Question

Is Standard costing still a useful tool for the Management accountant? How could it be adapted to suit the service sector?

Answer 1

Standard costing is a useful tool for the management accountant

A standard cost system can be valuable for top management in planning and decision making. More reasonable and easier inventory measurements A standard cost system provides easier inventory valuation than an actual cost system. Under an actual cost system, unit costs for batches of identical products may differ widely.

benefits that result from a business using a standard cost system are

• Improved cost control.
• More useful information for managerial planning and decision making.
• More reasonable and easier inventory measurements.
• Cost savings in record-keeping.
• Possible reductions in production costs

Improved cost control Companies can gain greater cost control by setting standards for each type of cost incurred and then highlighting exceptions or variances—instances where things did not go as planned. Variances provide a starting point for judging the effectiveness of managers in controlling the costs for which they are held responsible.

Assume, for example, that in a production center, actual direct materials costs of $ 52,015 exceeded standard costs by $ 6,015. Knowing that actual direct materials costs exceeded standard costs by $ 6,015 is more useful than merely knowing the actual direct materials costs amounted to $ 52,015. Now the firm can investigate the cause of the excess of actual costs over standard costs and take action.

Further investigation should reveal whether the exception or variance was caused by the inefficient use of materials or resulted from higher prices due to inflation or inefficient purchasing. In either case, the standard cost system acts as an early warning system by highlighting a potential hazard for management.

More useful information for managerial planning and decision making When management develops appropriate cost standards and succeeds in controlling production costs, future actual costs should be close to the standard. As a result, management can use standard costs in preparing more accurate budgets and in estimating costs for bidding on jobs. A standard cost system can be valuable for top management in planning and decision making.

More reasonable and easier inventory measurements A standard cost system provides easier inventory valuation than an actual cost system. Under an actual cost system, unit costs for batches of identical products may differ widely. For example, this variation can occur because of a machine malfunction during the production of a given batch that increases the labor and overhead charged to that batch. Under a standard cost system, the company would not include such unusual costs in inventory. Rather, it would charge these excess costs to variance accounts after comparing actual costs to standard costs.

Thus, in a standard cost system, a company assumes that all units of a given product produced during a particular time period have the same unit cost. Logically, identical physical units produced in a given time period should be recorded at the same cost.

Cost savings in record-keeping Although a standard cost system may seem to require more detailed record-keeping during the accounting period than an actual cost system, the reverse is true. For example, a system that accumulates only actual costs shows cost flows between inventory accounts and eventually into the cost of goods sold. It records these varying amounts of actual unit costs that must be calculated during the period. In a standard cost system, a company shows the cost flows between inventory accounts and into the cost of goods sold at consistent standard amounts during the period. It needs no special calculations to determine actual unit costs during the period. Instead, companies may print standard cost sheets in advance showing standard quantities and standard unit costs for the materials, labor, and overhead needed to produce a certain product.

Possible reductions in production costs A standard cost system may lead to cost savings. The use of standard costs may cause employees to become more cost-conscious and to seek improved methods of completing their tasks. Only when employees become active in reducing costs can companies really become successful in cost control.

Standard costing to suit for the service sector

Standard costing differentiates product costs and period costs. Product costs are associated with product manufacturing, while period costs aren't directly associated with any product. For a service company, product manufacturing is equivalent to delivering a specific service.

The service sector follows a different approach to pricing their service. Although service has no physical existence it must be priced and billed to customers. Most service organizations use a form of time and material pricing to arrive at the price of a service. Service companies such as appliance repair shops, automobile repair businesses arrive at prices by using two computations, one for labor and other for materials and parts. As with a cost-based approach a markup percentage is used to add the cost of overhead to the direct cost of labor, materials, and parts. If materials and parts are not part of the service being performed, then only direct labor costs are used as the basis for determining the price. For professionals such as accountants and consultants, a factor representing all overhead costs is applied to the base labor costs to establish a price for the services.

The service industry is highly competitive and, as a result, service providers are always looking for more efficient ways to operate that will reduce their overall costs. One of these is cost accounting. While this method of accounting was initially developed for the manufacturing industry, it has been adopted by various sectors of the service industry and has proven useful.

significant costs which are incurred in service sectors are :

(i) Direct labor

(ii) Service overheads