Advantages And Disadvantages Of Standard Costing Technique

Advantages of Standard costing technique

There are various cost accounting techniques which are followed by different organizations. Standard Costing can be defined as a cost accounting technique with which an expected cost is substituted for an actual cost in the accounting records and then variances showing the difference between the expected cost and actual cost are calculated and recorded in the books. This accounting technique is being used by many manufacturers for the identification of variances between the actual cost of the goods being produced and the cost that should have been incurred for producing such goods (Axelsen, Green, & Ridley, 2017). Standard costing disclosed the deviation in the cost from the standards set by an organization and helps in clarifying the causes of such deviation so the matters in regard to which remedial actions are required to be taken should be informed of to the management. So, basically standard costing technique involves the following steps: firstly, the ascertaining and applying standard costs; secondly, evaluation of actual cost; thirdly, determining the variances on the basis of comparison of standard cost with the actual cost; fourthly, analyzing the resulting variances; and lastly, on the basis of variance analysis, determining the appropriate measures that are required to be taken (Bailey, Collins, & Abbott, 2017). The main objective of standard costing is to help the management in taking correct decisions on various aspects of business like, price fixation of goods produced, decisions in relation to make-or-buy which will prove more beneficial to the organization, along with ascertain the evaluation of performance and it also helps in implementing proper system of budgetary control in the operation of an entity. The standard cost system of accounting has both advantages as well as disadvantages. The same has been discussed in brief below in this report. But even after the shortcomings faced by the standard cost accounting technique, it has been adopted as the system of cost accounting by many industries widely. We have taken the bas of two journals on standard cost accounting system for a better research. Both the journals have been studied comprehensively and the leanings from those are also discussed in this assignment.

There are various advantages of standard costing technique, which are discussed below:

1. It helps an organization in implementing proper budgetary control system for smooth functioning of the business,
2. It helps the management by acting as a control device,
3. It acts as a guide in several function of the management by helping in price formulation and policies relating to productions, etc.(Bromwich & Scapens, 2016).
4. Standard costing focuses on the variances in different costs, the analysis and measurement of which helps the management to detect the mistakes and inefficiencies and investigate the reasons behind them.
5. Standard costing is very useful for the purpose of budgeting and planning as these costs are predetermined. It helps in estimating the effect of any changes in the relationship of cost-price-volume thereby assisting the management in future decision making.
6. This system of costing helps the management in the prompt preparation of profit and loss account for short period in order to analyse the business trends by the management for prompt decision making(DeZoort & Harrison, 2016).
7. This system of cost accounting also helps in the proper evaluation of the performance of the staffs in different cost centres with the use of calculation of various types of variances.

Apart from the advantages discussed above, standard costing technique suffers from few drawbacks as well. These drawbacks are as discussed below:

1. The variance analysis that is stressed upon by this technique helps in the allocation of mistakes. However, the liability of the executives are only limited to those actions which are found to be actually controlled by them. In order to properly allocate the liability of responsibility, it is necessary to first segregate the variances into the controllable and non-controllable portions, which to be honest, is an uphill task and many a times the staff responsible for doing so is reluctant. As it increases the work load.
2. The standards are generally based on the entity’s average past result, maximum theoretical efficacy or its obtainable good yield, which are either too radical or too firm. There is adverse effect on the motivation and morale of the employees if these standards are too high, as it becomes difficult to achieve and thus creates undue pressure on the employees. Sometimes the management set standards which are very high and practically impossible to be achieved, this lowers the confidence and morale of the staffs(Dan, 1995).
3. Change is a constant phenomenon. The business condition of an organization keeps on changing as a result of which the standards are always changing. There is great requirement of constant revision in the standards so that the actual results are in fact comparable with the standards. The constant revision of the standards poses various problems, especially in adjustment of inventory. Also, the requirement of revising the standards on a timely basis adds up to the cost of the organization and it also requires management’s full time and attention, which the management are not always prepared for.
4. Standard costing is an expensive technique, since the degree of technical skill involved with such costing technique is very high. Moreover, the regular updating requirement also increases the cost of an organization, along with the cost involved in implementing it in the very first time(Dan, 1995).  Therefore, small and medium sized organization cannot afford to introduce this system of cost accounting as their financial resources are limited. However, the benefit of such technique is will be very high as compared to the initial cost involved, in case this technique of cost accounting is once introduced.  

The two journal articles which have been considered here for discussion on the given topic are “Standard Costing Games that Managers Play” by Calvasina, Richard V and Calvasina, Eugene J and “How to Tell If Standard Costs are Really Standard” by Barnes, John L.

The first journal paper emphasizes on the matters relating to the demerits of standard costing techniques and that the damage caused by it to the managers by providing misinformation are more than the advantages it is believed to give to the organization. In the end the main sufferer of the system is the corporation (Calvasina & Calvasina, 2017). The second journal emphasizes on the evaluation of the evaluation of improvements in the standard costing methodologies in a textile industry. It focuses on the updating of worn out methods and procedures of standard costing in order to keep this system of cost accounting going. 

Disadvantages of Standard costing technique

The objective of the first case study is to draw attention towards the flaw of standard costing techniques. The author has initially discussed the there are three basic functions of standard costing technique, these are: firstly, the collection of actual costs of the manufacturing operations; secondly, determination of the achievement of the above manufacturing operation and lastly the performance evaluation from the standard by the reporting of variances. The managers places heavy reliance on such data for detecting those areas the performance of which are not in compliance with the budget and to keep a check on the cost centers to ensure that they are running efficiently to achieve the goals set by the organization during the planning stage. The author has discussed the standard costing technique in reference various games, the first one of which is “Everlasting Standard Game”. Under this game the author has discussed the situation in case of the companies which are either small with nonexistent department of industrial engineering or those the managers of which are under a notion that implementation of standard costing technique is one time process and once implemented, no revision in standards are required (Barnes, 2015). The standard quantities of material and labor which was set during the formation of the company was not revised for years and after number of years revision was done only in respect of labor and material cost ignoring any revision in the requirement of material quantities and labor hours. This results in the manager’s reluctance to review the reports since the same data is being produced without any value addition to the standards which are conventionally followed by the organization. Consequently, the efficiency variance and material variance are outdated. The second game is the “Unbreakable Schedule Game”, as per which the standard costs are revised but only on the scheduled time set for such revision. No consideration is being given to the major changes in the costing or production techniques that are occurring between the dates set for revision (Choy, 2018). Due to the rigidity of the system, again as per the first game, the variances calculated are misleading. This type problem is witnessed in those companies the management of which does not want to spend much time on the accounting function of the company. The third game is named as the “Methods Change Variance Game”, the main objective of the adoption of this game is to uproot the problem associated with the labor efficiency variance. This labor efficiency variance is being calculated to reflect the difference between the labor efficiency based on the old standard that is currently followed by the company and the labor efficiency variance that would have been calculated based on the new standard, if it was currently employed. Both the reports of variances are then presented to the manager (Dichev, 2017). The cost in relation to the preparation of both reports is not fully evident. The fourth game is the “Material Mix Game”, this is basically the other version of the method change variance game, and the only difference is that it is in respect of material mix variance. Under this strategy, in the manufacture of a product a combination of different ingredients is used and the quantities of each raw material are specified. Only the total amounts of the ingredients are reduced with a change in their proportion. As a result of which the material mix variance turns out to be favorable. The fifth game is the “All Encompassing Standard”, this is a little different version of the material mix game. Under this game, the company produces a variety of products which are identical on outside but differ in its uses. The average costs of the products are kept same as per the cost card but the proportions of the ingredients are calculated on the basis of strength that is provided by each product (Kew & Stredwick, 2017). In this game, the material mix variance will appear as long as the strength of the product does not match the standard strength as per the cost card. The sixth and the last game is the “Full Figure Standard Game”, in this game the company adds a little to the expected quantities of labor and material to ensure that the cost is met and the variances are favorable. This method is adopted so that the achievable standards are actually achieved by the organization.

Discussion on the two journals

In the second case the author focuses on the necessity of the continuous updating of the costing system, especially in the textile manufacturing companies. The author was the chief accounting and controlling officer in Graniteville Company. He discussed the system of cost accounting adopted by the company and the weaknesses observed by him in the system. He pointed out the basis questions faced by the team in respect of cost accounting. These were: the problems in respect of the cost accounting; the cost accounting goals and objectives of the company; and how the company should achieve its goals and objectives and also solve other problems, .the author has discussed the various goals and objectives of the cost accounting which involved that the system must have the capability to provide details which are accurate and reliable, it should the management with timely information at all levels (Trieu, 2017). The intracompany profit centers must be excluded from the cost system of the company and in considering the cost centers of the company all the activities must be included. The cost standards of the company are required to reflect along with the optimum practical operation of each plant, the goal for operating management, which is challenging and could be achieved. For the purpose of projecting the gross margin and evaluating the operations with the use of variance between the actual and projected costs, the information relating to the standard cost must be combined with estimated sales price (Naci & Hasan, 2012). For allowing the development of a standard inventory of carrying value by style there was a need for standard costing system. The author has also highlighted the areas which poses major problem in the system of cost accounting. These are in respect of the issues relating to documentation of the system of cost accounting, integration of general accounting system with the cost accounting system due to which the required financial data is not captured by the current general accounting system. The payroll and data collection system fails to provide accurate information which is required by the cost accounting system on a timely basis, .the author has also provided certain recommendations based on his study, these includes implementing various controls systems relating to payroll data collection and reporting; production reporting; dyes and chemicals; maintenance and capital expenditure, supplies and raw materials; and also the system of accounting followed must be updated on timely basis and the system should be analyzed by the project team (Jefferson, 2017). In view of the author, the system of cost accounting must be managed by a set of skilled staffs who can who can make efficient uses of this technique as the deficiencies in the people operating the cost accounting system is the worst system deficiency. Therefore, the management should set an objective of developing automated mechanisms in order collect data and for the purpose of inquiry so that the flow of basic information could be simplified by the elimination of clerical procedures associated with the process. The management should also develop an automated mechanism for the purpose of calculating variances, accurate cost estimates and revisions in the cost which are necessary for the changes in business environment.

The similarities between the two studies given below:

1. Both the case studies have emphasized on the updating of the standards of the standard costing system on a timely basis(Grenier, 2017).
2. In both the case studies the focus was on improvising the cost accounting system…

The differences between the two case studies are as follows:

1. We have observed that the first case study focuses more different approach that could be adopted in the standard cost while the second highlighted mainly on increasing the standards of cost accounting system.
2. The first case study has been discussed considering the application of standard costing system in any organization while the second has pointed the major requirements in a textile manufacturing company.

From the above case studies, there are number of things to be noticed and learned. The points noted would in fact be highly useful for the Australian Companies who have adopted or look forward to adopt the same. The major points to be learned from the first case study are discussed as follows:

1. The standards which are followed must be current and not outdated. The management should review and update the standards on a continuous basis instead of waiting for the dates set for revision of standards. The revision of standards should be based on any major changes that occur in the costing system(Kim, Schmidgall, & Damitio, 2017).
2. The standards followed must be relevant. When there is any change in the layout of plant as per the decision of the management, then the cost card relating to the material mix or the procedures followed to produce a product must be changed too. If the same is not changed as per the plant layout then the value of inventories as well the reports on performance provided will be invalid and misleading.
3. The standards followed must be realistic and not ambiguous. The standards set for overheads like material, labour and manufacturing overheads must not be rigid. The point is that the standards set should not be such which cannot be achieved.
4. Standards set should be used in a positive way. The standards must not be too strict. The reason behind unfavourable variance should be analysed. Moreover, favourable variances do not always indicate profit. It should be ensured that the standards set are correct(Kuhn & Morris, 2016).
5. Standards followed must be based on future. The standards should be set keeping in mind the past performance but it should be aimed towards future prospects. This is one of the reasons why the standards should be updated on a continuous basis.

From the second case study the key points which might be useful for the Australian companies are listed below:

1. The textile manufacturing company, Graniteville Company has face some major issues relating to the cost accounting system, the same has been overcome by improvising the system by automating and documenting the system of cost accounting; formalizing a project team for the development of standard cost accounting system(Schoenberger, 2016).
2. The project team allocated to the standard cost accounting system of the company should prepare a test cost ledger and report formats constituting the budget standards  

References

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Bailey, C., Collins, D., & Abbott, L. (2017). The Impact of Enterprise Risk Management on the Audit Process: Evidence from Audit Fees and Audit Delay. Auditing: A Journal of Practice & Theory, 37(3), 25-46.

Barnes, J. L. (2015). How to Tell If Standard Costs are Really Standard. Journal of Management Accounting Research, 25(3), 130-143.

Bromwich, M., & Scapens, R. (2016). Management Accounting Research: 25 years on. Management Accounting Research, 31(1), 1-9.

Calvasina, R. V., & Calvasina, E. J. (2017). Standard Costing Games that Managers Play. Journal of Management Accounting Research, 12(2), 33-65.

Choy, Y. K. (2018). Cost-benefit Analysis, Values, Wellbeing and Ethics: An Indigenous Worldview Analysis. Ecological Economics, 145. Retrieved from https://doi.org/10.1016/j.ecolecon.2017.08.005

Dan, S. (1995). The benefits of activity-based cost management to the manufacturing industry. Journal of Management Accounting Research, 7, 167.

DeZoort, F., & Harrison, P. (2016). Understanding Auditors sense of Responsibility for detecting fraud within organization. Journal of Business Ethics, 1-18.

Dichev, I. (2017). On the conceptual foundations of financial reporting. Accounting and Business Research, 47(6), 617-632. doi:https://doi.org/10.1080/00014788.2017.1299620

Grenier, J. (2017). Encouraging Professional Skepticism in the Industry Specialization Era. Journal of Business Ethics, 142(2), 241-256.

Jefferson, M. (2017). Energy, Complexity and Wealth Maximization, R. Ayres. Springer, Switzerland . Technological Forecasting and Social Change, 353-354.

Kew, J., & Stredwick, J. (2017). Business Environment: Managing in a Strategic Context (second ed.). London: Chartered Institute of Personnel and Development.

Kim, M., Schmidgall, R., & Damitio, J. (2017). Key Managerial Accounting Skills for Lodging Industry Managers: The Third Phase of a Repeated Cross-Sectional Study. International Journal of Hospitality & Tourism Administration, , 18(1), 23-40.

Kuhn, J., & Morris, B. (2016). IT internal control weaknesses and the market value of firms. Journal of Enterprise Information Management, 30(6).

Naci, T., & Hasan, O. (2012). The Measurement and Management of Unused Capacity in a Time Driven Activity Based Costing System. Journal of Applied Management Accounting Research, 10(2), 43-55.

Schoenberger, E. (2016). Environmentally sustainable mining: The case of tailings storage facilities. Elsevier, 119-128. doi:https://dx.doi.org/10.1016/j.resourpol.2016.04.009

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