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📚 Learn/ Paper 4 — Cost & Management Accounting/ Standard Costing & Variance Analysis
Microlesson · 5-min read

Setting Standards - Physical and Price/Rate Standards

# Setting Standards — Physical and Price/Rate Standards

## Part A: Physical Standards

Physical standards express inputs in units or hours — not monetary terms. Two types: Material Quantity and Labour Time.

### Setting Material Quantity Standards

StepAction
1. Standardise ProductsDecide what to produce, which type, and how much (based on production plan and orders)
2. Product StudyAnalyse how the product can be made; identify prerequisites and materials (engineering dept or consultants)
3. Specification ListList types and quantities of materials; identify substitutes; include expected wastage allowances; ensure flexibility
4. Test RunsConduct sample runs; test quality and quantity; record deviations; update specification list

### Setting Labour Time Standards

1. Standardise product (same as above)

2. Labour specification: Identify labour grades and time needed (based on past records + normal idle time allowance)

3. Standardise methods: Select proper machines and sequence of operations

4. Manufacturing layout: Prepare plan of operations for each product

5. Time and motion study: Determine best method for each job; set standard time for an average worker (includes learning effect)

6. Training and trial: Train workers; record time during trial runs to validate the standard

### Setting Overhead Standards

  • Variable overheads: Based on material quantity or labour hours (usually labour time worked)
  • Fixed overheads: Based on budgeted production volume

### Problems in Setting Physical Standards

ProblemRoot Cause
Inexperienced workersStandard time unreliable for new product lines
Technological changesNew machines → output uncertain until conditions stabilise
Product diversificationNew products require fresh standards from scratch
Material specification issuesSub-standard materials make set standards unachievable
Choosing standard typeIdeal vs. attainable vs. past average — a dilemma for cost accountants
Waste standardsUnavoidable waste vs. historical average waste levels — hard to determine

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## Part B: Price/Rate Standards

Price standards translate physical standards into monetary cost standards.

Price standards can be based on:

  • Actual average price expected to prevail during the coming year, OR
  • Normal price expected over a cycle of seasons (multiple years)

### Setting Material Price Standards

1. Use purchasing department's market knowledge to estimate prices

2. Consider existing stock and the prices at which it is currently held

3. Account for orders already placed for future delivery

4. Factor in Minimum Support Price (if applicable)

5. Handle anticipated price fluctuations:

Fluctuation TypeTreatment
Monthly variationsSimple average over the year, adjusted for known secular changes
Seasonal (bulk purchase)Weighted average of likely prices at purchase time
Seasonal (purchases spread over year)Weighted average of prices across the whole year
Year-to-yearCareful statistical estimate of price for the next year

### Setting Wage Rate Standards

FactorHow It Informs the Standard
Job AnalysisUnderstand skill complexity of each role
Time and Motion StudiesEstablish fair compensation for actual work content
Industry BenchmarkingEnsure rates are competitive
Collective Bargaining AgreementsLegally binding negotiated rates
Legal RequirementsComply with Minimum Wages Act and Factories Act constraints
Skill and ExperienceReward expertise and seniority
ProductivityLink pay to performance metrics
Cost of LivingRegional adjustments for high-cost locations
Internal EquityPay parity among employees with similar roles
Periodic ReviewsReview regularly to maintain relevance

Worked example

### Example 1

Material Price Standard with seasonal fluctuations: A company buys raw material. Expected prices: Jan–Mar ₹100/kg, Apr–Jun ₹110/kg, Jul–Sep ₹120/kg, Oct–Dec ₹90/kg. The company buys evenly throughout the year (spread purchases). Weighted average standard price = (100×3 + 110×3 + 120×3 + 90×3) ÷ 12 = (300+330+360+270) ÷ 12 = 1,260 ÷ 12 = ₹105/kg. If the company instead buys all at once in July, standard price = ₹120/kg (price at point of purchase).

### Example 2

Labour Time Standard via Time and Motion Study: An average worker assembles 10 units per hour under normal conditions → Standard time = 6 minutes per unit. Standard wage rate = ₹120/hour (established through job analysis + collective bargaining). Standard labour cost per unit = ₹120 × (6/60) = ₹12 per unit. During trial run, new worker takes 8 minutes — this deviation is noted but the standard remains 6 minutes (the average worker benchmark).

⚠️ Common exam mistakes

  • Setting material quantity standards without including normal wastage — the specification list must explicitly include an allowance for unavoidable wastage; using zero-wastage standards creates impossible targets.
  • Using a single annual price when prices vary seasonally — the correct averaging method depends on the purchase pattern (bulk vs. spread); one-size-fits-all leads to inaccurate standards.
  • Ignoring collective bargaining agreements when setting wage rate standards — these are legally binding and override management's preferred rates.
  • Basing labour time standards on the fastest worker rather than the average worker — standards must represent what a trained average worker achieves, otherwise most workers will show adverse efficiency variances.
  • Forgetting to update standards after test runs reveal consistent deviations — the specification list must be revised to reflect test run findings.
Bare-Act text Section 12 — Payment of Minimum Rate of Wages · Minimum Wages Act, 1948 · click to expand
Nothing shall be paid to a worker at a rate less than the minimum rate of wages fixed by the appropriate Government.
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