Standard costing is the term used in the context of cost accountancy. Standard costing is a popular approach to costing that has been used by businesses all over the world for past many years. Standard costing in simple words refers to that process by which the management of the company sets standards or targets also known as predetermined costs beyond which the expected costs for manufacturing are unacceptable and require analysis on the part of the management. In order to have a better understanding of this concept, one should look at some of the advantages and disadvantages of standard costing –
Advantages of Standard Costing
Standard Costing Provides Basis for Comparision
The first and foremost advantage of standard costing is that it allows a company to compare the actual costs of producing a product against the budgeted or standard costs of producing that same product which in turn will help the company in analyzing the operational efficiency of the company apart from helping the managers making better decisions about the pricing of various products and making changes to the production process so that actual cost does not exceed the standard cost estimates set out by top management during the planning process.
Identification of Wastage and Inefficiency
Another benefit of standard costing is that it helps the company to identify areas where there is wastage and inefficiency which in turn will help the company in ensuring that those areas are paid attention and the problem is rectified thus limiting the wastage and increasing the efficiency of the company.
Setting Benchmarks and Fixing Responsibility
Another positive of standard costing is that since standard costing sets standards or benchmarks for costs related to various processes it helps the managers to identify departments as well as people who are achieving the benchmarks thus ensuring that nonperformers are held responsible for their actions and in a way it helps the company in making people accountable for their actions.
Disadvantages of Standard Costing
Inaccurate allocation of overhead costs
The biggest drawback of standard costing is that sometimes there is inaccurate allocation of overhead costs. When using this approach, businesses allocate overhead costs to products based on a predetermined rate. However, this allocation can be inaccurate if the actual amount of overhead costs incurred differs from the amount budgeted. Hence this inaccurate allocation of the overhead cost will not only result in products being wrongly priced but also will lead to an inaccurate assessment of the variance analysis which is carried out by the company based on standard costs.
Inflexibility of Standard Costing
Another disadvantage of standard costing is the inflexibility associated with standard costing. This approach is not well suited for businesses that operate or work in rapidly changing business environments. This is because the predetermined overhead rates used in standard costing are based on historical data and do not account for changes in the business environment. As a result standard costing is not ideal for those companies where the business environment and costs are changing rapidly.
Lack of Timely Information
Another problem with standard costing is that it does not provide timely information. This approach relies on historical data, which can be outdated by the time products are manufactured and sold. As a result, businesses may make decisions based on information that has the risk of being outdated and hence of no use to the company leading to financial losses for the company depending on standard costs for its products.
As one can see from the above that standard costing has pros as well as cons and that is the reason why any company thinking of adopting standard costing in their company should carefully read the above points and then only should take any decision.