Setting standards

1. Importance of Setting Standards

• Standards are critical for effective control in budgeting.
• Too high standards → demotivation.
• Too liberal standards → no cost control; standards lose meaning.
• Ideal standards must be:
  • Reasonably accurate
  • Achievable with effort

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2. Material Standards

Sources:

• R&D Documents
• Engineering Drawings / Bill of Materials
• Inputs from Production or Purchase Departments

Standard Material Cost =

Standard Quantity × Standard Rate

• Standard Quantity: Includes a small buffer for minor variations.
• Standard Rate: Quoted by suppliers or market price collected by the Purchase Department.

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3. Labour Standards

• Determined using:
  • Time & Motion Studies
  • Consultants' inputs (from similar industries)
• Labour Rates: Provided by HR Department
• Required especially if labour content is high in the product.

⚠️ Note: In highly automated industries, labour cost is minimal or included under machine cost.

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4. Machine Hour Rate (When Labour is Automated)

• Includes:
  • Labour Cost (operator salary)
  • Fuel/Electricity
  • Repairs & Maintenance
  • Factory space depreciation

Example Calculation

Component	Cost/Hour (Rs.)
Depreciation (Rs. 250,000 / 10,000 hrs)	25
Power Consumption	200
Repairs & Maintenance (20% of cost/year, 1200 hrs/year)	42
Operator Salary (Rs. 20,000/month, 100 hrs)	200
Factory Space (600 sq. ft. × Rs. 20, ÷ 100 hrs)	120
Total	Rs. 587/hr

This becomes the Standard Machine Hour Rate.

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5. Overhead Standards

• Difficult without Activity-Based Costing (ABC)
• Departments must:
  • List resources required
  • Estimate variable vs fixed components
  • Past accounting data helps in refining this estimate

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6. Activity-Based Costing (ABC) Role

• When available, ABC output provides:
  • Activity list
  • Associated costs
• Acts as a built-in standard for budgeting.

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7. Examples

A. Material Standard – Herbal Toothpowder (FMCG)

Ingredient	Quantity (grams)
Bentonite Clay	200
Baking Soda	200
Salt	100
Neem Powder	100
Peppermint Powder	100
Amla Powder	80
Turmeric Powder	80
Fennel Seed Powder	50
Clove Powder	50
Spirulina Powder	20
Cardamom Powder	20

Total = 1 KG
Used as standard quantity list; purchase team collects market rates.

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B. Machine Hour Rate – Mixer/Blender

Component	Monthly Cost (Rs.)	Hourly Cost (Rs.)
Machine Depreciation	—	25
Power	—	200
Repairs & Maintenance	—	42
Operator Salary	20,000	200
Factory Depreciation	12,000 (600 sq. ft.)	120
Total per Hour	—	Rs. 587

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8. Revising Standards

• Standards should be updated if:
  • Input costs change (e.g., electricity, salary hikes)
  • Usage assumptions change

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9. Theoretical vs Practical Standards

• Theoretical Standard: Maximum efficiency without breaks
• Practical Standard: Achievable under normal working conditions

Example A: Machine Hours

• Machine Capacity = 240 hrs/month
• Actual Usage = 100 hrs/month (due to cleaning, setup, downtime)
• Practical hours (100) preferred for standard setting

Example B: Shirt Stitching

• Experienced Worker: 1 shirt/hour → 8 shirts/shift (theoretical)
• Realistic Output: 6 shirts/shift (with breaks)
• Practical Standard Hour = 1 hr 20 mins/shirt

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