Standard Costing: Definition, Advantages, And Disadvantages

Introduction to Standard Costing

This is the technique of costing wherein the expected cost for a product is compared as against the actual costs that have been recorded and the variances if any, are recorded for the purposes of controlling these costs and the apt actions are then undertaken so that the future costs could be controlled. This is the approach which is further simplified and which shows in the difference between the expected and the actual costs and also some of the other alternatives include FIFO, LIFO methods. In this, a huge amount of historical cost information has to be maintained for all of the stock items held in the inventory.

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The technique includes the creation of some of the estimated or the standard costs for a few of the activities that takes place inside the organisation. The main reason for the same is the fact that there are a number of different applications which is too time consuming to collect in the actual costs and hence, this technique is sued since it saves time.

The standard costs are usually higher than the actual costs, these costs helps in the calculation of the variable that would break in into difference and these are caused by the factors such as the changes that takes place in the wage rates, the cost of the materials etc. the cost accountant has the responsibility of changing these standard costs and bring them in line with the actual costs that are being incurred.

The following are the advantages of this system:

  • The majority of the companies fail to use this technique when it comes to the calculation of the cost of the ending inventory which is quiet useful for the other companies. In numerous cases, the users are not even aware that they could in fact use this technique (Accounting tools, 2018).
  • A budget is always prepared using the standard costs. This mainly due to the reason that it is somewhat not possible to be included in the actual costs of an item on the day on which the budgets are made final. And mainly due to the reason that the budget is always prepared so that the company could compare it with the actual costs that have bene incurred in the financial reports through in the budget period.
  • It is one of the easiest things to print in to show in a report which shows the period end inventory balances which is then multiplied in by the standard cost of each one of the item and this helps in the generation of the valuation of the ending inventory. This result does not always match up with the actual cost of the inventory but is in fact very much closer. It is quiet easy for the actual costs to change for the highest dollar of the components of the inventory on some frequent basis and also leaves in the items which have a lower value for some of the occasional cost reviews.
  • The practise of aggregating in the actual costs into the cost pools is very big for the purposes of allocating these costs to the inventory but then the same could be done through the use of the overhead application rate and also adjust in the rate once in every months so as to keep the actual costs closer.
  • In case, the company makes the custom products, then these standard costs could be used for the purposes of compiling in the projected costs of the different requirements of the customers after which the margins could be added. This is quite a complex system.

Almost all of the companies does have budgets and they use the calculations using the standard costs in order to quote for any specific customer received by them and lay down the profit that they could earn in the near future. This would help them in assessing in the actual performance as against the expected performance.

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The following are the issues that are encountered with by following this technique:

  • Cost plus contracts: this technique could not be used in case the contract is valued at cost plus profit. Since then the actual costs are used.
  • Inappropriate activities: the different and the numerous number of the variances that have been reported in the standard costing system would drive in the management for the purposes of taking the actions that are not correct for the purposes of creating in the favourable variances. In order to illustrate, in case, the company buys the raw material in bulk so that they could get the same at discounted prices, then though the company is saving in costs being incurred towards the purchase of raw material but it is also blocking its investment in that inventory. In the same way, if the management schedules in longer production runs to reduce in the labour inefficiencies, then it would though decrease in the labour inefficiency but increase labour rate (Accounting coach, 2018).
  • Environment: this system does not consider the fact that the costs change with the years or the day that pass by. And hence, the reliance on these standard for the number of months or even a year before these costs are updated. But in the real life, through the way of continuous improvement, the actual costs are being reduced each by each reducing day and hence, there is a call for the up-dation of these costs frequently (Lumen learning, 2018).
  • Feedback: an important piece of the standard costing system is the fact that the accounting staff completes in at the end of each of the reporting periods. In case, the department of production concentrates on the immediate feedback for some instant correction, then the reporting of these variances would be delayed which would be bad for the management of the company.
  • Information: the technique is used for the purposes of clouting in the variance at the department level and hence, the inefficiency at an individual or at a unit level cannot be determined.

The following are the variances that pertains to the standard costs:

  • Rate variance: this is the variance which is calculated by the difference between the actual price that has been paid and the expected to the standard prices of that thing multiplied by the actual quantity of that product that has been purchased.
  • Volume variance: this is the variance which is calculated by the difference between the actual quantity that has been sold and consumed and the budget amount and which is multiplied by the standard price per unit (Accounting notes, 2018).

Therefore, in the nutshell, variance is either in the price that has been paid for it or is the variance in the quantity that has been purchased.

Explanation of the purposes of the Articles:

The main aim of the first article is to examine and illustrate in the scenario of this technique in the listed pharmaceutical and chemical industry in Bangladesh. Another aim of this study was to understand the reasons for which the old costing system is still being used in this sector. The study talks about the reasons to why the old technique is still being used which is the traditional costing method when the new technique has already been introduced such as the ABC< Lean manufacturing, six sigma etc. then the importance of the various different functions of standard costing have been investigated in this study.

Advantages of Standard Costing

In respect of the second article, there have been many of the tools such as activity based costing, the balance scorecard and the target costing system that have gained some importance in the business community. The traditional accounting technique prevails in practise. The main aim of the second article is the examination of the use and the relevance of the system of standard costing used at the Swedish manufacturing company SKF and also provides in the ways through which the system could be improved. The study states the areas wherein this technique could be improved.

Analysis of the findings:

Article 1: Toward Understanding the Complexities of Service Costing: A Review of Theory and Practice (taken from Journal of Applied Management Accounting Reserch):

This article talks about the Pharmaceutical and the chemical industry in the country of Bangladesh which is one of the most important sectors in the economy. It counts for 97% of the total requirements of the medicines and employs about 115,000 employees in them. There are about 100 companies that produce various different chemicals in the country but the number of listed companies are only 28. This study focusses on those companies only. The study found that about 75% of these companies were using the standard costing for various different purposes.

This shows the fact that even when there have been many changes and even when a number of new methodologies and techniques have been introduced into the system, even then the old techniques  do not fail to appeal to these companies. And the main reason behind the same is the fact that this old technique is simple when it comes to being used. When inquired about the reason as to why the companies use the standard costing, all of the companies mentioned that it controls costs and also helps in placing cost to the inventory. It further helps in budgeting.

When asked about as to the types of standards that have been sent in by these companies, they replied that they help in attaining the standards and also sets in the currents standard and 14% stated that they set in the ideal standard and only 10% sets in the basic standard.

Whether the company’s chose to use the design or the engineering studies, the companies does favour in the historical usage of the stated method. When asked about the frequency of reviewing these standards, there were many of the heterogeneous responses. About 28.725% stated that these were reviewed on quarterly basis and about 23.81% of the people stated that the changes in the economic as well as in the business conditions. About 14.28% of the people review these standards on an annual basis and 9.52% of the people review in these standards on a continuous basis and some of the reviews these twice in a year.

Disadvantages of Standard Costing

The study further states that the operating factors were the main factors that led to the emergence of the variances. There were many of the random factors which include the poor recording of the costs and the poor budgeting as being the reasons for the emergence of the variances. The majority of these companies use the material price and the quantity variances along with the variance of the sales volume and the price variances and then a very few use the variable and the fixed manufacturing overhead. Then the smallest number of companies use the labour rate and the efficiency variances for their reporting. Then the material mix and the yield variance is used by the minimum number of companies. The study states that the size of the variance is the most apt factor when it comes to investigation of the variance.

Some of the companies stated that they often use the combination of the various factors along with the various other practise which is not consistent. There are a number of disadvantages of using this technique that often pose a question of its continuous adoption in the modern manufacturing environments.

The standards set in the managed often and very quickly become outdated as the internal operating conditions and the external environmental changes frequently. There is an increased amount of automotive operations, bypassing of the continuous improvements accompanied with the lack of the detailed data that was also reported in by these companies as being the major disadvantages of the standard based costing.

In the nutshell, from the above it could be concluded that the new techniques such as the Lean, six sigma has not appealed in to these companies in the industry of Chemical and Pharmaceuticals in the country of Bangladesh. And it is due to this reason that these companies are still going for the standard costing system (Elsie, 2013).

Article 2:

what kind of activity based information does your purpose require: International Journal of Operations and Products management?

In this, the study is based on only 1 company which is the Swedish manufacturing company SKF. It is the leading producer of ball bearings. The company uses the standard costing system which is very much available each and every level of the entity. The company has implemented many of the guidelines with relation to costs that have to be followed on timely basis. Many of the people are responsible for this system and hence have received signals with regard to the guidelines that have not been used as was intended. There was a suspicion that the information of the standard cost is somewhat not suitable and is not being following correctly.

It is due to the following reasons that this technique is being used:

  • Information: this is the information which is required in order to run in the company successfully. The main aim of the technique is to provide in the financial information to the managers so that the various activities could be planned, controlled for which the company is responsible and also to see the financial impact of the stated decisions that they could make. Thus technique helps in providing the cost data that could be further used for many purposes. The author further argues in this study that the system could be used for the purposes of setting up the budgets and also in the evaluation of the performance of the managers, to persuade the non-performance of the activities that have not been planned and hence, that would help in alerting the decision makers to the ones that could be out of control and the same could be used in the situations that would be out of control and that are in need of a remedial action. This technique also helps in providing in the forecast of the future costs that are to be incurred for the purposes of making the decisions, to understand the way in which the tracing of the costs is done to the products and for the purposes of evaluating the inventory and also to provide in the target that would motivate in the individuals.
  • Setting up of the budgets and also evaluate the performance: the technique is very much reliable and is very much convenient and could be easily used for the purposes of budgeting. This is the data that could be converted into the schedule of the budgeted production into the physical and the monetary requirements for the materials, labour etc. As per the Dury, the budgets that are prepared using the targets that are achievable and also reliable are capable of being better than when the standard costs are not available. These costs which are the standard costs are the ones that have been identified using some careful studies of the material usage. And hence, varies with time and volume. This technique also provides in a very strong basis for the purposes of expecting the performance of the managers in the future. If the company wants to measure performance, then the actual performance has to be compared with a certain set of costs. The difference between the 2 would be termed as variance and the management could then take initiatives to control these variances.
  • Feedback control system: Hussey and Hussey during the year 1999 stated that one of the main benefits of using this standard costing technique is that it acts as a control device. It is very important to plan the results and to identify the important variances that takes place. The variances are continuously monitored so that the same could be controlled. He further states that the technique helps in monitoring in the results achieved with the outcomes that were expected and then this could be followed by the corrective actions that would entail.
  • Decision making: for the purposes of making the decisions, figures and numbers are required. This technique provides in the future costs that would be incurred which serves as a very valuable source when it comes to making an informed decision. This is in the sense that the management is duty bound to make the decisions which pertain to the setting up of the prices of the products. If the management knows about the price of any product, then that would help it in focussing on the most profitable product mix and also in the analysing the product if it has the potential of making losses.
  • Inventory valuation: these are the costs that simplifies the task of tracing in the costs to inventory. If this technique is not in place, then it would be necessary to maintain in the records of the actual costs for each one of the individual material stocks which may but possible for the management of the company. When there is a sound standard costing system, then that would not call for keeping of all of the records (Sofia, 1994).
  • outcomes/lessons learnt:

In the nutshell, this system of standard costing is very much helpful and it proves down its superiority and usefulness. Though there are many of the disadvantages that it suffers from but still the advantages or the benefits outlay the disadvantages.

Both of these Articles talk about the use of the standard costing system in their companies.

The following are the 4 lesson learnt in respect of the topic:

  • It helps the management in tracing costs of each unit or the product
  • It helps the management in making an informed decision
  • It helps the management in evaluating the performance of the mangers
  • It helps in controlling the costs since it compares in the costs are incurred against the costs that should have bene incurred and then the appropriate corrective actions could be undertaken timely so that these variances could be controlled in the future.

The outcomes that would be useful for the Australian companies are as follows:

  • In the world of automation, the use of the standard cot system enhances efficiency of the company’s business operations (Deltek, 2018).
  • While the standard costing helps in the estimation of the inventory but there are many of the inventory related issues that still needs to be addressed (Automation world, 2018).

References: (2018). What is standard costing? | AccountingCoach. [online] (2018). Proper Use of Standard Cost Methods Enhances Efficiency | Automation World. 

Bragg, S. and Bragg, S. (2018). Standard costing. (2018). 8.4 Advantages and Disadvantages of Standard Costing | Managerial Accounting. (2018). Standard Costing and Variance Analysis. 

Learn Accounting: Notes, Procedures, Problems and Solutions. (2018). Standard Costing: Meaning and Objectives | Cost Accounting

Borjesson, s. (1994). What kind of activity-based information does your purpose require?.

Elsie, c. (2013). Toward Understanding the Complexities of Service Costing: A Review of Theory and Practice.