Standard Costing - Introduction and Need

# Standard Costing — Introduction and Need

## What is Standard Costing?

Standard costs are predetermined unit costs established in advance and used as benchmarks in management accounting.

They represent the planned cost of producing one unit of product or service, determined through:

• Engineering studies and time-motion analysis
• Historical data and trends
• Market analysis for input prices
• Management's operational plans

## Uses of Standard Costs

## Why Standard Costing is Preferred (Reasons)

### (a) Prediction of Future Costs

• Standard costs are carefully calculated considering both current conditions and future possibilities
• Used to estimate expenses for proposed projects, orders, and activities
• Helps evaluate profitability of planned endeavours before committing resources

### (b) Providing Targets to Achieve

• Standard costs act as targets for responsibility centres
• Continuous performance monitoring against standards enables early detection of deviations
• Deviations trigger investigation and corrective action — management by exception

### (c) Budgeting and Performance Evaluation

• Standard costs are the foundation of the budgeting process
• Managerial performance is evaluated against budgets built on standard costs
• Encourages cost discipline for both quality and quantity of output
• Variances can be traced to responsible departments for corrective measures

### (d) Interim Profit Measurement and Inventory Valuation

• Actual profits are only confirmed at year-end after all accounts close
• Standard costs allow interim profit estimation throughout the year:

> Revenue − Standard Cost of Sales = Estimated Interim Profit

• Also used for inventory valuation between accounting periods

## Standard Costing vs. Budgeting