Redesigning cost systems: Is standard costing obsolete? ProQuest

In the end, standard product costs are simply based on several assumptions – often not very valid ones. Standard costs are developed before the new fiscal year starts through a series of steps by the accounting team. Finance spends considerable effort with each business function to re-estimate the cost of producing a product.

Faulty standard cost calculations can have serious implications for a business. By keeping standard prices updated and setting realistic standards, businesses can ensure that their standard costing calculations are accurate and provide helpful information for decision-making. Finally, the standard cost can assess the financial impact of proposed company production process changes. By calculating the expected change in cost for a given change, management can make more informed decisions about whether or not to implement the change.

Are there any limitations to using standard costing data for developing key performance indicators (KPIs)?

It is a tool managers in different departments can use to help make decisions about pricing, product mix, and process improvement. While accountants may use Standard Costing to help prepare financial statements, managers can use it to make decisions that will improve the financial performance of their department or company. There are a few different schools of thought regarding standard costing and profitability. Some people believe standard costing is an accurate way to determine profitability, while others believe it can lead to inaccurate results. If a standard cost is inaccurate, the best course of action is to identify the root cause of the inaccuracy and ensure it is corrected. This could involve updating key assumptions or data points used in the calculation or changing processes to ensure accurate data collection.

In most cases, the Standard Costing approach is the one that is suggested for use by manufacturers. It compares the expenses incurred to the standard values and analyzed variation so performance may be monitored. These unreasonable and unrealistic standards would not motivate students to do well in the course. This standard level is not the best motivator because employees may see this level as unattainable. At Finance Strategists, we partner with financial experts to ensure the accuracy of our financial content. The currently attainable standard is the most popular standard, and standards of this kind are acceptable to employees because they provide a definite goal and challenge to them.

Materials Standards

For example, for businesses with complex manufacturing processes that include multi-level BOMs and a myriad of yields, recalculating a standard cost for a finished product off-hand is a difficult, if not impossible, exercise. However, as prices fluctuate and manufacturing efficiencies vary, the static inventory number represented by the standard cost will be incorrect. Using the standard, for example, to represent the production cost for quoting sale prices will lead to unprofitability. Budgetary control and standard costing have the common objective of cost control by establishing pre-determined targets. These two techniques are similar in certain respects but differ in respect of other points. This does not mean the actual costs will never be used, typically a company’s accountant will periodically update the variances as that information becomes available.

It is a fictional example, yet provides a realistic picture of the level of detail involved in setting standard costs. Since standard costs are usually slightly different from actual costs, the cost accountant periodically calculates variances that break out differences caused by such factors as labor rate changes and the cost of materials. The cost accountant may also periodically change the standard costs to bring them into closer alignment with actual costs. Traditional standard costing must comply with generally accepted accounting principles (GAAP) and actually aligns itself more with answering financial accounting requirements rather than providing solutions for management accountants. Traditional approaches limit themselves by defining cost behavior only in terms of production or sales volume.

Formula to calculate the standard cost:

Specifically, they need costs standards to determine how efficiently and profitably their institutions are operating. If a company deals with custom products, then it uses standard costs to compile the projected cost of a customer’s requirements, after which it adds a margin. This may be quite a complex system, where the sales department uses a database of component costs that change depending upon the bookkeeping for startups unit quantity that the customer wants to order. This system may also account for changes in the company’s production costs at different volume levels, since this may call for the use of longer production runs that are less expensive. As targets are met, the finance team works with the business stakeholders to set new, challenging, attainable targets that keep the organizations motivated and driven.

• One of the essential aspects of standard costing is ensuring that all assumptions are correct.
• A number of the variances reported under a standard costing system will drive management to take incorrect actions to create favorable variances.
• These entities include management, current and prospective investors, creditors, government agencies and bodies, and scientific research institutions.
• Due to the number of steps and resources required, updating all inputs is not practical.
• They represent the management’s best and most accurate estimate of how much money must be spent on raw materials, direct and indirect labor, and manufacturing overhead to manufacture a single product unit.

There are almost always differences between the actual and standard costs, which are noted as variances, as a manufacturer must pay its suppliers and employees the actual costs. A standard cost is one that a company expects at the outset of a year under a normal level of operational efficiency. Standard costs are used periodically as a basis for comparison with actual costs. A complex system of variance calculations is an integral part of a standard costing system, which the accounting staff completes at the end of each reporting period. If the production department is focused on immediate feedback of problems for instant correction, the reporting of these variances is much too late to be useful. The setting of standards and the reporting’ through variance accounting is now a complicated laborious time consuming and costly business.