Any business is concerned about increasing the wealth and reducing the costs. "Cost Accounting has various important tools in order to achieve these objectives. Marginal costing, Budgetary Control and Standard Costing are such tool d, by the use of which management achieve its objectives easily.(Gupta et al. 2007).
Costing is a method of evaluating the costs for any business, specifically in a manufacturing environment.
Costs can be categorised in many ways,
By Element - Material Costs, Labour Costs and Expenses
By Nature - Direct Costs and Indirect Costs
By Behaviour - Fixed Costs, Variable Costs and Semi - Variable costs
By Function - Production, Admin, Finance, Sales etc
Evaluating the costs helps the business in many ways,
Control of Costs
In a manufacturing environment if we consider the Material, Labour and Overheads incurred in a production department, an analysis can be made as to the costs incurred for a period or forecast for the costs that are expected.
Get your grade
or your money back
using our Essay Writing Service!
If the costs are known, the organisation could further evaluate the costs and workout in option that could help to reduce the costs. For example the company could consider replacing the permanent labour with Temporary labour of reducing the labour hours when the production is low. Likewise they could evaluate the costs incurred for Material and Expenses and control the costs.
As discussed above if the costs incurred are known by the organisation they could plan in advance. The planning could help the organisation to avoid any surprises and ensure production achieves the best in output and costs.
Costs are a key factor in any organisation's decision making process. Major decisions are made based on the costs. For example if an organisation finds out using a machine would be cheaper than labour, and if it's viable they may consider automating the processes in the organisation and so on.
Costing methods vary organisation to organisation and with the time the costing methods used in the past have been vanished or modified over time.
Few costing methods used in practice can be defined as,
Activity Based costing
Absorption costing and
In regards to the above mentioned costs, standard costing was one of costs that have been debated over time of its use and whether it's suitable in the current production environment.
The term standard costing implies the budgeted unit cost for an item. Standard costs represent the planned costs of a product and are generally established well before production begins. The establishment of standards thus provides management with goals to attain (i.e., planning) and bases for comparison with normal results (ie control). In a way standard costing is like a budgeting process. But still the standard costs are calculated as cost per unit rather than cost for all like the budget. In the current business environment the standard costing process is advantageous in many different aspects like inventory costing, cost control, budgeting, pricing and keeping records. According to Brown (2010) there is an extent to which the standard costing could apply in the modern business world. As the technology is changing, the changing requirement of the consumers and the reduced life cycle of the products are increasing the importance of the importance of the standard costing.
Standard costing is setting up a cost based which can be used as a yardstick to measure the actual performance, ie Standard costing methods will be used to find out the expected costs that should be incurred in material, labour and overheads for a batch of goods. These standard costs will be measured against the actual costs incurred for the same. The difference in expected costs and actual costs will be compared to find out whether the results are better or worse. If the actual costs are more it's considered the production was inefficient and vice versa.
These differences are known as Variances. These variances are further analysed to find out whether these are favourable or adverse. If adverse the organisation investigates to find out why the actuals exceeded the standards and work on methods to control these costs to ensure the organisation does not make a loss.
Standard costing in Modern Business Environment
Always on Time
Marked to Standard
The business environment is changing and the requirements of the society and increased competition in the market has put the organisations under pressure to perform better for survival. This is apparent in almost all the industries and more specifically for the organisations in the manufacturing environment.
Costing is a key for the manufacturing organisation to find out how the organisation can supply a quality product with low costs to increase the wealth of the organisation. There are various methods of costing used by organisations, and one of them would be the Standard Costing.
In the current environment the production methods have significantly improved, mainly in the developed countries. The competition is high and selling price has become one of the key in gaining the competitive advantage? In a modern business environment of this nature how can standard costing contribute?
It could be argued that standard costing is simply budgeting the costs and comparing it with the actuals. It's accepted the variance analysis does help to put some controls, by evaluating the variances. However the million dollar question is how the costs can be determined in advance? On what basis this could be done?
In modern environment there are various production methods have been introduced and just relying on Standard costing will not going to help.
A recent report issued by KPMG in association with CIMA states, that Standard Costing is still used by organisations all over the world. However the issues in using standard costing can be identified as,
Calculating the prices
Different countries use different methods of calculating the standard costs, which makes comparison inconsistent.
Standard costs are not updated continuously, ie historical costs are being used which provides wrong information
Standard costs are not used correctly.
Even though there are lots of changes in the Modern Business Environment, Standard cost method still remains as one of the concepts used heavily. However the following changes are to be incorporated into the Standard costing to ensure the use of Standard costing is actually worth using.
Serious consideration should be given when the standard costs are considered and the costs are to be updated with the changes in the market.
Standard cots should be used carefully in making decisions. Decisions made on pure cost basis could be wrong.
Standard costs should be used carefully as to not to promote inefficiency. If the standard costs allow more labour hours and more materials, this could prompt inefficiency in the production function.
The variance analysis should be used and the main focus should be on the costs which can be controlled.
In summary, even though there are various methods of costing and production methods have been introduced in the modern business environment Standard costing still lives, but the above said points to be considered to ensure use of Standard costing is still useful in a modern business environment.
Is Standard costing relevant in 21st century?
The world is changing rapidly and globalization has become inevitable. The changes have influenced in all aspects of Finance and Management Accounting. Now most of the countries have started using the International Accounting standards.
The changing requirements of the people and the advance in technology in the 21st have created a need for a good planning. The Victorian standard cost model developed for the treasury in 2006 to estimate the administrative costs was considered as one of the most efficient models. ( The Department of Treasury and Finance, 2006).
In the 21st century the focus has been moved and the consideration is not made purely based on costs. In addition to the costs the value addition has become an important factor. Costing methods used should not just assist in making a cost savings or control costs, but also should add value to the products and the production process. With this is mind several modern costing methods have been introduced, and few of them are,
Business Process Re-engineering
Total Quality Management ( TQM)
Just in Time ( JIT)
Activity Based Costing
And Balanced Score Card
Though some people believe the above mentioned methods are more advanced, still in many firms standard costing and variance analysis seem to be the main accounting methods used worldwide. According to Marie et al (2010) the studies carried out in the developed countries indicate that 3% of the companies in UK, and 86% of in Japan still use the standard costing method, According to Kaplan and Atkinson (1989) standard costing in mainly used for to purposes 1) allocating manufacturing costs during cost of goods sold and inventories.2)providing useful information for management decision making.
This Essay is
a Student's Work
This essay has been submitted by a student. This is not an example of the work written by our professional essay writers.Examples of our work
Hence it could be argued, even though there are various costing methods being introduced, Standard Costing has become inseparable when Management Accounting is considered. The changes embedded in to the Standard Costing methods will ensure the Standard costing methods will be used by the businesses in the foreseeable future.
Standard costing by George Brown and some other authors.
According to Gupta(2007) standard costing is a tool of cost control which determines the standard cost of a product or service , compares it with the actual cost and eliminates any variance.
George Brown, Drury and Sakurai are few of the few of the key players involved in analysing the Standard Costing and the use in the current environment.
H.J Wheldon(1978) explains standard cost is a method of deriving statistics whish show the actual cost of the product, standard cost of the product and the difference between these which is called variance.
They argue with the change of need of the customers, the sophisticated product requirements, shorter product life cycles, increasing competition and the growth of technology the organisations have been compelled to make changes as the way they operate and the costing systems they use. The main systems in use can be identified as Just in Time, Total Quality Management, Value chain and Activity Based costing. These methods concentrates more in reducing costs, adding value to the products or services and continuously improving both . These are useful methods when the products are made in accordance with the customer's expectation and frequently changing needs. Even though these methods deviate from the way standard costing works, standard costing is still useful for the following functions in a Manufacturing environment.
As per their discussions they mention one of the drawbacks of the standard costing is the way variances are interpreted. If the variances are interpreted in a wrong way this could end up in making wrong decisions. For example a change to a material mix to ensure quality product is supplied may show an adverse variance and this could suggest the company has performed bad, but this is not the actual case as if this change has not happened it would have been more detrimental to the organisation.
They suggest the best way is to use the standard costing in conjunction with other modern methods of Management Accounting. A good example would be to find the target price for a product and trace back the cost for the product. This cost should be compared with the Standard costing. If a negative variance exists, the organisation should work on methods to minimize the losses by improving the processes or increasing efficiency. In summary they stress that Standard Costing is not going to demise in the near future as it's one of the base for all the modern Management Accounting principles. However this should be used with other methods and continuously improved for an organisation to achieve its goals.
Arguments for standard costing, using empirical evidence
Needles (2007) explains standard costing as a useful tool for the management as it is based on the realistic figures of costs. This is widely used by the management to control the costs and develop budgets.
It could be argued, with the changes in the economy and business environment the standard costing is nothing other than a method in demise. However a recent study carried out shows a different finding. As per the finding a survey by Business today from 113 large sized companies in India, 53% out of the 77.36% respondents confirmed they are using Standard Costing. Waldron and Everett, 2002 confirms the Indian practices similar to the situation in US.
The finding also confirms that over 75% firms in USA, UK, Ireland and Sweden use Standard Costing. (Cornick et al.,1998; Clarke and Brislane, 2000; and Ask and Ax, 1997 in Anand et al.)
As per a research carried out by Attiea Marie, Walid Cheffu, Rosmy Jean Louis and Ananth Rao and the article published in the Management Accounting Quarterly Magazine 2010, the following facts have been found.
The research was carried out in Dubai and this research contradicts the arguments that the standard costing is in demise.
The following chart is from the research done in Dubai, which clearly says what percentage of companies still wants to use the Standard Costing.
As per these empirical studies Standard Costing is still an important Management Accounting principle and contributes to the following factors,
Standard Costing helps to manage the Inventory costs by monitoring the materials prices and usage and variances of great help to monitor and control
Standard costing is very important in building up the budgets.
Most of the companies are sensitive to variances and variance analysis is a key factor for most of the organisations to control the Materials, Labour and Overheads.
Standard costing is simple to use and an affordable method by most of the organisations.
Standard costing is flexible and can be easily adopted by any organisation.
Standard costing can be used with other modern accounting methods to monitor and control.
Arguments against standard costing using empirical evidence
Though standard cost is considered as one of the efficient methods there are drawbacks in this method too. "Developing a standard cost involves judgement and practicality in identifying the material and labour types, quantities and prices as well as understanding the type s of organisational overhead and how they behave"(Kinney & Railborn, 2008).
A recent survey carried out by KPMG in UK covering the 12 large fortune 500 companies in the Pharmaceutical, Consumer goods and Industrials, in association with CIMA has found the following against the standard costing.
Standard Costing is overused in several occasions as a decision making tool
Organisations do not clearly understand for which areas the standard costing should be used and to which extent. Overusing standard costing in decision making will end up in wrong decision being made in several key areas.
There is no one global way of using standard costing and variances. This will create issues in comparisons. This comparison issue will cause issue in benchmarking and questions the validity of using Standard costing in growing globalisation?
Due to the increased economic volatility it has become an important factor to update the costs. However the lack of continuous updates in the standard costing virtually invalidates the use of standard costing.
Different overhead absorption methods are used by different organisations. This will create issues in having the correct standard costs.
Focus is on Controllable costs only
When standard cost is considered, most of the organisations are concerned only about the costs that can be controlled. This will leave out the other costs. Also the argument exists how the controllable and non- controllable costs are identified? It could be an ad hoc process and might not give the correct information.
How Standard Costing has changed over time
Standard costing is used by the organisations for a long time. Over time the Management accounting principles has changed and most of the old Management Accounting principles are not in use with the introduction of new methods. However standard costing has survived over time and the demise is not closer either.
Standard cost has significantly changed over time. One of the negative factors was the reactive nature of the standard costing and providing the historic results. However this has changed over time and standard costing now works alone or works with other methods. The costs are changed according to the market conditions and variances are interpreted with care. The cost is not purely considered, in addition other factors such as adding value in to the product and services have been taken in to consideration when variance analysis is carried out.
Using historical costs was another issue with the old style standard costing. However over time this has changed with the flexibility of the standard costing systems.
Overall Standard costing is getting popular again despite other sophisticated methods are being introduced.
Pros & Cons of Standard Costing
Standard costing is considered to be a very good aid in budgeting as it uses historical data and factors from the environment when deciding the costs. When the actual data is still not available it could help to set prices for any projects. It is a good decision making tool.
The standard costing method helps maintain the book keeping as it is an easier way to allocate the costs for any object. There is no need to record the changes in the costs as well. This is also a very simpler method in stock keeping compared to the weighted average costing method and First in first out methods.
Standard costing also helps the management to concentrate on critical business needs. Their concentration will be needed only when the performance goes done.
This technique becomes a very useful one for employees when they realise and accept the performance standards this provides. This could help the organisation to be conscious about the costs and provide an incentive for the employees.
The standard costing method also helps the organisation to make a person responsible for the accounts and for a certain are. This could be an advantage when actual costs have to be calculated.
Same as the good things about the standard costing method there are various drawbacks of it as well.
Sometimes standard costing could act in adverse as well. The employees and the management could have a conflict of interest in the standards used.
The actual costs will not be always the same as the standard costs. The resource prices, their availability, time of the year and inflation could influence in the change of prices. So standard cost is not a method a business can fully depend on, unless the costs are updated to reflect these changes.
Variance analysis is important element of Standard Costing. If this is not interpreted correctly that could express wrong messages and the organisation could make the wrong decisions.
Despite the criticism about Standard Costing, it's still a highly valued Costing method by a large number of companies all over the world. Until the budgets are used to control the costs and revenues, standard costing will remain in the market.
With the era of using standard costing with other modern techniques, its apparent the Standard costing will have a long life, even though Standard Costing will have to adopt to the changes in the Modern Business Environment.