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.