Standard costs are predetermined cost which may be used as a yardstick to measure the efficiency with which actual costs has been incurred under given circumstance. To illustrate, the amount of raw material required to produce a unit of product can be determined and the cost of that raw material estimated. This becomes the standard material input. If actual raw material usage or costs differ from the standards, the difference which is called ‘variance’ is reported to manager concerned. When size of the variance is significant, a detailed investigation will be made to determine the causes of variance.
According to the chartered Institute of Management Accountants (C.I.M.A) London, “Standard cost is the predetermined cost based on technical estimates for materials, labour and overhead for a selected period of time for a prescribed set of working conditions.”
The Institute of Cost and Works Accountants defines standard costs as “Standard costs are prepared and used to clarify the final results of a business, particularly by measurement of variations of actual costs from standard costs and the analysis of the causes of variations for the purpose of maintaining efficiency of executive action.”
Thus standard costs is a predetermined which determines what each product or service ‘should be’ under given circumstances. From the above definitions we may note that standard costs are:
i) Pre-determined cost: Standard cost is always determined in advance and ahead of actual point of time of incurring of costs.
ii) Based on technical estimated: Standard cost is determined only on the basis of a technical estimate and on a rational basis.
iii) For the purpose of Comparison: The very purpose of standard cost is to aid the comparison with actual costs.
iv) Based for price fixing: The prices are fixed in advance and hence the only variation basis is the standard cost.
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