Question

Standard costs facilitate management planning. What are the other advantages of standard costs?

Answer 1

Standard Costing Overview

Standard costing is the practice of substituting an expected cost for an actual cost in the accounting records. Subsequently, variances are recorded to show the difference between the expected and actual costs. This approach represents a simplified alternative to cost layering systems, such as the FIFO and LIFO methods, where large amounts of historical cost information must be maintained for inventory items held in stock.Since standard costs are usually slightly different from actual costs, the cost accountant periodically calculates variances that break out differences caused by such factors as labor rate changes and the cost of materials. The cost accountant may periodically change the standard costs to bring them into closer alignment with actual costs.

Advantages of Standard Costing

1. 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.

2. Budgeting - A budget is always composed of standard costs, since it would be impossible to include in it the exact actual cost of an item on the day the budget is finalized. Also, since a key application of the budget is to compare it to actual results in subsequent periods, the standards used within it continue to appear in financial reports through the budget period.

3. 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.

4. Overhead application - If it takes too long to aggregate actual costs into cost pools for allocation to inventory, then you may use a standard overhead application rate instead, and adjust this rate every few months to keep it close to actual costs.

5. Coordination - The establishment of standards coordinates all functions—manufacturing, marketing, engineering, research and accounting towards the achievement of a common goal. Setting standards involves defining and communicating targets so that they can work towards the attainment of the goal.

6. Standards as Incetives to Employees - If standards are reasonable and attainable they act as incentives to employees to improve their performance and to maintain the quality of the product.Standards motivate workers, supervisors and foremen to work more efficiently in the accomplishment of their respective standards. Many incentives like cash bonus, individual and group bonus, prizes, vacation time, and promotions can be given for equaling or surpassing standards. Similarly, management can decide upon action to be taken for below standard performance.