Friday, June 6, 2008

What is the use of Standard costing

Q:- What is the use of Standard costing ?

Ans. Reasons for using a Standard Costing System:
There are several reasons for using a standard costing system:

Cost Control: The most frequent reason cited by companies for using standard costing systems is cost control. One might initially think that standard costing provides less information than actual costing, because a standard costing system tracks inventory using budgeted amounts that were known before the first day of the period, and fails to incorporate valuable information about how actual costs have differed from budget during the period. However, this reasoning is not correct, because actual costs are tracked by the accounting system in journal entries to accrue liabilities for the purchase of materials and the payment of labor, entries to record accumulated depreciation, and entries to record other costs related to production. Hence, a standard costing system records both budgeted amounts (via debits to work-in-process, finished goods, and cost-of-goods-sold) and actual costs incurred. The difference between these budgeted amounts and actual amounts provides important information about cost control. This information could be available to a company that uses an actual costing system or a normal costing system, but the analysis would not be an integral part of the general ledger system. Rather, it might be done, for example, on a spreadsheet program on a personal computer. The advantage of a standard costing system is that the general ledger system itself tracks the information necessary to provide detailed performance reports showing cost variances.

Smooth out short-term fluctuations in direct costs: Similar to the reasons given in the previous chapter for using normal costing to average the overhead rate over time, there are reasons to average direct costs. For example, if an apparel manufacturer purchases denim fabric from different textile mills at slightly different prices, should these differences be tracked through finished goods inventory and into cost-of-goods-sold? In other words, should the accounting system track the fact that jeans production on Tuesday cost a few cents more per unit than production on Wednesday, because the fabric used on Tuesday came from a different mill, and the negotiated fabric price with that mill was slightly higher? Many companies prefer to average out these small differences in direct costs.

When actual overhead rates are used, production volume of each product affects the reported costs of all other products: This reason, which was discussed in the previous chapter on normal costing, represents an advantage of standard costing over actual costing, but does not represent an advantage of standard costing over normal costing.

Costing systems that use budgeted data are economical: Accounting systems should satisfy a cost-benefit test: more sophisticated accounting systems are more costly to design, implement and operate. If the alternative to a standard costing system is an actual costing system that tracks actual costs in a more timely (and more expensive) manner, then management should assess whether the improvement in the quality of the decisions that will be made using that information is worth the additional cost. In many cases, standard costing systems provide highly reliable information, and the additional cost of operating an actual costing system is not warranted.

Summary of Actual Costing, Normal Costing and Standard Costing:
The following table summarizes and compares three commonly-used costing systems.

Actual Costing System

Normal Costing System

Standard Costing System

Direct Costs:

(Actual prices or rates x actual quantity of inputs per output) x actual outputs

(Actual prices or rates x actual quantity of inputs per output) x actual outputs

(Budgeted prices or rates x standard inputs allowed for each output) x actual outputs

Overhead Costs:

Actual overhead rates x actual quantity of the allocation base incurred.

Budgeted overhead rates x actual quantity of the allocation base incurred.

Budgeted overhead rates x (standard inputs allowed for actual outputs achieved)

The following points are worth noting:

1. All three costing systems record the cost of inventory based on actual output units produced. The static budget level of production does not appear anywhere in this table.

2. Actual costing and normal costing are identical with respect to how direct costs are treated.

3. With respect to overhead costs, actual costing and normal costing use different overhead rates, but both costing systems multiply the overhead rate by the same amount: the actual quantity of the allocation base incurred.

4. Normal costing and standard costing use the same overhead rate.

5. Standard costing records the cost of inventory using a flexible budget concept: the inputs “that should have been used” for the output achieved.

There are costing systems other than these three. For example, some service sector companies apply direct costs using budgeted prices multiplied by actual quantities of inputs. For example, many accounting firms track professional labor costs using budgeted professional staff hourly rates multiplied by actual staff time incurred on each job.

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