In a standard costing system, standards are normally categorized as ideal standards and practical standards. The difference between these two types of standards is briefly explained below:
Ideal standards are standards that do not allow for normal wastage and work interruption due to breakdown of machinery, employees’ rest periods, shortage of raw materials or any other reason. The achievement of such standards requires highly skilled and motivated workers and the best possible use of production facilities. In short, we can say that the ideal standards can only be achieved under the best and perfect work circumstances.
The use of ideal standards is not common among companies because they are based on highly strict assumptions that do not allow even the normal inefficiencies.
Advantages of ideal standards
The advocates of ideal standards argue that even though a company will rarely attain these standards, they offer the following advantages:
- Ideal standards are highly challenging and require continuous struggle towards excellence which ultimately increase production, reduce per unit cost and increase profit.
- These standards may help in continuous improvement in work methods and techniques.
- These standards can be helpful in measuring the employees’ efficiency and maximum production capacity of the plant.
- The difficulty involved in obtaining ideal standards acts as a constant reminder of responsibility to workers and managers.
Disadvantages of ideal standards
Ideal standards has the following disadvantages:
- The ideal standards usually seem impossible to achieve and therefore may discourage even the most diligent and highly motivated workers.
- The occurrence of large variances from ideal standards is normal which reduces the effectiveness of “manage by exception”.
- Normally, the interpretation of variances from normal standards is very difficult.
- Ideal standards are normally considered unrealistic for inventory planning and forecasting.
Practical standards are standards that are challenging but achievable through the use of efficient and motivated workers under normal working conditions. They allow for work interruptions because of machine breakdowns, workers’ rest periods and other conditions that are considered normal in a particular work environment.
Most of the companies using standard costing system set practical standards rather than ideal standards.
Advantages of practical standards
Practical standards have the following advantages:
- While setting practical standards management does not assume the perfect, but normal working conditions. Therefore, the variances from practical standards reflect abnormal conditions that really need immediate attention towards remedial actions.
- Practical standards take into account all normal wastage and inefficiencies and can therefore be used for inventory planning and forecasting cash flows.
Disadvantages of practical standards
The only disadvantage of practical standards is that they seem easy to attain as compared to ideal standards and may therefore create a sluggish behavior among workers.