Advantages and Disadvantages of Standard Costing
Standard costing establishes and maintains fixed costs for materials, labour, and overhead connected with a product or service. It compares and monitors the real cost of manufacturing using actual costs and predefined costs, which are standard costs. Companies use standard costing to track expenses and verify that the costs of producing products and services are within budget and consistent with the estimated costs.
Standard costing is applicable in a wide range of industries, including manufacturing, services, and retail. It's also employed in projects when the price of goods and labour aren't known ahead of time, like buildings.
The basic phases in standard pricing are as follows:
Below are some pros and cons of standard costing:
Advantages of Standard Costing
Aids in Administration
Standard costing is a management strategy that assists management in cost planning and control by setting and adhering to preset norms of material, labour, and overhead prices. It is used to compare real costs to standard expenses in order to assess, monitor, and analyze performance. This method enables management to identify areas of cost overruns or underruns and take appropriate remedial actions.
Standard costing assists management in cost planning and control by establishing a baseline against which actual costs may be assessed. This further assists management in better understanding the expenses of creating items or services and determining how much to charge for them. It also helps management in identifying cost-cutting opportunities and determining where extra expenditures may be required.
By comparing actual expenses to specified norms, standard pricing also aids management in measuring and monitoring performance. This assists in identifying areas of cost overruns or underruns and allows management to pinpoint the cause of these issues. This helps management to make required changes and enhance the cost management methods.
Overall, standard costing is an important management technique since it helps to monitor and control expenses while also improving performance. It serves as a baseline against which actual costs may be compared, allowing management to discover areas of cost overruns or underruns and take appropriate remedial action.
Encourage Economy and Efficiency
Standard costing is an accounting approach for recording and analyzing the cost of manufacturing a product or providing a service. It is a standard practice among firms in numerous sectors and is extensively used to monitor performance and evaluate a company's financial achievements. Standard costing is very useful for manufacturers and other organizations that create a variety of items. The main benefit of standard pricing is that it promotes economy and efficiency.
Standard costing enables a corporation to set pricing for its products and services based on the materials, labour, and administrative expenses connected with its production. The organization can discover waste and inefficiency by establishing cost guidelines for each type of product or service. This can assist the firm in adjusting its manufacturing processes and making better use of its resources.
Standard costing can also be used to compare actual costs to cost standards. The firm may then assess how close it is to meeting the cost targets and make modifications as needed. This assists the organization in identifying areas where it may cut expenses and improve efficiency.
The benefit of standard pricing is that it promotes economy and efficiency. A corporation can better manage its resources and achieve its goals by establishing cost guidelines and comparing actual costs to them.
Simplify Bookkeeping and Accounting
By establishing predefined criteria for each expenditure, standard costing is an accounting technique that assists firms in better managing their costs. This enables businesses to create budgets, evaluate performance, and, if necessary, take corrective action.
Standard costing has the benefit of allowing for straightforward accounting and bookkeeping since it offers a structured, systematic manner to monitor and report expenditures. By doing this, businesses are better able to comprehend their costs and decide how to allocate their resources. Companies may quickly discover areas where they may be overpaying or underperforming by comparing their real expenses to the standard costs using standard costing. They may also make budget adjustments and more precise financial projections using this information.
Standard costing also assists firms in locating opportunities for cost reductions and process enhancements. Businesses can find places where they can reduce expenses or streamline operations by comparing real prices to standard costs. Operations may become more effective as a result of increasing profitability.
Standard costing is an efficient method for managing and reporting expenditures overall. Businesses may use it to manage expenses, find areas where they can cut expenditures, and arrive at wise judgments. It is a vital tool for organizations of all sizes since it makes accounting and bookkeeping simpler.
Disadvantages of Standard Costing
Generate Sporadic and Pointless Information
In order to plan and manage operations, standard costing is a budgeting and cost-control technique. It is frequently used in manufacturing, where expenses are foreseen and then monitored to make sure they are under budget. However, standard pricing also has certain drawbacks, including the potential for producing infrequent and pointless data. This is so that conventional costing doesn't utilize real expenses but rather predefined costs. Budgeted expenses and actual costs may differ, as predetermined costs may not precisely represent real expenditures.
Standard costing is also less adaptable than other budgeting and cost-control strategies. This may restrict the information generated by standard costing's usefulness because it may not be appropriate in particular circumstances. Standard costing may also be time-consuming and demand a high level of skill to correctly set and manage the expenses. This may make it more challenging to utilize typical costing and may lessen the information's value.
Insensitivity of Management
A cost accounting technique called "standard costing" allocates expenses to goods and services in advance. This technique has the advantage of giving businesses a budget to operate with by enabling them to forecast future expenditures and know the price of their goods and services. However, a drawback of this approach is management's need for more sensitivity.
Due to the preset character of the system when employing standard costing, managers may grow indifferent to changes in actual costs. The corporation might not be aware of a cost increase if real costs exceed the preset standard costs until financial statements are issued and the standard costs are compared to them. This means that an organization may be losing money without realizing it and will not be able to take corrective action on time.
Additionally, management can stop paying attention to deviations from the norm and changes to the standard expenses. Management might not be aware that the firm's standard expenses need to alter as a result of market developments until it is too late and the company has already lost money.
In conclusion, standard costing has drawbacks due to management's lack of sensitivity, which might make it difficult for the business to recognize actual cost changes and alter standard prices promptly. This might result in lost opportunities to save money, as well as the organization running at a loss without realizing it.
Issues with Labor and Productivity
In the standard costing technique of budgeting, cost elements are given fixed dollar values. Standard costing has the drawback of resulting in erroneous labour costs and production rates. This is so because labour costs and production rates may not accurately reflect actual labour costs and output rates as they are defined by the predetermined norm and may change frequently.
For instance, labour expenses may be inflated, and the production rate may be understated if the standard cost for a given job is set too low. As a result, judgments and planning may be made that are not based on an accurate understanding of the job's actual costs and output rate. The same issue of erroneous data for decision-making arises if the standard cost is set too high since labour expenses may be inflated, and the production rate may be understated here too. Standard costing often has limitations when it comes to precisely estimating labour costs and production rates, which is another drawback of the approach.
Standards being misunderstood
A "favourable" variable occasionally has an equal or greater negative impact than an "unfavourable" variance. For example, let's say McDonald's needs to know how much hamburger meat should be in a Big Mac based on its price.
A "favourable" deviation would imply that less meat was utilized than called for by the standard. In this case, the result will be negative and possibly make the customer unhappy.
Absence of Additional Important Goals
With standard cost reporting systems, there could be a propensity to prioritize standards compliance at the expense of other crucial goals like preserving and enhancing quality, on-time delivery, and customer happiness.
Utilizing extra performance measurements that concentrate on these other goals helps lessen this propensity.
Absence of Necessary Standards
Continuous improvement may be required to thrive in the present competitive climate; simply fulfilling requirements may not be enough.
For this reason, rather than focusing just on achieving standards, some businesses pay attention to patterns in standard cost variations.
In some businesses, engineering standards are being replaced by either a very difficult target cost or a rolling average of real costs, which is supposed to decrease.
Standard costing is an excellent method for measuring and managing costs in a business. It is an efficient method of comparing actual expenses to expected costs and tracking performance. It is crucial to emphasize, however, that standard costing does not come without drawbacks. It is critical to examine the system's accuracy and complexity, as well as the possibility of biased outcomes. Companies should also be aware of alternative cost-analysis approaches, such as activity-based costing, and select the appropriate strategy for their specific needs.