Management by Exception The standard costing is an example of management by exception. By studying the variances, management’s attention is directed towards those items, which are not proceeding according to the plan. Most of the management’s time is saved and can be directed to other value adding activities. Management only concentrates on the ‘few’ exceptions reported.
- Cost Reduction The process of setting, revising and monitoring standards encourages reappraisal of methods, materials and techniques thus leading to cost reductions. Analysis of unfavourable variances directs cost analysis to factors that are making costs to exceed the budgeted costs thus these factors can be controlled, leading to cost reduction.
- Pricing Standard costs serve a s a reliable base of calculating total cost of producing a good or service, to which a margin can be added to determine the selling price.
- Inventory Valuation Standard costing makes inventory valuation much easier, if the actual number of physical units in the inventory is known, then the inventory value is simply determined by multiplying the standard cot per unit by the physical units.
- Motivation A properly developed standard costing system requires the full participation of all management levels (upper, middle and lower levels) and the employees. This creates motivation for the employees as they feel part of the system.
- Cost Control A well implemented standard costing system acts as a yardstick against which all costs are measured to determine whether the variance from the standard is favourable or unfavourable. This creates cost consciousness in the organization and in the end enables the organization to control costs.
- Budgeting is made easier One of the greatest benefits of standard costing is to be found in setting budgets for the organization and its departments. As earlier illustrated once the desired output units are known, then the budgeted cost is simply the output units desired multiplied by the standard cost per unit.
i.e. Budgeted Cost = Output units x Standard Cost per unit
- Performance Evaluation is Simplified As already noted, standard costing creates a cost consciousness in the organization so that any cost can be easily evaluated whether it has favourable or unfavourable variance, so that appropriate corrective measures can be taken. Once budgets are prepared and agreed upon (anticipatively), and employees performance can be acceptably measure against the set standards to determine whether the performance is acceptable or not: appropriate corrective measures (punishment or reward) can then be acceptably taken by the management.
Disadvantages of Standard Costing
- The system of standard costing is expensive to install A lot of money is spent in studying output requirements in terms of labour, materials and overheads.
- Time Consuming A lot of time is also spent in developing and installing reliable standard costing systems.
- Obsolescence: In fast changing conditions (e.g. inhyperinflationary economies where prices of labour, materials and overheads change rapidly), standards become out of date quickly. They therefore lose their control and motivational effects.
- Hard to Understand Some standard costing systems are overly elaborate and are therefore not well understood by line managers and employees. This makes their implementation difficult.
- Effectiveness depends on Environment For standard costing systems to be effective in cost control and performance evaluation, then a participative and democratic management style is required. The top management and employees need to be committed to attaining the set standards of performance. An effective and efficient management information system is also required so as to provide employees and managers with reliable, accurate and timely feedback regarding their performance. Lack of one or more of these requirements frustrates the success of a standard costing system so that its effectiveness cannot be realized.
- It is Subjective As we have already seen, there are several types of standards that an organization can adopt (basic, ideal, attainable and cement). What is therefore a standard in an organization depends on its management. It is also important to note that what is referred to as a significant variance depends on the organization’s management, thus the subjectivity. If this subjectivity is poorly managed, (for example, punishing employees for insignificant unfavourable variances of for variances arising from factors beyond their control), then a standard costing system can lead to employee frustration and poor goal congruence in the organization.
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