Managerial Accounting - Standard Costs
The technology is continuously making inroads in the industry. The firms are switching over to cheaper raw materials. They are resorting to waste processing or re-cycling thus reducing their raw material costs. Labor is rapidly being replaced by automation, computers and robots. The plants are becoming capital intensive. The organizations are getting leaner and flatter. Global competition and frequent design changes require a business concern to remain ever vigilant. This has increased the importance of information for better and timely decision making. The very first decision is ‘making of a budget’ which is primarily based on standard quantities and costs.
What is a Standard?
The word standard means a yardstick or benchmark or barometer or touchstone. Standard are dictated by the industrial environment. A standard is an estimate which is realistic in nature. It is not difficult to achieve otherwise it would de-motivate the manager to exert themselves. Also, it is not something easy as it would create lethargy among the employees.
What is a Cost?
Cost is a worth or sacrifice of time and money or value or price-tag or outlay or spending.
Various costing systems
What is Standard Costing?
The standard cost is an estimated cost which determines in advance what each product or service should cost under the given circumstances. It is a bench mark for the cost of a product, process or component. It is also called planned cost or predicted cost or pre-determined cost. For fixing or calculation of standard cost, engineering estimates are obtained of inputs required along-with their price based on the prevailing market conditions as well as past experience.
In the words of Backer and Jacobsen, “Standard cost is the amount the firm thinks a product or the operation of the process for a period of time should cost, based upon certain assumed conditions of efficiency, economic conditions and other factors.”
The CIMA, London has defined standard cost as “a predetermined cost which is calculated from management standards of efficient operations and the relevant necessary expenditure.”
It may be noted that standard cost is always for a single unit whereas budget is standard cost multiplied by the standard quantity of output.
Advantges and Dis-advantages of Standard Costing
- Basis for comparison and Control
- Ficilitate Management by Exception whereby a manager would only intervenue if the operations are not progressing as expected or deviations are observed.
- Performance Evaluation through variance analysis
- Provides motivations to employees as standard are achieveable with reasonable efforts.
- Eliminate inefficiencies.
- Primary focus has been direct labour which is shrinking
- Requires a stable process to be cost effective
- Shorter product life makes standard out-dated soon
- It leads to cost minimization rather than value maximization
- Tend to be small or non-existent in automatic production process
WAYS TO SET SET STANDARDS:
- Analysis of the past data to find out trends and structures. It is the same as time series analysis whereby past trends and patterns are observed and standards are set.
- If there is no past data, task analysis helps us. This covers time and motion study, prototyping,experiment, sampling, analysis and synthesis.
- A task-anlysis includes duration of each sub-task, its frequency, complexity and environmental conditions. It could be manual task such as bricklaying. Such a task would be analyzed through a time and motion study.In short, it is shift from what a product did cost to what a product should cost.
- The above methods may be combined.
An extension of Standard Costing
Many themes have been developed and proved useful in cost control and performance evaluation. These are:
- Just in time philosophy
- Balance Scorecard
- Management by exception
JUST IN TIME
Just-in-time (JIT) is philosophy. It reduces cost as everything is performed on time. There is no wait and lesser investment. This in turn improves Return On Investment (ROI). One application is in the field of inventory management. There are very lean inventories or no inventories. A pull approach is used whereby the production is carried out only when a specific order is received. In turn, raw materials and labour is procured as per production program. The raw material suppliers are asked to send the requisite material at a specific time and date. In this way, the delivery trucks are unloaded right in the production hall. There are no carrying costs and neglible ordering costs.
A strategic planning and management system used extensively in business and industry. Besides, its use is common in government, and nonprofit organizations.It was originated by Drs. Robert Kaplan (Harvard Business School) and David Norton as a performance measurement framework that added strategic non-financial performance measures to traditional financial metrics to give managers and executives a more 'balanced' view of organizational performance.
Management by Exception (MBE)
Manager do not intervene in areas where work is proceeding according to the schedule. Under MBE, actual results are constatly compared with the standard ones and any deviation is brought to the notice of the top-management. If the deviation is un-expected, the matter would be investigated. Any corrective action depends on the circumstances. At times, there are external factors which adversly affect the result such as inflation, changes in law. However, most of the time, it is dishonesty or inefficiency for which management must take some action.
MBE enable the management to focus on really important matter and stretgic tasks
Standard costing is a management tool for control. It serves two purposes: cost control and product costing. It sets a bench mark for measuring actual performance.
In order to control, one should know what is expected by way of standard, what has been done and if the two differ, what corrective action to be taken. Sometime, we adopt a given performance, sometime we change man, material or machine and sometime we change the standard which was perhaps set too high. It is a continued activity for the optimum utilization of resources.
This has been explained in details in a hub entitled: Managerial Accounting - Variance Analysis.