Question

What are five factors managers often consider when determining the significance of a variance?

What are various ways in which standard-costing systems should be adapted in modern manufacturing environment?

What are criticisms of standard costing in a modern manufacturing environment?

Answer 1

A standard cost variance is the difference between a standard cost and an actual cost. This variance is used to monitor the costs incurred by a business, with management taking action when a material negative variance is incurred. If actual cost exceeds the standard costs, it is an unfavorable variance. On the other hand, if actual cost is less than the standard cost, it is a favorable variance.

Factors that managers often consider when determining the significance of a variance are as follows

• the size of variances
• the extent to which the variances are recurring
• trends in the variances
• the controllability of the variances and
• the perceived costs and benefits of investigating the variances

Various ways in which standard-costing should be adapted in today’s manufacturing environment are as follows:

• Reduced importance of labor standards and variances: As direct labor occupies a diminished role in today’s manufacturing environment, the standards and variances used to control labor costs also decline in importance.
• Emphasis on material and overhead costs: As labor diminishes in its importance, material and overhead cost stake on greater significance.
• Cost drivers: Identification of the factors that drive production costs takes on greater importance in the cost management system.
• Shifting cost structure: Advanced manufacturing systems require large outlays for production equipment, which entail a shift in the cost structure from variable costs toward fixed costs. Overhead cost control becomes especially critical.
• High quality and no defects: Total quality control programs that typically accompany a JIT approach strive for very high quality levels for both raw materials and finished products. One result should be very low material price and quantity variances and low costs of rework.
• Non-value-added costs: A key objective of a cost management system is the elimination of non-value-added costs. As these costs are reduced or eliminated, standards must be revised frequently to provide accurate benchmarks for cost control.

Criticism of Standard Costing

The following are some of the criticism which may be leveled against the standard costing system.

• Variation in price: One of the chief problem faced in the operation of the standard costing system is the precise estimation of likely prices or rate to be paid. The variability of prices is so great that even actual prices are not necessarily adequately representative of cost. But the use of sophisticated forecasting techniques should be able to cover the price fluctuation to some extent. Besides this, the system provides for isolating uncontrollable variances arising from variations to be dealt with separately.
• Varying levels of output: If the standard level of output set for pre- determination of standard costs is not achieved, the standard costs are said to be not realised. However, the statement that the capacity utilisation cannot be precisely estimated for absorption of overheads may be true only in some industries of jobbing type. In vast majority of industries, use of forecasting techniques, market research, etc., help to estimate the output with reasonable accuracy and thus the variation is unlikely to be very large. Prime cost will not be affected by such variation and, moreover, variance analysis helps to measure the effects of idle time.
• Changing standard of technology: In case of industries that have frequent technological changes affecting the conditions of production, standard costing may not be suitable. This criticism does not affect the system of standard costing. Cost reduction and cost control is a cardinal feature of standard costing because standards once set do not always remain stable. They have to be revised.
• Attitude of technical people: Technical people are accustomed to think of standards as physical standards and, therefore, they will be misled by standard costs. Since technical people can be educated to adopt themselves to the system through orientation courses, it is not an insurmountable difficulty.
• Mix of products: Standard costing presupposes a pre-determined combination of products both in variety and quantity. The mixture of materials used to manufacture the products may vary in the long run but since standard costs are set normally for a short period, such changes can be taken care of by revision of standards.
• Level of Performance: Standards may be either too strict or too liberal because they may be based on (a) theoretical maximum efficiency, (b) attainable good performance or (c) average past performance. To overcome this difficulty, the management should give thought to the selection of a suitable type of standard. The type of standard most effective in the control of costs is one which represents an attainable level of good performance.
• Standard costs cannot possibly reflect the true value in exchange. If previous historical costs are amended roughly to arrive at estimates for ad hoc purposes, they are not standard costs in the strict sense of the term and hence they cannot also reflect true value in exchange. In arriving at standard costs, however, the economic and technical factors, internal and external, are brought together and analysed to arrive at quantities and prices which reflect optimum operations. The resulting costs, therefore, become realistic measures of the sacrifices involved.
• Fixation of standards may be costly: It may require high order of skill and competency. Small concerns, therefore, feel difficulty in the operation of such system.

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