenever the organisation is setting this type of standards, due weightage is given for all the expected conditions.

(e)    Activity Level. The quantum of output or the level of activity to be obtained in forthcoming period must be divided clearly before establishing any standards. In this regard the sales potential and production capacity decide the quantum of output to be manufactured within a specified future period. Any of the idle capacity, unutilised capacity, and other key factors should be considered before determining the attainable level of output.

(f)     Organisation for Standard Costing. For the purpose of achieving successful standard costing system, the organisation should appoint a separate committee. The committee consists of marketing manager, production manager, purchase manager, human resource manager, chief engineer and cost accountant. The committee may supply all information to different departments. They may revise the standards if necessary and finally approve the standards according to the current price level of the economy.


IV. Setting of Standards

After approval of the standards from the committee, the standard cost is determined for each and every element of cost such as direct material, direct labour and overheads. Cost accountant act as a coordinator of these activities and also he ensures that the setting of standards is accurate.