Advantages of Standard Costing: In Accounting, you have heard the word many times ‘Standard Costing’. The term brought a positive change in costing. It changed the way of costing. But before knowing about Standard costing and its benefits, let’s have a look about the term Standard Cost.
What is Standard Costing?
Standard cost is termed as the expected cost per unit of a product, produced during a certain time, based on several factors. It helps in measuring the performance and controlling the deviations. And during the time of quotation it decides the selling price of the product.
Standard cost is Widely considered as a powerful management tool for a manufacturer.
The three main factors that determine the Standard cost are: Material cost, Labour cost and overheads.
In simple words, Standard costing can be termed as a costing method that helps in the preparation and use of standard cost. A costing method used to compare the standard cost with the actual cost, to find the difference between costing and its causes, and report it to the management for its improvement.
It has to undergo a set of processes, and afterward it is implemented for the betterment of the costing system. Below is the process of Standard costing, its implementation and establishments.
Process of Standard costing
Building Standard: First of all on the basis of estimate and cost accepted by the management and production engineer, standards are established. During the time of standard cost building past data, present plan of production and future plans are observed carefully.
Deciding actual cost: After the establishment of standards, actual cost for material, labour and overhead is decided.
Comparing standard cost and actual cost: After deciding the actual cost of each element, it is compared with standard cost to observe the differences.
Determining the cause: During the comparison of standard cost and actual cost, if a difference is observed in costing, the next step is to determine its causes to take right action.
Disposing the difference: Last step of this process includes disposing of the costing difference by transferring it to a profit and loss account.
Due to the wide fluctuation in the market, the costing system was getting old and inappropriate for the firms and then it needed the standard costing system. The old costing system was failing to explain the causes of increased cost or any changes in costing. Standard costing system was implemented because of its salient features.
Below are some of the major advantages of standard costing provides:
Advantages of Standard Costing
Budget: Since standard cost is predetermined, it helps in preparing the budget more accurately using the standard costing system. It can also assess staff’s performance on the basis of these budgets.
Guidance: During the time of price formulation and production policy establishment, standard costing helps the management in every possible way. It also guides the management detecting ineffective areas and processes within the firm.
Cost control: Standard costing identifies the cost of a single unit of a product. If the differences of costing is observed and analysed regularly, it would lead to more effective cost control.
Standard for all its elements i.e. labour, product and overhead is predetermined so it helps in growing the firm’s productivity, which leads to reducing the cost and increasing the profit.
Formulation of price: Old costing system used to calculate the price of a project after their incurrence, but by using standard costing the price can be calculated beforehand. It helps the company dealing with a certain project, as it calculates the estimated project cost using standard cost and then adds up the margin.
Account valuation: If the actual cost of a product is changing day-by-day, a firm should also update its standard cost regularly. With the help of standard costing a firm can value its account and can set the allowance of their employees. By valuing their stocks at a standard cost, firms can reduce their profit irregularity.
Performance check: By using standard costing firms can easily check their business performance. By comparing its actual result with the target set by standard cost, a firm can easily highlight its achievement and challenges also. It can be used as a feedback tool, a firm can solve its problems by taking right action against its wrong steps on time.
Despite having so many advantages, standard costing has some problems also. Let’s take a look at the problems faced by the firms using standard costing:
Disadvantages of Standard Costing
Not allowed in cost-plus contract: In cost-plus contracts, firms are paid for the project on the basis of actual cost not the standard cost. Standard costing is not allowed in cost-plus contracts, because standard cost varies compared to actual cost of the project.
Gives slow feedback: Due the complexity in calculations,standard costing is a slow feedback giver. If the firms immediately want their business problems feedback, it might disappoint them, as its reports are too late to be useful.
Sometimes it’s costly: Due to its requirement of high technical skill, sometimes it’s costly. Due to their limited budget, sometimes small firms are unable to introduce this system in their businesses.
Keep changing: If actual cost is changing regularly, then standard cost should also be changed frequently. Standard cost should be changed very correctly, sometimes it creates a lot of problems while changing, especially in the accounting system.
Sometimes demotivates: Standard cost should always be formulated correctly. If it is too high, it can demotivate and affect the morale of a firm’s employees.
Non-realistic: Since actual cost is real but standard cost may not be realistic in nature, making it difficult for the firms to gain profits and motivate their employees at the very same time.
All sides of standard costing are covered in this article: the term, its process, its advantages and disadvantages also. But it’s true for a firm to gain more profits using standard costing methods.