As such, the unit costs computed on the basis of historical data vary, in turn, from day to day. Such fluctuating cost information is of little use in fixation of selling price. They are planned costs which tell us what the costs should be. Accordingly, historical costs are of little use from the point of view of cost control and decision making.
The number of detectives and their cost of rectification should be looked into by going through the previous production records. A low standard which everyone can achieve does not bring out the best performance. standard costing system On the other hand, too high a standard being impossible to achieve, is treated with disdain and indifference. Setting up right standards requires cooperation of various line managers in the organisation.
Disadvantages of standard costing
Employees should receive positive reinforcement for work well done. Management, by exception, by its nature, tends to focus on the negative. Some companies report variances and key operating data daily or even more frequently. Standard costing helps in distinguishing between skilled and unskilled activities. So the skilled worker only gives pays attention to improving the activities of the unskilled workers. Standard Costing helps to apply the principle of “Management by exception”.
- It is a part of cost account, a projection of all cost accounts.
- However, it can be used more effectively in industries which have standardised repetitive nature of operations i.e. process industry.
- The standard cost of a product is a useful starling point in pricing.
- In turn, management can take action to correct the problems, seek higher selling prices, etc.
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It is not reasonable to expect the price of all materials and labor to remain constant for 12 months. For example, the grade of material used to establish the standard may no longer be available. Ranking should look to how stakeholders are affected by costs and any decisions related to cost variance, or why the variance occurred. For example, if a cost variance is due to an additional cost to make a product eco-friendly, then an organization may determine that incurring the cost is a benefit to its stakeholders.
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It avoids the need to compute a new average unit price with each input entry, as is the case, when perpetual inventory records are kept at actual cost. (b) Use of current standards which closely represent expected actual performance, is economical. Such attainable standards can be used in planning, budgeting and control processes. Where standards are not close to expected actual performance, they may be applicable for control purposes, but are not realistic for planning and budgeting use. (iii) Identifying the reasons for the difference between actual performance and standards through variance analysis. It only suggests establishing standards for each element of cost and ensuring that the activities are performed by incurring not more than the pre-determined or standard costs.
Large variances from the ideal are normal and difficult to manage by exceptions. First, they assume that the production process is labor-paced; if labor works faster, the output will go up. Standards are one of the important quantitative tools in the hand of management to control and measure the performance of business operations. In adverse economic times, firms use the same efficiencies to downsize, right size, or otherwise reduce their labor force.
Steps to Calculate the Standard Cost
Under standard costing, only quantities have to be maintained on stores records. This saving is, of course, partially offset by the added cost of establishing and revising standards. With all this information, it becomes possible to ascertain the extent to which an available price will cover out-of-pocket costs and contribute to recovery of fixed costs. The standard cost provides one of the many factors that should be considered in pricing. The knowledge of standard cost of product can be useful as one of many factors to be taken into account for pricing.
- To ascertain production costs at the beginning of an accounting period, he considered the company’s production process, past trends, and anticipated market conditions in the future.
- Vice versa, the standard costs already determined can be used as aids in the preparation of budgets.
- After the company purchased the coffee grounds, it discovered it paid $0.60 per ounce.
- It bases on the average between the highest and lowest production over the cycle.
- (ii) A comparison of actual performance with standards by preparing appropriate reports showing difference between actual and standard performance.
- These details serve as a basis to measure the efficiency against which actual quantities and costs are compared.