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What is standard costing and why use it

Bridget Holmstrom - Saturday, February 14, 2015

What is standard costing and why does business use it

Standard costing is best used in those departments and organisations that have repetitive and standardised processes that use predictable amounts of materials, labour and other resources.  This is best applied to manufacturing but can also be used in the service sector where there is a consistent service.  Good examples in the service sector include fast food restaurants which use standard menus.  Guest room cleaning is generally a fairly standard operation involving labour and a few other resources.

A business could choose to use different costs levels for the standard costing.  This could include:

  • basic cost - these are cost standards that are left unchanged for long periods.  This means that the the base enables a comparison with actual costs over a number of years using the same standard. 
  • ideal cost - this is the perfect standard that can be achieved with maximum efficiency and minimum wastage.  It is unlikely that, in reality, these standards could ever me achieved because there is always a degree of uncertainty around production.  This is particularly true where there is human activity
  • currently attainable cost - costs that should be incurred under reasonably efficient operating conditions.  They are achievable with some degree of difficulty.  Allowances will be made for spoilage, breakdowns and other lost time.  These allowances are excluded from the ideal costs.

Why use standard costing

Assisting the decision making process

Standard costs helps business forecast future costs and therefore better control their business.  Knowing what the level of future costs are likely to be assists with decision making.  Standard costing also helps with the budget process as, once the levels of sales and production have been forecast then the standard costs can be used to calculate the budget costs of production.  This has a significant impact on the amount of time that is needed to calculate the budgeted costs.

Controlling and motivating

Studies have demonstrated that management and staff who do not have a target operate at a lower level than do those staff that have an achievable, motivational target.  A standard costing target will also help identify those managers not working as efficiently as they should be and help to reward those managers who do achieve those challenging standard costs.  Managers may also be alerted to those areas of production that are not in control and where increased focus and supervision is necessary to bring the operation back into acceptable cost levels.

Cost tracking

Using the standard costs can make the production of internal management accounts a much quicker activity than would be the case if actual costs were to be used.  Using actual costs means that costs must be tracked and then allocated to between the cost of sales and inventories.   

But

  • Standard costing is an expensive and time consuming management accounting exercise.  Although the use of sophisticated cost accounting software can help reduce the time needed standard costing is still an expensive exercise.  All the records must be kept up to date with the most recent purchasing costs.
  • There is little scope for individual initiative and creativity which can be demotivating for employees.
  • Standard costing is not generally appropriate where there are regular changes to the items produced, for example, where the menu items regularly change.
  • An unintended consequence of standard costing could be a focus on short term results rather than a more long term overview