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| Standard Costing System |
Standard Cost: Definition, Benefits, Disadvantages
Standard costs compare standard costs and revenues with the actual results of the process, find out the reasons for the variations, provide information about deviations to management to take steps to improve it.
A standard costing system initially records the cost of production on a standard.
The inventory accounts inventory flows from the inventory accounts (from work-to-process to finished goods costs) at their standard cost per unit.
When the actual cost becomes known, adjusting entries are made which restores the balance of each account from the standard as actual (or approximate such a restriction).
The components of this adjustment entry provide information about the company's performance for the period, in particular about production efficiency and cost control.
What is 'standard'?
A standard is a standard for measuring performance. Another way of defining a standard is that it is something that is predetermined or planned, and management wishes that the actual results are equal to the standards. Standards are an important quantitative tool in management's hands to control and measure the performance of business operations.
However, this to a large extent depends on the type of standards used to make decisions about control actions and to measure performance.
Standard cost objective.
Standard costing systems help in planning operations and gaining insight into the potential impact of managerial decisions on cost levels and profits. The standard cost is used for:
👉 Establishment of budget.
👉 Controlling costs, directing and motivating employees, and measuring efficiency.
👉 Promote possible cost reduction.
👉 Simplify cost processes and speed up cost reports.
👉 Handing over material costs, process work, and finished inventory.
👉 Setting the basis for the establishment of bids and contracts and the sale price
Advantages and Importance of standard costing system
The standard cost system has the following main benefits or benefits:
Helps management
The use of standard costs is an important element from the standpoint of exception. If cost remains within the standard, managers can be a focus on the other issues.
When costs fall significantly outside standards, managers are alerted that attention may be required. This approach helps the managers to focus on the important issues.
Boost economy and efficiency
Standards seen by employees as appropriate can boost economy and efficiency. They provide a benchmark that individuals can use to judge their performances'.
Simplify accounting and bookkeeping
Standard costing can simplify bookkeeping. Instead of actual recording costs for each task, standard costs for materials, labor and overhead can be charged for jobs.
Standard costing naturally fits into an integrated system of responsibility accounting. Standards establish what the costs should be, who should be responsible for them, and what the actual costs are under control.
Standard Cost System Disadvantages / Problems / Limitations
The use of standard costs can present many potential problems or disadvantages.
Most of these problems result from improper use of standard costs and management by exception theory or using standard costs in situations in which they are not justified.
Can produce infrequent and useless information
Standard cost variance reports are usually prepared every month and often issued days or even weeks after the end of the month. As a result, the information in the report may be so rancid that it is almost useless.
From time to time, frequent reports that are nearly correct are often better than unexpected reports that are very accurate but are outdated by the time they are released.
Some companies are now reporting variances and other key operating data daily or even more often.
Lack of management sensitivity
If managers are insensitive and use variance reports as a club, morale may suffer. Employees should receive positive reinforcement to work well. Management, by exception, by its very nature, focuses on the negative.
If variances are used as a club, subordinates may be tempted to cover unfavorable variances or perform acts that are not in the best interests of the company to ensure that variances are compatible.
For example, workers may be put on an accidental effort to increase production at the end of the month to avoid adverse labor efficiency deviations. In the rush to produce, quality may suffer.
Problems with labor and their output rate
The labor quantity standard and the efficiency version make two important assumptions.
First, they believe that the production process is laborious; If labor works fast, the output will increase.
However, output in many companies is no longer determined by how fast labor works; Rather, it is determined by the processing speed of the machines.
Second, the calculation assumes that labor is a variable cost.
However, direct labor can inevitably be fixed, and then an undue emphasis on labor efficiency variations creates pressure to produce additional work in the process and finished goods inventories.
Problem with misunderstanding standards
In some cases, the "favorable" version may be worse or worse than the "unfavorable" version. For example, McDonald's has a standard for the amount of hamburger meat a Big Mac should have.
A "favorable" version would mean that less meat was used than the standard specified. The result is a lousy Big Mac and possibly a disgruntled customer.
Boycott of other important objectives
There may be a trend with standard cost reporting systems to meet standards for other important objectives such as maintaining and improving quality, timely delivery, and customer satisfaction.
This tendency can be reduced by using complementary performance measures that focus on these other objectives.
Just meeting the standard is not enough.
Just meeting standards may not be enough; Continuous improvement may be necessary to survive in the current competitive environment.
For this reason, some companies focus on trends in the standard costing version - aiming for continuous improvement rather than just meeting standards.
In other companies, engineered standards are being replaced by a rolling average of actual costs that are expected to fall from the target or very challenging costs.
Ideal standard
Ideal standards are those that can only be attained under the best of circumstances.
They do not allow any machine breakdown or other work interruptions, and they call for a level of effort that can only be achieved 100% of the time by the most skilled and skilled employees working in peak effort.
Sometimes some managers feel that such a standard has a motivational value.
These managers argue that even though employees know they will rarely meet standards, it is reminiscent of the need for ever-increasing efficiency and effort.
Some firms use ideal standards. Most managers find that ideal standards discourage even the most hardworking workers.
Furthermore, it is difficult to interpret the variations from ideal standards. Larger-than-ideal versions are common, and exceptions are difficult to manage.
Practical standard
Practical standards are standards that are agile but attainable. They allow for normal machine downtimes and the employee's rest time periods. They can be highly efficient, however, despite efforts by the average worker.
Variations from such standards represent deviations that fall outside normal operating conditions and indicate a need for management attention. In addition, practical standards can serve many purposes.
In addition to indicating unusual circumstances, they can also be used to predict cash flows and plan lists.
In contrast, idealized standards cannot be used in forecasting and planning; They do not allow for common inefficiencies, and so they result in unrealistic planning and forecasting data.
Comparison of budget and standards
Budgeting is a way to gain reliable and quick information about the operation and control of an enterprise.
When construction budgets are based on materials, labor, and factory overheads, a strong team is formed for potential control and cost reduction.
Standards are almost unavoidable in setting a budget.
Because both the standard and the budget are aimed at the same objective-managerial control, it is felt that both are similar and cannot function independently.
This opinion is supported by the fact that both use predetermined costs for the coming time.
Both budget and standard costs make it possible to produce reports that compare actual costs and pre-determined costs for management.
The creation of a budget without the use of standard cost figures can never lead to an actual budgetary control system.
The principle difference between budget and standard cost lies in their scope. The budget, as a statement of expected costs, acts as a guidepost, placing the business on a charted course.
On the other hand, the standards do not state what the cost is expected to be, but rather what they will do if some performance is achieved.
A budget emphasizes the volume and cost level of the business, which must be maintained if the firm is to operate as desired. The standard stress is the level to which the cost should be reduced. If the cost reaches this level, the profit will increase.
Similarities of budgetary control and standard costing
The following are the similarities of budgetary control and standard costing:
Both systems deploy predetermined figures
Both systems are useful accounting tools to management in controlling costs
Both systems require proper administration. Actual results should be compared to budgets and standards, and any variations must be examined. Cost control problems should be continuously studied, and corrective actions are taken where necessary. Where appropriate budgets or standards need to be revised so that they are realistic
It is interesting to note that both systems can operate independently, but since both systems involve the estimation of costs, most firms often operate both systems together.
The budget set can be used as a guide in setting standard costs and Vice versa, the standard costs already determined can be used as aids in the preparation of budgets.
Difference between Standard Cost and Budgetary Control
Variance analysis
Answer: Differential analysis is usually associated with interpreting the difference (or variance) between actual costs and accepted standard costs for good output.
For example, the difference in material costs can be divided into content value version and content usage version. The difference between actual direct labor costs and standard direct labor costs can be divided into the rate variation and efficiency variant.
Differences in overhead manufacturing can be divided into expense, efficiency, and volume versions. Mix and yeast variance can also be calculated.
The diversified analysis helps management to understand current costs and then to control future costs.
The miscellaneous analysis is also used to explain the difference between real-world dollars and budgetary sales dollars.
Examples include sales price variance, sales volume (or volume) variance, and sales mix variance. The difference in the relative ratio of sales can cause some difference in the company's profits.
Material cost variance
The name of the variance is self-explanatory, reflecting the difference between the standard cost of materials and the actual cost of materials. Material cost variance is between the standard material cost for actual production in units and the actual cost.
Material cost variance = (standard cost of material - actual cost of material used)
Define material cost variance? Classify material cost variance. Is a favorable variance always an indicator of efficiency in operation?
In a standard costing system, some favorable versions are not indicators of operational efficiency.
For example, material price variance, labor rate variance, manufacturing overhead expenses and budget version, and production volume variance are generally not related to the efficiency of operations.
On the other hand, material use variance, labor efficiency variance, and variable manufacturing efficiency variance are indicators of operating efficiency.
However, some variations may arise from parameters that were not realistic.
For example, if a unit of output takes 2.4 hours to produce, but the standard is set to 2.5 hours, then there should be a compatible version of 0.1 hours.
This is a result of a variation of 0.1 hours from the unrealistic standard rather than operational efficiency.
The conclusion
In short, managers must exercise considerable caution in the use of a standard costing system.
Managers should go out of their way to focus on the positive and become aware of potential unintended consequences rather than focusing on the negative.
Nevertheless, standards cost are still found in the large majority of manufacturing industries and many services companies, although their use is changing.
For the evaluation of performance, the standard cost variance can be suppressed by an interesting development known as a balanced scorecard in the future.
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