9 important Standards for Controlling the Cost (Management)

9 important Standards for Cost Control in management

Common cost standards are classified as follows:-

1. Historical cost:

Past or historical cost becomes a basis for comparison and evaluation of future expectancies. The total cost per unit of output is usually split into elementary parts like direct materials cost direct labour cost, factory burden and office burden so as to facilitate comparison between items of historical cost and actual cost.

Advantages

(1) For using as a standard, historical cost can be ascertained easily and economically from past accounting records.

(2) The comparative efficiency of the business over a number of years is clearly indicated by it.

(3) The standard is also easy and simple for understanding on the part of all subordinates and they can be induced to use the standard as a guide to their action.

(4) Small companies use historical cost widely as their standard and even large companies have to depend upon historical cost for those areas in which no other cost standards are available.

Limitations:

But historical cost suffers from a number of limitations. First, past working conditions and facilitates that produced a certain result might not present on subsequent years. Accordingly past cost may fail to serve as a measure of performance in the years to come. Secondly, past cost might not represent a satisfactory cost that should be strived for.

When historical cost is too high, it results in giving a premium on inefficiencies. Thirdly, cost data relating to overhead expenses are not available promptly. As accounting results are prepared and presented several months behind the time of operations, cost figures of last month or last year may not be obtained in time. Fourthly, historical cost fails to provide standards for all aspects of the business.

As it depends on accounting records for obtaining cost data, cost control becomes synonymous with financial control and operational aspects are left out of control.

Finally, historical cost can never prescribe what the cost should be under planned conditions of work. Routine performance of the past is allowed to repeat itself without improvement.

2. Estimated Cost:

Estimated cost of future operations is used by many companies as standards against which actual costs are compared and appraised. Estimated costs are established from the result of past experience, the impact of present conditions and the interpretation of future trends and situations.

For serving as control standards, estimated costs, are the outcome of study, analysis and judgment on the part of managers. The value of estimated costs becomes as good as it is ascertained by an analyst. When prepared by an expert estimator, this cost is made to represent a realistic picture of the situation and becomes an accurate standard for control.

Advantages:

Under certain circumstances, estimated costs provide the best available cost standard.

(1) In a business with rapidly changing situation as well as in enterprises having non-repetitive character activities, estimated costs supply the sensible a practical standard for control purpose.

(2) Intangible operations like research, morale development, public relations and so forth are not subject to control by any other standards except estimated costs.

(3) Estimated costs are superior to historical costs as control standards. As estimated cost peers into the future and incorporates the results for forecasts it provides a sound basis for evaluating actual costs.

Limitations:

Like historical cost estimated cost also fail to prescribe what the cost should be under scientifically determined conditions. Secondly, determination of accurate estimated cost is a difficult task and depends upon the knowledge and experience of the analyst.

3. Standard Cost:

It is standard cost which alone determines what the cost should be under satisfactory conditions of work and efficient operations of plant: Standard cost considers the available physical facilities, ‘working conditions and plant capacity so as to arrive at an idea about the expected cost of products or services.

It seeks to make all possible cost reductions through the application of improved methods and procedures. For the establishment of improved methods and procedures standard cost takes the help of time study, motion study and work study. Standard cost is thus the result of detailed study and analysis and is very helpful for control purposes.

Standard costs however need not be idealistic in character. They should be tailor made to meet the needs and situations of a company. Standard costs should represent cost which can be obtained at a reasonable and attainable level of efficiency.

Advantages:

Standard costs offer many advantages as a standard for control and serve as a guide to many operations.

(1) As standard costs are developed from the study of past operations and existing conditions they become a pointer to the weaker aspects of operation.

(2) Standard costs are prepared from set-up physical standards in respect of materials, labour and overhead burden. Thus standard costs provide both physical standards in quantitative terms and cost standards in financial terms.

(3) Because of comprehensive character standards cost control exercises a permeating influence on all aspects operations. Measurement and evaluation of current performance as well as of current expenses become much more effective in character.

(4) Since the standard cost provides the desirable cost to be achieved under satisfactory conditions and since most actual costs are higher than the standard cost, the performance can be measured quantitatively by expressing gap as a percentage of the standard cost.

(5) As the standard cost is determined from work study as well as time and motion study, it provides the basis for work simplification, piece-rate wage fixation and methods standardisation.

(6) Standard costs give aid to budgetary control particularly for introducing flexibility there in.

Limitations:

(1) Standard costs are expensive to set up and difficult to operate in many cases.

(2) Standard costs may require frequent revisions of cost standards and physical standards along with changes in operating conditions. Accordingly, standard costs are confined to those enterprises which operate under more or less stable conditions and which carry standardised mass production for a ,vide market.

(3) Standard costs may provide an illusory definiteness to the cost standard. Translation of physical standards into financial terms is likely to become arbitrary and doubtful in many cases.

(4) Standard costs have the danger of being outdates very quickly, and to guard against this danger, there arises necessity of continuous study and analysis of cost factors.

4. Marginal Costing:

A marginal costing is the amount of change in aggregate cost resulting from an increase or decrease in the volume of output by one unit of production. It is a form of differential cost determined to reveal the incidence on profit of changes in production output.

It is a special technique which helps the management to study the effect of changes in volume of output on profit. It necessitates total costs to be analysed into (a) fixed costs and (b) marginal or variable costs.

The fixed costs which accrue with the passage of time are incurred during the period irrespective of the volume of output and are charged directly to Profit and Loss Account. Only the variable costs are regarded as the cost of products being manufactured under marginal costing.

5. Direct Costing:

Direct costing in that costing in which there is a practice of charging all direct costs to operations, processes or products: leaving all the indirect costs to be written off against profits in the period in which they arise. The direct costs are the variable costs. This technique is similar to ‘Marginal costing’ except that some fixed costs could be considered to be direct costs in appropriate circumstances.

6. Absorption Costing:

Absorption costing is that cost in which there is the practice of charging all costs, both variable and fixed, to operations, processes or products. This is the traditional technique as opposed to Marginal or Direct Costing techniques. Here both the fixed and variable costs are charged in the same manner.

7. Uniform Costing:

Uniform costing is that cost in which several similar undertakings join together to adopt a common approach to costing problems. They adopt the same method of costing and the same set of books in order to compare the performance of one with the other and thus to drive the benefit of one’s performances by the other.

8. Continuous Costing:

Continuous costing is that costing in which tnei costs are ascertained by recording and allocating the costs as and when they are incurred during the continuance of production. In this type of costing the overheads are based on estimates and are changed at predetermined rates. This method is very useful for cost ascertainment and cost-control.

9. Post Costing:

Post costing is that in which costs are analysed after the costs are incurred and production is completed so as to show the cost of the units which have been produced. It is just like a post audit or Balance Sheet audit and as limited use only.

This is mostly used in cost plus contracts where the contract price depends on actual cost of the contract plus the agreed margin of profit on actual cost. Further it is also useful where the Government makes an enquiry into the costs for purposes of giving assistance to any factory or industry.