This lesson introduces standard costing as a system for cost control and performance evaluation. It defines what a standard cost is, explains the purpose of standard costing, and outlines the process of setting standards for various cost elements.

• Definition and Purpose: A standard cost is a predetermined, planned cost for a product or service, based on the expected level of efficiency and price levels. Standard costing is a system that sets these predetermined costs and then compares them with actual costs to measure performance. Its primary purpose is to provide a basis for cost control, performance evaluation, and variance analysis. It also simplifies inventory valuation .

• Types of Standards: Different types of standards can be set to serve different purposes:

  • Ideal Standards: These are set on the assumption of perfect operating conditions (e.g., no idle time, maximum efficiency). They are often used to motivate employees but may be demotivating if they are unattainable.

  • Attainable Standards: These are set to represent realistic, efficient levels of performance that are challenging but achievable. They are most commonly used for budgeting and performance evaluation.

• Setting Standards: Standards are set for each element of cost:

  • Material Standards: Includes the Standard Price (expected cost of materials) and the Standard Quantity (expected usage of materials for one unit).

  • Labour Standards: Includes the Standard Rate (expected hourly wage rate) and the Standard Hours (expected time to produce one unit).

  • Overhead Standards: Includes a Standard Overhead Rate, often based on a predetermined level of activity (e.g., per direct labour hour or machine hour) for both variable and fixed overheads.

• Management by Exception: The standard costing system is designed to support “management by exception,” where management focuses its attention on significant variances (deviations from the standard). Small variances are deemed acceptable, but large variances are investigated to identify root causes and take corrective action .