STANDARD COST: Definition, Benefits, and Limitations

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• Products may not be adequately built or constructed with inferior materials.
• A standard cost system is commonly used to budget for projects, manage production costs on a particular run, and evaluate the costs once the production is done.
• For this reason, historical costing is simply a post-mortem of a case and has its own limitations.
• The accounting team then must process journal entries to allocate the difference (a positive or negative variance) back to the products.
• In turn, management can take action to correct the problems, seek higher selling prices, etc.

Calculating and reporting on deviations is not always deemed realistic or even necessary unless the resulting information can be used by management to improve a company’s operations or cut its expenses. To calculate inventory value, a corporation simply multiplies the amount of real inventory by the standard cost of each item. Because the “standard” cost is being used in the computation, the amount will not be exact, but it will be near to the actual cost if the company has been conducting this type of production for a while.

Organization

The entire company benefits from top management to the production line workers. In the long run, it can mean greater ROI for a company with conscientious management and employees. This way, the standard costing system helps highlight areas of possible hazards. Standard costing techniques have been applied successfully in all industries that produce standardized products or follow process costing methods.

• This makes it a much more accurate method for determining the actual cost of a product or service.
• Standard costing is a system of accounting that uses predetermined standard costs for direct material, direct labor, and factory overheads.
• As data models and customization are quickly becoming the new standard in business reporting, outdated legacy systems and methodology must make their exit so organizations can survive and thrive.
• The variance indicates a deviation from what was recorded in the profit plan.
• The goal is to produce a product or service at the lowest possible cost while meeting quality standards.

Standard costs also assist the management team when making decisions about long-term pricing. In ICMA’s definition of standard cost, the phrase „management’s standards of efficient operation” is important. C-level executives tracking profitability and plant managers whose bonuses depend on higher margins are constantly looking to reduce redundant spending caused by operational and resource inefficiencies.

Is Standard Costing For Determining Profitability?

Yes, those extra costs will eventually be accounted for by being added to the variance cost, but in order to keep things simple, an inventory valuation will normally use the standard costing technique. Companies budget using standard expenses since actual costs cannot yet be identified. For example, if two companies have similar products, but one has a higher standard cost, its production process may be less efficient or effective. This information can help management identify areas where improvements can be made. In contrast, standard cost accounting must account for the complexities of actual working environments where variances occur due to changes in sales volumes or demand.

How to perform Variance Analysis between Standard and Actual cost

However, cost accounting professionals must not be comfortable with easy. No more end-of-year standard to actual analysis and true-up, impacting the P&L and Balance Sheet. No more beginning of year inventory reval, impacting the P&L and Balance Sheet. Elimination of variances, particularly variances that make no logical sense and cause a loss of business trust in the system and finance function. Save weeks/months of time required to input, adjust, and validate standard cost inputs into the system.

How to Create Standard Costs

Standard costs are widely used in decision-making in many different industries and fields. These standard costs are calculated based on historical data, industry norms, or cost models. They provide a standard benchmark to compare actual results, allowing businesses to assess their performance relative to expectations.

Failing to adjust the standard cost for production variances affects the income statement’s cost of goods sold account. For example, when standard costs are higher than actual costs, the cost of goods is higher than normal, and profit is lower than normal. Actual costs lower than standard costs have the opposite effect, understating the cost of goods sold and reporting a higher profit. Manufacturing companies are typically the primary users of standard cost accounting.

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

Each system has advantages and disadvantages, so selecting the one that best suits the company’s needs is crucial. The system a business chooses will impact how it makes decisions and how profitable it is. Standard costing is backward-looking, inaccurate, and resource-intensive. As organizations strive to be agile and flexible, they must have a system that conforms to them instead of being beholden to the system. Savvy plant operations teams will find ways to steer the conversation around any unfavorable variances that they have towards being related to these uncontrollable factors.