Table of Contents
Standard cost is expected to be incurred in the production of goods or services. Standard cost is a predetermined cost. The cost can also be described as a future cost since it is expected to take place in the future. The determinations are done on the basis of past costing information. The determination of the costs is also done on the basis of the normal capacity. In addition, standard costing is an estimated cost that is used in particular performing operations. It is also an estimated cost of producing certain goods within a company. Normally, the standard cost is used on a basis of comparison with the actual cost. It is developed from the historical data analysis (Jiambalvo, 2016). Additionally, it always varies from the actual cost of operation or producing goods because of the market factors that might affect the prices of goods. In performance reporting, standard costing is applied in measuring the variation that is caused between the standard and the actual costs (Parker, 2013). The variance is calculated to maintain the maximum efficiency in the production of a good and service. It is also used in performance reporting as a control tool. During performance report, standard costing greatly simplifies bookkeeping process. Instead of recording the actual cost, it is easy to use the standard cost rather than the actual cost making the process of reporting performance to be simple.
Advantages of standard costing
Standard costing is important in the measure of efficiency. Standard costing provides a means through which the actual costs in production are compared to determine the actual performance of a product. Cost control can then be determined and it is helpful in cost reduction. Determination of cost variance is also an importance of standard costing. Determination of standard costing will enable singling out of areas of inefficiency and corrective measures taken. The other advantage of standard costing is facilitating cost control. All costing systems have the role of costs controlling and cost reduction. Through standard costing, cost control can be exercised and relevant information provided to be used in cost reduction (Parker, 2013). Cost saving during keeping of records is enhanced by standard cost. This is due to the fact that the standard costing requires less work to keep records when compared to the actual cost. Decision making is an important aspect in the production process. Standard costing is helpful in talking important decisions through the provision of valuable guidance. The standard costing has the aspect of the analysis of variance hence it is used to single out inefficiency (Mehta, 2016). Once the inefficiency is singled out, the person creating the inefficiency will be advised on how to fix it. Therefore analysis of variance will fix the responsibility for efficiency. Additionally, standard costing provides the managerial team with the information used in the process of decision making. Once the manager has developed the appropriate standard cost which will succeed in maintaining the actual cost, it will be easy for the team to plan on other activities using the available resources. The information can be used to prepare accurate budget too.
Disadvantages of standard costing
One drawback in the use of standard costing is difficulty in establishing standards (Cheatham & Cheatham, 2006). In the application of the method, it is difficult to establish standard costs of labor, materials and overhead. This makes it sometimes inaccurate and cannot be used. The use of standard costing is expensive. The use of standard costing is expensive for small concerns. The establishments and the use of the method require high levels of technical skills. The method ignores the qualitative aspect of production. In the application of the method, aspects such as lead, customer satisfaction, quality and the service are ignored. The application of the tool has an assumption of a constant condition. Variance is limited by the existence of controversial materiality. The process of determining the limits of materials are controversial and difficult (Hansen, Mowen & Hansen, 2007). Therefore, because determining materiality requires individual judgment, the decision by an individual might raise conflict among the people.
When using standard Costing, chances are high that lack of reporting of variance might happen. Workers do not always report all the variance that exists. This leads to a diminishing of the budgets. The technique leads to low morale for workers. This is due to the fact that most managers focus on unfavorable variance than favorable variance. At most times unfavorable variance reduces morale on the worker’s side.
Favorable and unfavorable variance in the description of labor
Favorable variance means that the actual results obtained are different from what was expected but the variation in the results is favorable to the business (Dopuch, Birnberg & Demski, 2007). In an example, the difference might have led to increased profits. Unfavorable variance on the other hand implies that the results obtained are not as they were planned and the deviation in the results is not favorable to the business. In an example, the resulting profits may be low since the actual revenues are low that the expected. Favorable variance implies that management has decided to use few inputs than the estimated ones. It is done to reduce the cost of production and increase profit. In relation to labor, if workers manufacture a particular number of units in less amount of time than it is stipulated then it becomes favorable. On the other hand , the unfavorable condition is a situation whereby the management decides to use more input than the budgeted ones as long as it does not incur losses. For example is workers produces a certain number of units using more time than stipulated then it becomes unfavorable labor efficiency.
The use of standard costs by organization
Many organizations are adopting the use of standard costs. One of the reasons for the increased use o standard costs is to plan on the budget of the coming years and then compare the costs that are achieved with those that had been planned. The adoption is also used to determine whether the production costs of the organization are on track with the expected outcomes or whether a corrective measure in needed to make the costs inline with the estimations or the plans. The costs have been used by management in directing their attention to where problems might be in the organization. More firms are adopting the use of standard costing. This is because the technique is used to plan carefully what the products cost within the firm and the cost of entire production. It also gives the management the ability to know and understand the expected outcome of the entire year’s operations
Calculation of labor variances
Formula for Material and Labor Variance
Material difference = Actual quantity (Actual price –Standard Price)
=AQ (AP-SP)
Labor Variance = (Standard direct labor rate –Actual direct labor rate)χ actual hours
(SR-AR) AH
- Standard cost variance for material and labor
| Material price variance (purchase basis) | 4500 (favorable) |
| Material price variance (usable basis) | 3500 (favorable) |
| Labor rate variance | 5400 (unfavorable) |
- Reasons for the variances
The variance for materials on both the purchase and the usable basis were both favorable to the organization since the materials when used will produce a profit to the organization. The cost of the materials is favorable to the production on the tents.
- Standard variable costs of 1700 tents
| Direct material | 3500 |
| Direct labor | 5400 |
| Total variable cost | 8900 |
The undeviating labor inconsistency influences the working of the HR department towards determining the lower wage rate with the employee union. After calculations, a positive value means that the standard labor rates exceed the actual rate (Lucey, 2002). On the other hand, a negative rate indicates standard labor rate is lower than actual labor rate.
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Favorable and unfavorable speculations
The difference that is in the actual and standard costs may be favorable while in face unfavorable due to material price variance. Material price variance affects the actual costs and hence the favorable costs may be in the actual sense unfavorable. This is reflected in the price of favorable material price. The calculated unfavorable cost also might be in fact favorable due to material and labor variances. Calculation of favorable variance might turn out to be unfavorable while calculation of unfavorable variance might turn out to be favorable. This is because, during the calculation of favorable variance, the standard cost is used as a motivator and encouragement of greater effort hence turning out to be unfavorable (Al-Omiri & Drury, 2007). This is due to the fact that more inputs will be used to motivate workers. In the other hand unfavorable condition might turn out to be favorable when the costs of the inputs are reduced.
Behavioral issues arising from the use of standard costing
One of the behavioral problems in the application of standard costing in an organization is that the people are encouraged top do the wrong things when they know the performance would be measured. Mass production that is a behavior of the people on the shop floor is contrary to lean. The use of standard costing in these cases mainly looks at how the organization makes money in the manufacturing process. This behavior may be dangerous to the progress of the organization. These are a dysfunctional behavioral problem that rises as a result of using standard costing technique. The fixed overhead variance does not have relevance for control purposes. However, it does not rise as a result of overspending or under spending but as a result of variation in the production of a number of units. Additionally, the behavior of increasing the production of a large number of batches is a problem that arises with the use of the standard costing technique. It increases the time needed to be spent in a machine and therefore, it is seen as a risk. Lastly, the workers use variance as a tool to compel the manager to buy the resources in bulk. This is a behavioral dysfunction as managers find it difficult to enter the purchases into the inventory at once.
Conclusion
Despite the importance of standard cost to an organization, they are not needed in the management decisions made by an organization. In fact, value stream costing which is an alternative provides a more reliable way through which decisions can be made in an organization. Standard cost cannot be applied in the decisions that involve whether a new product should be introduced in the organization. When an organization that is used to applying standard costs in its decisions develop a behavior, the behavior becomes dangerous to the processes of the organization. Standard Costing remains a basic principle used in account control and management. More firms should adopt the technique as it helps the managers to plan and make a vital decision about the future. However, it is supposed to be used in a careful manner as some workers tend to misreport or do not record some of the actual spending. They rely on the standard cost only.
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