Pre-requisites for the success of standard costing

For establishing a system of standard costing, a number of requirements are to be fulfilled, which are;

1. Establishment of Cost Centres

2. Classification of Accounts

3. Types of Standards

4. Setting Standard Costs

Let’s have a discussion on each of them to have a good understanding of the process.

1. Establishment of Cost Centres:

A cost centre is a person, location or an equipment or ( a group of these ) In respect of which costs are to be ascertained. For example there may be 10 machines in a manufacturing concern, each machine can be classified as a cost centre. Each department or function  in a business enterprise forms a cost centre. Further, there can be a number of Cost centres in each department or function. A cost centre which relates to a person is called personal cost centre and a cost centre which relates to location or equipments is called impersonal cost centre. The purpose of setting cost centre is cost ascertainment and cost control. So while establishing a cost centre, the person who is responsible for that particular cost centre should be ascertained.

2. Classification of Accounts:

Accounts are classified on the basis of functions, revenue item, assets and liabilities items to meet a required purpose. To meet speedy collection and analysis of accounts, codes and symbols are used.

3. Types of Standards:

A standard is the level of performance which the management accepted by the management. On the basis of these levels , standard costs are determined. There are mainly four types of Standards:

a) Ideal Standard:

The standard which is set under ideal conditions e.g. maximum sales, best possible prices for materials, least possible rates for labour etc. But this standard is of little practical use as ideal conditions are difficult to attain and moreover  do not remain ideal for long. Hence though we can fix a target for employees but these targets are not possible to attain.

b) Expected Stardard:

The standard which is actually expected to be achieved, under current conditions, in  the budget period, is called expected stadard. An expected standard is more realistic than ideal stadard. These Stardards are set on expected performance after allowing a resonable allowance for unavoidable losses and deviations from perfect efficiency. Expected stadards are set for short term basis and are frequently revised.

c) Normal Standard:

Normal stadard represents an average figure which is based on average past performance of the business after considering seasonal and cyclic changes.

d) Basic Standard:

This is a standard fixed in relation to a base year using the principle of index numbers. Just like an index number against which we measure subsequent price changes, basic standard us fixed for a long term of period without any adjustment for the present conditions. Basic standard can be used as a tool for cost control but this cannot be a reliable standard for measuring efficiency.

4. Setting Standard Costs:

The success of the standard costing system in an enterprise depends upon the reliability and accuracy of Standards. Hence utmost care should be taken while setting standards. In an enterprise, Standard Costing committee is formed for this purpose Consisting of Produnction manager, Production engineer, Personnel manager, Sales manager, Cost accountant and other important departmental heads. Cost accountant is entrusted  with the  responsibility of supplying required cost figures as well as coordinating the activities of the budget committee. He must ensure that the standards set are accurate and realistic for the success of Standard costing system.



Standard Costing – An Introduction

One of the primary function of management accounting is to help in managerial control and cost control is perhaps the most crucial part of managerial control. The success of management of a business enterprise depends to a large extent on efficient cost control. Standard costing is one of the most important tool in the hands of management which helps it to plan and control costs of business operations. Under standard costing, the costs of different business operations are predetermined. These predetermined costs are called Standard costs. The actual costs are then measured and compared with the standards set for that particular business process. The difference between the standard costs and actual costs is known as variance. These variances are analysed and reasons are investigated so that management can take remedial steps to check them in time. Hence standard costing is an important tool for planning, decision making and controlling costs of business operations. Continue Reading

Need for the valuation of goodwill

The valuation of the Goodwill of a sole proprietorship is done when the business is being sold, but in case of a partnership firm and a joint stock company goodwill can be sold to some another business entity without selling the whole business. Hence when you are going to sell the goodwill of your business, you should be assured of the value of your goodwill at that particular time.

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Methods of valuation of Goodwill

There are three methods of valuation of goodwill of the firm;

1. Average Profits Method

2. Super Profits Method

3. Capitalisation Method


1. Average Profits Method:

Under this metod goodwill is calculated on the basis of the average of some agreed number of past years. The average is then multiplied by the agreed number of years. This is the simplest and the most commonly used method of the valuation of goodwill.

Goodwill = Average Profits X Number of years of Puchase

Before calculating the average profits the following adjustments should be made in the profits of the firm:

a. Any abnormal profits shoulld be deducted from the net profits of that year.

b. Any abnormal loss should be added back to the nat profits of that year.

c. Non operating incomes eg. income from investments etc should be deducted from the net profits of that year.

Now we will explain this method with the help of a simple example.

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Calculation of cash flows from operating activities

Particulars Amount
Net Profit as per Statement of Profit and Loss or Difference between the closing and opening balance of Statement of Profit and Loss. xxx
Add: Transfer to Reserves xxx
Deffered Tax Liabilities (Net) xxx
Proposed Dividend (Current Year) xxx
Interim Dividend paid during the Year xxx
Provision for Tax made during the year xxx
Extraordinary Items, if any, debited to Statement of Profit
and Loss xxx
Less: Deferred Tax Assets(Net) (xxx)
Tax Refund if any (xxx)
Extraordinary Items, if any, credited to Statement of Profit
Loss (xxx)

Net Profit before Taxation and Extraordinary Items xxx
Add: Depreciation xxx
Goodwill,patents etc written off xxx
Interest on Long term borrowings/debentures xxx
Discount on issue of shares/ Loss on issue of debentures
written off xxx
Loss on sale of fixed assets xxx
Less:Interest on investments earned (xxx)
Rental income (xxx)
Dividend income (xxx)
Profit on sale of fixed assets (xxx)

Operating Profit before Working Capital Changes xxx