Improved cost control: Companies can have higher amount of cost control by setting cost control standards for measuring what types of cost are incurred and what kind of variances occur. Variance shows where the things doesn’t go as planned and thus lead to the difference in the estimated and the actual data. Besides helps in judging the capabilities of the manager in controlling and influencing the cost incurred in the organization.
Budgeting: A budget always portrays the standard or the estimated cost as it is impossible to judge the right amounts beforehand. So, budget is used to compare the actual results with the estimated one.
Possible reductions in production costs: The standard cost system help in cost saving and make the employees aware about the ways to save cost and seek help from improved methods of doing a task or a job. Thus, in this way companies achieve cost reduction and ultimately achieving their goals and objectives.
Price formulation: If the company is dealing in the customized product then the standard cost of the generating a product will be treated as the projected cost of a customer’s requirement, to which the margin cost will be added. This system also consider the changes in the company’s production cost.
More useful information for managerial planning and decision-making: Management prepares estimated cost standards and if they succeeds in managing different cost incurred in the company then as a result, management can use these estimated costs in making more appropriate budgets. Standard cost system is very useful for the upper level management in planning and in decision making.
Disadvantages of standard cost system
Controversial materiality limits for variances: The management is responsible to find out what is the reason for material or unusual variance as materiality includes individual judgment.
Cost plus contracts: If you are working under a contract where you sell the product to the customers at the cost incurred and plus the profit, then the actual cost should be used rather than the standard cost.
Non-reporting of certain variances: Workers doesn’t always report all the variances and in fact doesn’t report the negative exception and would try to conceal the facts. By hiding the facts, the workers diminishes the effectiveness of the budgeting.
The calculation of variance is a very complex system and a very important pay of standard costing system.
Drives inappropriate activities: In the urge to correct the variances reported in the standard costing system the management may take incorrect actions. For example, the company would buy raw material in bulk to improve the purchase price variance, etc.
How to create a standard cost
Initially, the standard cost can be calculated easily by calculating the average cost incurred over the past few years and should be analyzed and then should attain a conclusion. However, there are many factors which should be kept in mind before setting a standard cost. They are:
Equipment age: When the end of the machinery is approaching, it becomes very clear that it may produce very less productive useful material and will produce more of scrap or the not so useful material for a company.
Equipment setup speeds: Generally, it takes a huge time to setup equipment in the production run and a huge amount of cost is involved but if the company works on the cost reduction plan, this can help the company in generating lower overhead cost.
Labor efficiency changes: if the company shifts from manual work to automated work such changes will hereby impact the number of labor force required in the company to produce a product.
Labor rate changes: It is better for a company to set a particular date at which the employees will receive their pay hike or set it according to the labor union contract.
Learning curve: As the number of products produced increases, it makes production staff evident at doing so. Thus, the standard labor cost should decline as production volumes rises.
Purchasing terms: It is up to the company that how it wants to fluctuate its prices and how effectively it can do cost cutting. Like for example, it can change the supplier from which the company is purchasing the product, but purchasing at different prices.
Any of the factor can play a major role in setting an effect standard cost thus, each aspect of such factors should be taken into consideration.
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