Introduction to Standard Costing

Cost control, leading to cost reduction, should always be the objective of any firm or institution where scarce resources are used. Even if the firm can sell its goods of services at a very remunerative price, it should still try to reduce the use of factors of production, without jeopardizing the quality of the product or the services. The best way of doing this is to constantly think as to whether the cost can be further reduced, but the first step is to try to see that these do not go beyond a level determined beforehand. If this approach is adopted, i.e., if an attempt is made to ascertain beforehand what costs should be and a further attempt is made to see that actual costs do not go beyond this level, the approach will be that of standard costing. In fact, it is the philosophy of standards which will bring the best results and not merely the mechanism of adopting the standard costing techniques. The philosophy of standards, in a nutshell, means scrupulously separating all types of wastages and losses and not allowing them to cloud the cost of production, at least for purposes of internal consumption. Suppose, a worker normally working 8 hours should produce 20 units for a wage of 20; the proper labour cost of production is 1 per unit. Suppose for any reason the worker produces only 12 units. Normally, the payment of 20 will be spread over 12 units and one would say that the labour cost per unit is 1.67. But if the philosophy of standards is practiced, one would say that the proper labour cost of 12 units will still remain 1 per unit of 12 in all; 8 units have not been produced and, therefore, at the rate or 1 per unit, there is loss of 8. This amount should be charged to a separate account. This account should be shown as a separate item in the revenue accounts of the firm so that management would know, at the end of each period, the extent of losses that have unnecessarily taken place. Of course, if extra efficiency has been obtained, the effect of that efficiency should be credited to a separate account and shown as a separate item in the revenue account.