8 5: Advantages and Disadvantages of Standard Costing Business LibreTexts

Cost accounting systems become more useful to management when they include budgeted amounts to serve as a point of comparison with actual results. The difference between the standard (expected) volume of production and the actual volume of production, gives rise to the standard cost volume variance. The standard costing variance is negative (unfavorable), as the actual units used are higher than the standard units, and the business incurred a greater cost than it expected to. The principle difference between budgets and standard costs lies in their scope. The budget, as a statement of expected costs, acts as a guidepost, which keeps the business on a charted course.

Standard costing is a managerial device to determine efficiency and effec­tiveness of cost performance. The term ‘standard cost’ has been defined as a predetermined cost which is calculated from the management’s standards of efficient operation and the relevant necessary expenditure. The Chocolate Cow Ice Cream Company has grown substantially recently, and management now feels the need to develop standards and compute variances. A consulting firm was hired to develop the standards and the format for the variance computation.

Definition of Standard Cost

The management gives atten­tion to the variances and takes corrective steps. The costing reports, based on standard cost, reveal the overall result of the manufacturing side. An idle capacity variance indicates the amount of overheads that is either under or over- absorbed because actual hours are either less or more than the hours on which the overhead rate was based. These may create difficulties in accurately determining material consumption standards, methods of work using new tools, processing requirements, etc. and labour hours for processing. This is because of the fact that the standard does not represent what should be attained in the present period. Hence, not being useful for cost control, basic standard is rarely used except as a basis for preparing current standard.

• (iii) Also included in the price standard are any freight or shipping costs the company will have to pay to obtain the materials.
• Standard Costing is defined as the use of Standard Costs in measuring and controlling the performance of a company.
• Variances provide a starting point for judging the effectiveness of managers in controlling the costs for which they are held responsible.
• Actual costs are compared with the standards costs and variances are determined.
• These standards aim at absolutely minimum cost, which is attainable only in perfect operating conditions.

Variances provide feedback information for management control. Physical standards may be set on ideal basis, practical basis or past actual basis. The cost accountant is confronted with the issue of choosing the right basis of standards to be adopted. There may be various ways in which the materials can be processed into finished output. Each of these methods of work has different material requirements, labour processing time, machine operating time, etc. This creates a problem of setting material consumption rates and standard time because of the fact that it becomes necessary to make adjustments for the lack of experience of workers.

Computation of Standard Cost and Actual Cost:

It is a target which is attainable and can be achieved if the expected conditions operate during the period for which the standard is set. It represents what should be achieved under actual conditions when plant and other facilities have been made by positive action, as efficient as possible. Conditions during standard costing system which period the standard is used are known as current conditions. Current conditions take into consideration material and labour price changes during the period when the standard is used. The amount of losses-normal or abnormal, in each sub-process over a considerable period of time should be examined.

However, it should be noted at this stage that Standard Costing is only a control device and not a distinct method of Product Costing. That means, it is not a substitute for any method of Product Costing. Hence, a standard figure is one against which one can measure an actual figure to ascertain how much actual figures differ from standard. Standard costing might lead to a focus on cost reduction at the expense of other vital aspects like quality and innovation. Ideal standards are those that can be attained only under the best circumstances. Meeting standards may not be sufficient; continual improvement may be necessary to survive in the competitive environment.

Difficulties in Fixation of Standard

Standard costing provides management with accurate and timely data, enabling informed decision-making based on real-time cost information. In sum, managers should exercise considerable care in their use of a standard cost system. This 0.1-hour variance results from the unrealistic standard rather than operational efficiency. By contrast, ideal standards cannot be used in forecasting and planning; they do not allow for normal inefficiencies, and therefore they result in unrealistic planning and forecasting figures.