Standard costing is a key element of performance management with a particular emphasis on budgeting and variance analysis. Show
The uses of standard costsThe main purposes of standard costs are:
Types of standardThere are four main types of standard: Attainable standards
Basic standards
Current standards
Ideal standards
Management control, variance analysis and 'management by exception'A key principle of management control is that of 'management by exception'. This involves the following steps:
Revising standards to calculate planning and operating variancesSome businesses revise standards and calculate what are known as "planning and operating" variances. There must be a good reason for deciding that the original standard cost is unrealistic. Deciding in retrospect that expected costs should be different from the standard should not be an arbitrary decision, aimed perhaps at shifting the blame for bad results due to poor operational management or poor cost estimation. A good reason for a change in the standard might be:
These types of situations do not occur frequently. The need to report planning and operational variances should therefore be an occasional, rather than a regular, event. If the budget is revised on a regular basis, the reasons for this should be investigated. It may be due to management attempting to shift the blame for poor results or due to a poor planning process. Illustration A company is operating in a fast changing environment and is considering whether analysing existing variances into a planning and operational element would help to improve performance. Discuss the advantages and disadvantages of the approach. Solution Advantages may include:
Disadvantages:
The suitability of standard costing in different organisationsStandard costing is most suited to organisations with:
The large scale repetition of production allows the average usage of resources to be determined. Standard costing is less suited to organisations that produce non-homogenous products or where the level of human intervention is high. Example: McDonalds Restaurants traditionally found it difficult to apply standard costing because each dish is slightly different to the last and there is a high level of human intervention.
Standard costing and variance analysis in the modern manufacturing environmentVariance analysis may not be appropriate because: Non-standard products Standard product costs apply to manufacturing environments in which quantities of an identical product are output from the production process. They are not suitable for manufacturing environments where products are non-standard or are customised to customer specifications. Standard costs become outdated quickly Shorter product life cycles in the modern business environment mean that standard costs will need to be reviewed and updated frequently.This will increase the cost of operating a standard cost system but, if the standards are not updated regularly, they will be of limited use for planning and control purposes. The extra work involved in maintaining up-to-date standards might limit the usefulness and relevance of a standard costing system. Production is highly automated It is doubtful whether standard costing is of much value for performance setting and control in automated manufacturing environments.There is an underlying assumption in standard costing that control can be exercised by concentrating on the efficiency of the workforce. Direct labour efficiency standards are seen as a key to management control.However, in practice, where manufacturing systems are highly automated,the rates of production output and materials consumption, are controlled by the machinery rather than the workforce. Ideal standard used Variances are the difference between actual performance and standard, measured in cost terms. The significance of variances for management control purposes depends on the type of standard cost used.JIT and TQM businesses often implement an ideal standard due to the emphasis on continuous improvement and high quality. Therefore, adverse variances with an ideal standard have a different meaning from adverse variances calculated with a current standard. Emphasis on continuous improvement Standard costing and adherence to a preset standard is inconsistent with the concept of continuous improvement, which is applied within TQM and JIT environments. Detailed information is required Variance analysis is often carried out on an aggregate basis (total material usage variance, total labour efficiency variance and so on) but in a complex and constantly changing business environment more detailed information is required for effective management control. Monitoring performance is important Variance analysis control reports tend to be made available to managers at the end of a reporting period. In the modern business environment managers need more 'real time' information about events as they occur. Standard costs and behavioural issuesStandard costs are set with a view to measuring actual performance against the standard, and reporting variances to the managers responsible. The aims of setting standards include:
Managers and employees might respond in different ways to standard setting. Factors to consider include: The type of standard setIndividuals might respond to standards in different ways, according to the difficulty of achieving the standard level of performance.
The level of participation in standard settingThe use of pay as a motivatorIf standards are used as a way of encouraging employees to improve their performance, motivation could be provided in the form of higher pay if targets are reached or exceeded. However, if employees are offered a bonus for achieving standard costs, this could increase their incentive to set low standards of performance, i.e. include 'slack' in the standard cost. Lower standards will increase the probability that the standards will be achieved and a bonus will be earned. Can standard costing help motivate employees?Standard cost also helps to motivate employees. This is because the system can be used to provide an incentive scheme wherein variance is minimized. Production and pricing policies are formulated with certainty when standard cost systems are in place.
How standard costs can be used to evaluate performance?Standard Cost:
Standard cost is a sub-set of Cost Accounting. It is generally used by manufacturers to get an idea of the normal expected cost of a process carried on in the industry. This gives them a benchmark upon which they can manoeuver their operations to obtain an ideal cost for their operations.
What is the purpose of using standard costs?A Standard Cost system is a common way to budget for planned projects, managing costs in a production run, and evaluating those costs after the production has finished. This system has the benefit of giving a business hard numbers to use when creating estimates for customers.
What are examples of standard costs?Examples include rent payable, utilities payable, insurance payable, salaries payable to office staff, office supplies, etc. read more is $15 per hour, and the standard fixed cost is $100,000. Therefore, the total hours required for producing one unit is 10 hours. Find the standard cost of the company.
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