Standard Costing System: Advantages and Disadvantages
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COST AND PERFORMANCE MANAGEMENT
TABLE OF CONTENTS
2.0 PURPOSES OF STANDARD COSTING
3.0 ADVANTAGES OF STANDARD COSTING
4.0 LIMITATION OF STANDARD COSTING
4.1 Limitations In Applicability
A standard cost is an estimated standard for each cost element of the projected unit costs, such as the standard resource usage and standard resource prices. Standard costing is principally used to value inventories and cost production and to act as a control. The uses of standard costing can to value cost production and inventories for cost accounting objective. In addition, uses of standard costing it can be used a control device by set up standards and comparing actual costs with the expected costs, therefore some organization may out of control in their highlighting areas (Manjumath and Andrew, 2011).
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According to Charles (1998), standard costs are preset target costs, and help to identify the problem on the evaluate performance and budget process. In a standard cost system, product costing is implemented by using predetermined standard costs for direct labor, material, and overhead. Standard costs are developed on the basis of historical cost data adjusted for expected changes in the product, engineering estimates, production techniques, and other considerations. Also, standard costing can be used to provide a forecasting of future costs to be used in decision making situations and lead on possible ways of improving efficiency.
Standards have to be set for the prices and quantities of services, materials, and labour to be spent in performing each operation relate with a product. Product standard costs are show out the list and adding the standard costs of operations needs to produce specific products. To methods are used for setting standard costs. First, past historical records can be used to appraise material usage and labour. Second, standards can be set due to engineering studies. Engineering studies have mention out of each operation detailed research is undertaken under controlled conditions, due to high levels of efficiency, to find out the quantities of materials and labour required. Target prices are then applied due to efficient purchasing to find out the standard costs (Rosalie, 2011).
2.0 PURPOSES OF STANDARD COSTING
2.1 Decision Making Purposes
As mentioned by Drury (2012), the standard costing represents a prediction of future costs and thus relevant sources of information for decision making purposes. Besides, the standard costing are frequently used for pricing decision since it imply future target costs based on the elimination of avoidable inefficiencies. When the company under well-organized operating, it may having a larger competitive advantage in the existing markets which comparing to those company fail to eliminate the avoidable costs since standard costs provide valuable information for pricing decision. It is therefore unwise to assume that inefficiencies are recoverable within the bid price. In other hand, the company can predict its product costs can focus on the most profitable material mix proportion and avoid potential loss-making activities. So, the standard costing is play an importance role in the decision making purposes.
2.2 Challenging Target
Drury (2012) stated that, providing a challenging target and such target can have a beneficial effect on motivation. In contrast, demotivational effect will happen when the challenging fail. The practical difficulty with such an approach lies in balancing necessary management freedom against slack performance. It seems to be the case that most organizations find this balancing act nearly impossible to achieve, which coupled with pressure to use limited financial resources effectively, will cause adoption of a ‘strict’ approach to control.
2.3 Setting Budgets
According to Drury (2012), the standard costing was contributed in the setting budgets and evaluating managerial performance. The quality of budgetary will be affected by the relevant and reliable source of information or data in the standard costing. Besides, the information or data which standard costs provided can easily convert budgeted production schedule into physical and monetary requirements for materials, labour, overhead and other services. Budgetary preparation time is considerably reduced if standard costs are available because the standard costs of operation and products can be readily built up into total costs of any budgeted volume and product mix. Moreover, standard cost also provide a foundation for estimating the actual performance cost in the future since standard costs are used as a close approximation to actual costs.
2.4 Control Device
One of the major purposes of a standard costing system is to act as a control device said by Hussey and Hussey (1998). Since the process of output will continually monitoring by the predetermined level. So, when there is a divergence between the actual and standard level, the control device will started the corrective actions (Appendix 1). Drury (2012) stated that, with a standard costing system variances are analyzed in great detail such as by element of cost, and price and quantity elements.
2.5 Inventory Valuation
Segelod and Carlsson (2010) argue that, the standard costs simplify the task of tracing costs for inventory valuation purposes. The inventories and production cost recorded at standard cost and a conversion to actual cost, it is made by writing off all the variance as a period cost. When there is failure to implement the standard costing system, it is necessary to maintain the records of actual costs for each individual material in order to determine the valuation of finished goods and work in progress inventory since the actual costs must be maintained at requirement of standard cost (Drury, 2012). So, a well-organized in the standard costing system does not call an organization to keep store records and product costs at actual costs.
3.0 ADVANTAGES OF STANDARD COSTING
As mentioned by Eric (2011), a budget is often calm of standard costs, because it would be difficult to comprise in the accurate actual cost of goods on the day the budget is confirmed. In addition, because of a main request of the budget is to compare it to actual results in consecutive periods, so that standards used will keep appearing in financial reports by the budget period.
3.2 Inventory Costing
Due to Eric (2011), standard costing are very easy to showing out the period end of the inventory balances report. The result of report might not accurately adaptation the inventory actual cost, however it is close. If the actual costs are constantly changing, it may be essential to update standard costs frequently. It is simple to grow up the costs for the highest dollar module of inventory on a frequent basis, and withdraw lower value items for infrequent cost revise.
3.3 Overhead Application
If the time is too long summary of the actual cost of the cost assigned to the inventory database, then it can use a standard application of rate instead to adjust the rate for every few months to keep it close to the actual cost (Nayab, 2010).
3.4 Price Formulation
According to Nayab (2010), an organizations deal with tradition products, then it can uses standard costs to compose the projected cost with add on a margin of client require. This might be very complex system, but the change in the sales department to use some of the cost will depend on the customer to order the number of units database. This system can also consider to changing the organizations production costs at every different volume of the levels, as this may require less expensive for use and production run longer. Nowadays, many organizations are using the standard cost to calculations and budgets to set up the price of the product; therefore it is easy to understand that standard costing will find some uses for the foreseeable future.
According to Nayab (2010), the standard costing methodology of comparing standard costs with actual costs allows a dependable assesses of the performance of various cost centers. The replace method of determining performance by comparing costs in different periods is fault as it does not consider the varying situation during both periods. Based on Eric (2011), standard costing systems always prove less resource consumption than the actual cost of comparable system. Actual costing system requires a lot of computing and the increasing amount of data, it can slow down the performance of the computer system standard cost system is not in the way. Although the system is lagging production is mainly caused by physical labor done some problems, slower system may prove to be harmful to rely on computer-controlled manufacturing.
3.6 Cost Control
There are many companies are using standard costing system, because it can provides information that the management can have cost control. Kumar (2008) argue that accounting system can tracked actual costs in report entries to accumulation liabilities for the labour payment and the materials purchase, entries to other cost record, and entries accumulated depreciation record which have involve in the production. Therefore, a standard costing system can records both budgeted figures and actual costs incurred in the production. By comparing the actual cost with standards cost, if there is a variance, the management can take immediate action to control the problems. Since standard costing can provide such information, standard costing is an important technique of cost control. The advantage of a standard costing system is that the general ledger system will auto follow up the necessary information to provide more comprehensive performance reports to display the cost variances (Caplan, 2010).
To develop a standard costing system, it require all the participation of all the management level (upper, middle and lower levels) and subordinates of the company. So that this creates motivation for the employees because they feel there are part of the system. Next, the standards fixed should be achieved by the employees and maintaining or improving the quality of the product. All the plans can be framed to reward with suitable incentives. The incentive system can motivate the employees to achieve or even higher levels expected of them. This increases efficiency, effectiveness and productivity of the whole production (Charles et al., 2011).
4.0 LIMITATIONS OF STANDARD COSTING
4.1 Limitations In Applicability
Debarshi Bhattacharyya (2012) argues that, the standard costing system is not effective for the organization which deals with non-standardized products which change according to the customer specific and requirement and needs. Customization based on customer requirement signifies each job requires a different set of work elements and components, and varying expenses. Therefore, the standard costing system is only applicable for the standardized products which consistent and repetitive process.
4.2 Reactive Nature
As mentioned by Nayab (2010), the standard costing methodology tends to react to issues rather than take a proactive approach to prevent problems. Since the corrective action is based on the result of variance analysis to take action but all the variance analysis is post mortems on past events so the standard costing system allows for the production process to run its inefficient course. Therefore, the standard costing is more suitable as a guideline for the standardized products and repeating situation in the future process which is not always a reflection of reality.
Bhabatosh Banerjee (2006) said that, the process of standard costing system requires high degree of technical skill to present high quality of work therefore it will higher charges. So, for those small organization may find it difficult to establish standard costing owing to their limited financial resources. However, once the system is established, the results to be achieved will far exceed the high initial cost.
4.3 Environment Effect
Due to environment change, in volatile conditions with rapidly changing method, rate and prices, standard quickly become out of date and thus lose their control and motivational effects (Jill et al., 2012). This can be leading to customer dissatisfaction with the company and loss of goodwill. Although, the problems can solving by use of planning and operational variances but this involves more subjectivity and more work.
In the conclusion, based on the purposes, advantages and disadvantages, it is important that a company uses a standard costing system. Because the standard costing system can provide standard performance information which they can easily compare to the actual performance. If the variance is favourable, it could be the management did a great job and the employees perform efficiently. On the other hand, if the variance is adverse, it could be the management lack of control about the operation, lack of quality control and others causes. So the variance can easily shows whether the company perform in a good track or bad. The company can use the variance to analyse and take immediate corrective action to improve the actual performance. Standard costing system can provide variances to the management for investigation of the operation.
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Appendix 1: Control System
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