After reviewing some of the suggested readings and in addition to your own research, describe the key elements of a standard cost system and its advantages and disadvantages as a tool for decision making.
The effectiveness of a proper costing system has been accepted worldwide by all categories of business starting from sole proprietors to giant companies. The costing system that is implemented within an organization aims to curb the various costs that are incurred pertaining to the cost of operations that are executed within a organization. The procedure adopted for controlling the costs has the primary objective of keeping the costs lower than what is anticipated. Therefore, it is very important for the management of an organization to establish, a proper costing system that is set according to the performance standards of the firm in order to curb the required costs.
This particular study aims to focus on the key elements that are involved in a standard costing system and the advantages and disadvantages of such a costing system.
Standard Costing System And Its Key Elements
Standard costing refers to the method in which an estimated cost that has to be incurred is replaced with the actual cost that has been incurred by the firm and then a variance report has been drawn that has evidently displays the difference between the estimated and actual costs. Standard costing essentially involves the construction of a group of assumed or standard costs for some or all activities of the company. This is done because it becomes difficult for the management of an organization to assign or compute the actual costs of various elements of operation. Moreover, the process of calculation and collection of the actual costs is too time consuming thus, the standard costs are utilized as a close approximation to actual costs. The reason of the standard costs being dissimilar to that of the actual costs calls for the accountant to regularly draw up a variance analysis report so that the reasons of variance could be effectively investigated and the standard costs could be adjusted accordingly (Kren, 2014).
The standard costing system particularly constitutes of the following four elements:
- The establishment of a proper standard cost for each operation
- Comparison between the actual cost incurred and the standard cost that has been estimated by the cost accountant
- Analysis of the different values of variance obtained from the differences between the standard and actual costs
- Lastly, the investigation of the significant variances and adoption of the required action
Advantages Of Standard Cost System
The advantages of the standard cost system can be listed down as follows (Nas, 2016):
- Budgeting – The application of the standard cost system results in the preparation of an effective budget. The analysis of the variances obtained from the budgets prepared, enable the management of an organization to effectively plan the required business strategies
- Inventory costing – The valuation of an inventory can be carried out with ease by applying the standard cost system. The particulars of the period end inventory system when multiplied with the standard costs results in an ending inventory valuation
- Overhead application – The establishment of a overhead application rate for the determining the cost of inventory is another potential advantage provided by the standard cost system
- Formulation of price – The standard cost system also results in the proper formulation of price of the product being sold by the organization in the market by obtaining the evidence from the budget variance analysis reports
Disadvantages Of The Standard Cost System
The disadvantages associated with the standard cost system can be listed down as follows (Klychova, Faskhutdinova, & Sadrieva, 2014):
- Cost plus contract – The business deals that involve the cost plus contract effectively result in payment from the customer that strictly involves the cost acquired in producing such a product and a profit margin that is applied on such a cost. Thus, the standard cost system cannot be applied in such a situation
- Slow process – A standard cost system involves a complex range of variance calculations that generally take some stipulated. Therefore, the use of a standard cost system impairs the management from receiving immediate feedback
- Ignorance of error at the lower level – The application of a standard cost system is done wholesomely on the entire business process, therefore, the errors or discrepancies occurring at the lower levels cannot be identified easily
Thus, as it can be inferred from the above discussion, all firms should adopt the application of a standard cost system as it results in a proper development of cost curbing methods by the preparation of the corresponding variance reports.
Klychova, G. S., Faskhutdinova, ?. S., & Sadrieva, E. R. (2014). Budget efficiency for cost control purposes in management accounting system. Mediterranean journal of social sciences, 5(24), 79.
Kren, L. (2014). Tracking value created by efficiency improvements in a traditional overhead cost management system. Engineering Management Journal, 26(1), 3-7.
Nas, T. F. (2016). Cost-benefit analysis: Theory and application. Lexington Books.