In spite of the benefits that have been mentioned for certain applications of costing in the standard way There are many instances where it’s not an appropriate costing method. These are the most problematic areas:
Cost-plus contracts. If you are in a contract with customers under which the client pays you for the expenses you incur and also profits (known as a cost-plus-contract) and you are required to utilize actual costs, in accordance with the contract’s terms. Costing in the standard way is not allowed.
Instigates unsuitable actions. Some of the deviations that are reported in a costing system could cause managers to make a mistake and generate favorable variations. For instance, they could purchase raw materials in larger quantities to boost the variance in price however this will increase the amount of inventory that is purchased. Additionally, the management could arrange longer production runs to increase labor efficiency variation however it’s preferable to make smaller quantities and offer less labour efficiency in exchange.
Fast-paced environment. The standard costing model assumes that costs will not alter much in the near future, meaning that you can depend on standard costs for several months or even a full year before updating your costs. However, in a scenario where the life of products is short or continual improvements are reducing costs, a standard expense can be outdated within a few months or.
Slow feedback. A complicated system of variance calculations is an integral element of the standard costing process which the accounting team completes at the conclusion of every reporting period. When the department of production is focussed on immediate feedback of issues for immediate correction, reporting the variances will be too late for them to be of any use.
Unit-level information. The variance calculations that usually accompany a costing report are done over the entire production unit, therefore, they are not able to give information on the discrepancies at a smaller scale, like an individual batch, work cell or unit.
The preceding list of examples highlights the number of scenarios where standard costing isn’t helpful and could lead to incorrect management decisions. However in the event that you’re aware of these problems you are usually able to successfully integrate costing practices to certain aspects of an organization’s business.
Advantages of Standard Costing
Although most businesses do not utilize standard costing for its primary application of calculating the cost of closing inventory, it’s beneficial for many other purposes. Most of the time, customers may not be aware that they’re using standard costing and that they’re making an estimation of what the actual costs are. Here are some possible uses:
Costing of inventory. It’s incredibly simple to create a report that shows the inventory balances at the end of the period (if you’re using an inventory system that is perpetual) add it to the cost per item, and then instantly create an inventory valuation that is culmination. The results may not correspond to the actual value for inventory items, however it’s similar. It is required to review standard costs often, especially if the actual costs are constantly changing. It is easier to update costs on the most costly mechanisms of inventory frequently and to leave the less valuable items for periodic cost reviews.
Overhead application. If it is taking too long to consolidate the actual cost into cost pool to allocation to inventory, you can employ a standard overhead rate instead. You can also modify this rate each few months to ensure it stays in line with actual costs.
production costs at various quantities, which might require the need for longer production runs, which are more affordable.
Budgeting. The budget is composed of cost-standards, as it is impossible to incorporate the exact cost of something on the day the budget is formulated. Furthermore, since one of the primary function in the process of preparing a budget is the ability to evaluate it against the actual results of future periods, the guidelines that are used in it continue to be included in financial reports throughout the duration of the budget.
Pricing formulation. If a company is involved in custom products, it employs typical costs to determine the estimated price of the customer’s needs and then adds to a margin. It could be complex, since the sales department utilizes the database of components costs which change based on the quantity of units that the client wants to purchase. This database can also reflect modifications to the business’s
Most businesses have budgets, and a lot utilize the standard method of cost calculation to determine the prices of their products, so it is evident the standard costs will have several uses in the near future. Particularly the case of standard costing, it provides an objective against which managers can assess the performance of their organization.
After going through the various math’s of variances, I have identified the reasons for the Material Price Variance Material Usage Variance Efficiency Variance and Labor Rate Variance.
Material Price Variance is when a company fails to purchase high-quality material, which results in a different price being paid. This can lead to poor buying decisions, extremely threatening the interests of the company like a purchase in a hurry to take advantage of a market that is not economically viable as well as to purchase a substitute material due to the lack of the specific material required in the contract. All of this is connected to the interdependence of variations when an event that has a positive impact on one variation but a negative effect on another. For instance purchasing lower quality products could lead to an increase in price, but it can also have a negative effect on the utilization of materials and productivity variance because of the quality of the material, resulting in an increase in the usage. The negative can be affected by the general rise in market prices. In these instances, the selling price must be adjusted to reflect the market price.
Material Usage Variances can be influenced by a variety of factors, including lack of care in the selection of material can affect the purpose of using materials and the resulting consumption. That brings us to use of substandard or defective material which can cause damage in the materials. Other causes include a modification to the plant or machinery that also result in the consumption of materials to an excessive degree. The reason for the fluctuations result from the excessive problems. Managers must ensure that the stocks is securely stored away and that only the minimum amount is distributed every day. It’s not only that. There are couple of more, including :
Poor material processing
Material mixtures are used in lieu of traditional mixtures
The Labour Efficiency Variance is impacted because the number of hours actually used are greater than the typical hours. It results from the use of an unsuitable standard that must be altered. Or, it could be that there has been idle time, and the ten working hours must be synced.
Bridget, C. (2012). Standard Costing. Available: http://www.accountingtools.com/standard-costing. This was last accessed on Oct 28, 2012.