Standard Costing

Advantages and Disadvantages of Standard Costing

Advantages of Standard Costing

• Assists with decision making including setting selling prices
• Assists with planning including production resource requirements
• Assists in controlling costs by investigating variance causes and making departments responsible for their performance
• Helps to identify inefficiencies in the production process
• Standard costs are more likely to be achieved if they are being closely monitored
• Exception reporting can be used where only variances outside a tolerable level are investigated (management by exception)
• Able to identify areas requiring improvement and explains the difference between expected and actual profit
• Sub-variances locate particular areas to investigate (NB: the total variance may be small but could mask large sub-variances cancelling each other out)

Disadvantages of Standard Costing

• If standards are set incorrectly or are unrealistic they create larger variance outcomes
  • An ideal standard assumes no material wastage, no labour idle time and no machine breakdowns — rarely achievable in practice
  • An attainable standard allows for an element of inefficiency and is more realistic
• Costs for material and labour may fluctuate frequently making standard costs quickly outdated (requiring regular readjustment)
• A change in production method from labour-intensive to capital-intensive will affect the entire standard costing framework
• Variance analysis can be complex when investigating sub-variances — e.g. material variances can impact on labour variances and vice versa
• Standard costing is more applicable to a homogenous product range — it is not easily applied to unique or bespoke products
• A variance may have arisen outside the control of the business (external factors) making it unfair to hold a manager responsible
• Large adverse variances, if viewed negatively, can de-motivate staff

Possible management actions following variances

Adverse variances:

• Investigate whether they could change supplier or negotiate bulk purchase discounts, trade discounts or cash discounts, or use cheaper (lower quality) material
• Investigate whether they could employ cheaper, lower-skilled labour and train them, or negotiate with part-time staff

Favourable variances:

• Investigate whether better quality materials were used (new supplier or more efficient machinery producing less waste)
• Investigate whether workers had more skills and were more efficient (e.g. more skilled workers available in the labour market)