Cost accounting: Limitations of standard costing
One of the reasons for management accounting is to facilitate control. The standard costing technique facilitates control by helping management improve production performance and efficiency.
Using standard costing has inherent merits and demerits. The demerits include limitations of the model, lack of accord over how it should be used and a potentially negative effect on the workforce.
Getting appropriate performance standards and resources
Any one of four benchmarks (basic, ideal, current or attainable standards) can be used as a benchmark. While having standards at their disposal might seem like a good thing, it can create discord over the appropriate benchmark to use. In addition, there could be an issue with the relationship between costs and resources. For instance, using cheaper, low-quality resources would reduce costs, but might decrease quality and increase wastage. Getting agreement on this trade-off can prove difficult.
Resistance and morale
As it was with scientific management, using standards can lead to reduced morale if it is not used with discretion and understanding. A typical example is if a variance is unfavourable and managers automatically assume that it is a result of reduced effort/efficiency on the part of employees. Another negative outcome is employees trying to game the system – sacrificing quality for production standards. Behavioural resistance and work-to-rule might also be unintended consequences of using standard costing techniques.
Catering for seasonal variations
Using benchmarks in environments where there are variations in costs can be problematic. Seasonal variations can affect the cost of direct materials. Sifting the impact of inflation and anticipating the effect of trade discounts may be impractical.
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Favourable variances might be unfavourable
It is tempting to assume that if costs/resources used in production are below expectations, the variance is favourable. After all, that is the definition of a favourable variance. However, this may suggest that quality was compromised. It hints at standard costing’s failure to factor quality and other intangibles properly. A multivariate analysis of variances may address this inherent limitation of the technique.
Good accounting information is useful when it is timely; variance reports may take long to produce – a fact that decreases its value and reliability. In addition to variance reports, setting and implementing performance standards can use significant staff and other resources, such as time. Avoiding this demerit is as easy as creating variance reports more frequently and minus unnecessary detail.
Over-emphasis on labour’s significance
The underpinning assumption of standard costing is that it assumes that labour efficiency should automatically increase productivity. Since production relies heavily on a number of other factors, this assumption can be very misleading. Standard costing does not always recognize the fixed component of labour either, treating labour as a variable cost.
Despite the standard costing technique having inherent disadvantages and limitations, these do not diminish its usefulness as a control mechanism. Some of the limitations can be mitigated or overridden by acknowledging them and being prudent in applying the technique.