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Standard costing is one of the methods used to aid the control of business operations and costs. It is geared towards waste elimination and the creation of performance efficiency. This is achieved through the formulation of cost plans or the setting up of standards. The definition of standard cost by CIMA is "a predetermined cost which is calculated from management's standards of efficient operations and the relevant necessary expenditure." The predetermined costs are on technical estimates such as overheads and material labor for a given span of time and also for prescribed set that accompanies the working conditions. In a nutshell standard cost may be defined as planned cost that is put on a product or service rendered (Paul & Samuel, 2007).
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Strengths of Standard Costing System:
It helps managers focus on vital issues. This is because the standard costing system is a form of management by exception treatment. It allows managers to focus on important issues in that they are alerted when the costs fall outside the standards (Flamholtz, 2005). This helps managers know when there exists problems that require their attention. In general the standards help the managers put their focus on vital issues.
It helps promote efficiency and economy. The standards do this since they provide benchmarks that enable individuals to judge their performance. When individuals are able to rate their performance then their efficiency is improved. This is facilitated since they are able to see their strengths and weaknesses. They are able to capitalize on their strengths and work on their weaknesses (Flamholtz, 2005).
It enables the simplification of bookkeeping. It does this since it facilitates the recording of actual costs that pertain to each and every job. It also enables the recording of the following costs; labor, costs of materials and overhead costs (Webster, 2000).
Standard costs facilitate accountability and fit naturally in the integrated system of responsible accounting. The standards stipulate what the costs should be, the person who should be responsible for the stipulated costs and the costs that are within control.
Disadvantages of Standard Costing System:
The shortcomings of Standard Costing stem out from their being used in situations in which they are inappropriate. They may also stem out from the management by exception approach or from their improper use.
Reports on standard cost variance are more often than not made on a monthly basis and are usually released weeks or days past the end of the month. As a result of this the data on the reports may be useless since they have already become stale. It has been noted that reports which are generated frequently and on a timely basis are approximately correct than those which are generated infrequently and are precise (Langfield & Thorne, 2006). The infrequently generated reports are more often than not out of date and usually are incorrect by the time they are released.
Below are some of the weaknesses of the use of Standard costs;
In the event managers are insensitive and when they make use of variance reports in the form of a club the morale of the workers may suffer. It is noted that employees work better when they get positive reinforcement for the work that they do very well. Management by exception on the other hand focuses on the negative (Ghosh, 2005). In the event variances are made use of like clubs then subordinates will be tempted to cover the unfavorable variances or they may also take actions that may not be favorable to the organization. For instance the workers may put in a lot of effort to increase their output at the last minute so as to avoid unfavorable labor efficiency. This they may do but it may result in the production of sub-standard goods or services.
It has been noted that efficiency variances and labor quantity standards make the following assumptions; production process is paced by labor and that labor is a variable cost. Labor paced implies that labor and output are directly proportional. This assumption does not stand as output is determined by the machines processing speeds. The second assumption also does not stand as direct labor may be fixed and also that undue emphasis exerted on labor efficiency variances results in build up of pressure in the finished goods and work in process inventories.
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There are also instances whereby "favorable" variance is worse than "unfavorable" variance. For instance, McDonald's has a stipulated amount of meat that should be out in the Big Mac. A "favorable" variance would imply that less meat would be most appropriate than what is put on the Big Mac. The result would be a substandard Big Mac and thus a dissatisfied customer.
Standard costing lays emphasis on meeting standards than on meeting objectives such as the maintenance and quality improvement, customer satisfaction and on time delivery. However the aforementioned tendency can be reduced by the use of supplemental performance tendencies that lay emphasis on the other objectives.
It has therefore been noted that just meeting standards may not be enough but constant improvement may be important so as to ensure survival in the prevailing competitive environment. Based on this reason, a number of companies focus on standard cost variances patterns that aim for continual advancement rather than the bear meeting of standards. In other companies, the engineered standards are being replaced by rollingtt typical actual costs that is expected to reduce or by the use of numerous challenging costs (Paul & Samuel, 2007).
It is therefore advisable for managers to be careful with the use of standard costing system. The managers should go out of their way to put emphasis on the positives rather than the negatives. They should also be aware of the unintended consequences.
The standard costing system is found in a large number of manufacturing companies and also in service companies. Nevertheless their use is changing. The system is being replaced by the use of a balanced scorecard.