Standard costing and Variance Analysis

7. Procedure for Establishing a
Standard Costing System
• Establishment of Cost Centers
• Classification and Codification of Accounts
• Determination of Type of Standard : The standards
are classified mainly into four types
• Ideal standard: This is one, which is set up under
ideal conditions. The ideal conditions may be such
as maximum output and sales, best possible prices
for materials and most satisfactory rates for labour
and overhead costs

8. • Expected standard: This is the level, which is
actually expected. Standards are set normally on a
short-term basis and frequent revisions may be
necessary. This standard is more realistic than the
ideal standard.
• Normal Standard: This represents an average
figure, which it is hoped will smooth out
fluctuations caused by seasonal and cyclical
changes. This should be attainable and it provides a
challenge to the staff

9. • Basic Standard:This is the level fixed in relation to a
base year
• Organization for Standard Costing: The success of
the standard costing system depends upon the
reliability of standards. Hence, the responsibility for
setting standards should be entrusted to a specific
person or a committee.
• (a) Purchase Manager (b) Personnel Manager (c)
Production Manager (d) Time and Motion Study
Engineer (e) Cost Accountant
• . Setting of Standards: The standards are set mainly
for the elements of cost, viz., Direct Materials,
Direct Labour, and Overheads

10. • Direct Material:
• Quantity: Material specifications will be produced
showing the standard quantity of each type of
material required. Normal loss in process must also
be estimated before the standard cost can be
ascertained.
• Price: A standard price will be calculated for each
type of material.

11. • Direct Labour:
• Standard Time : Standard time, based on the best
way of performing the job will be computed for
each grade of labour for each operation involved.
• Rate: The standard rate for the job will be
determined.
• Variable Overhead: This is defined by the I.C.M.A as
‘a cost, which intends to vary directly with the
volume of output.’ It is assumed that the overhead
rate per unit is constant, irrespective of the
quantity produced, so it is necessary to calculate
only a standard cost per unit or per hour.

12. • Fixed Overhead:
• This is defined by I.C.M.A. as ‘a cost, which intends to be
unaffected by variations in volume of output.’ The
standards will be ascertained for the ‘budgeted
expenditure’ for the period and also for the ‘budgeted
output’ in units or standard hours will be used to
calculate the overhead recovery rate.
• The Standard Hour:
• In the system of standard costing, the introduction of
standard hours can be very valuable. The I.C.M.A.
defines a standard hour as “a hypothetical hour, which
represents the amount of work that should be
performed in one hour under standard conditions.”