Why Do Companies Use Standard Costing Systems?
Standard costing is a system of accounting that uses predetermined standard costs for direct material, direct labor, and factory overheads. It is widely used in various industries due to the limitations of historical costing, which provides a record of past costs but lacks a forward-looking perspective.
Key Facts
- Improved cost control: A standard costing system allows companies to set standards for each type of cost incurred, which helps in highlighting exceptions or variances. This provides a starting point for evaluating the effectiveness of cost control measures.
- More useful information for managerial planning and decision making: By setting appropriate cost standards and effectively controlling production costs, management can use standard costs to prepare more accurate budgets and estimate costs for bidding on jobs. This helps in planning and decision making at the managerial level.
- More reasonable and easier inventory measurements: A standard cost system provides easier inventory valuation compared to an actual cost system. It assumes that all units of a given product produced during a particular time period have the same unit cost, making inventory measurements more reasonable and consistent.
- Cost savings in record-keeping: Contrary to the perception that a standard cost system requires more detailed record-keeping, it actually saves costs in this area. A standard cost system shows cost flows between inventory accounts and into cost of goods sold at consistent standard amounts during the period, eliminating the need for special calculations to determine actual unit costs.
- Possible reductions in production costs: Implementing a standard cost system can lead to cost savings. The use of standard costs can make employees more cost-conscious and encourage them to seek improved methods of completing their tasks, ultimately reducing production costs.
Standard costing offers several advantages to companies, including:
Improved Cost Control
A standard costing system allows companies to set standards for each type of cost incurred, which helps in highlighting exceptions or variances. This provides a starting point for evaluating the effectiveness of cost control measures. For instance, if actual direct materials costs exceed standard costs, the company can investigate the cause of the excess and take corrective action.
More Useful Information for Managerial Planning and Decision Making
By setting appropriate cost standards and effectively controlling production costs, management can use standard costs to prepare more accurate budgets and estimate costs for bidding on jobs. This helps in planning and decision making at the managerial level.
More Reasonable and Easier Inventory Measurements
A standard cost system provides easier inventory valuation compared to an actual cost system. It assumes that all units of a given product produced during a particular time period have the same unit cost, making inventory measurements more reasonable and consistent.
Cost Savings in Record-Keeping
Contrary to the perception that a standard cost system requires more detailed record-keeping, it actually saves costs in this area. A standard cost system shows cost flows between inventory accounts and into cost of goods sold at consistent standard amounts during the period, eliminating the need for special calculations to determine actual unit costs.
Possible Reductions in Production Costs
Implementing a standard cost system can lead to cost savings. The use of standard costs can make employees more cost-conscious and encourage them to seek improved methods of completing their tasks, ultimately reducing production costs.
Conclusion
Standard costing is a valuable tool for companies seeking to improve cost control, enhance managerial planning and decision-making, simplify inventory measurements, save costs in record-keeping, and potentially reduce production costs. Its widespread adoption across various industries is a testament to its effectiveness in providing useful information and facilitating better decision-making.
FAQs
What is standard costing?
Standard costing is a system of accounting that uses predetermined standard costs for direct material, direct labor, and factory overheads.
Why do companies use standard costing systems?
Companies use standard costing systems to improve cost control, enhance managerial planning and decision-making, simplify inventory measurements, save costs in record-keeping, and potentially reduce production costs.
How does a standard costing system help in cost control?
A standard costing system allows companies to set standards for each type of cost incurred, which helps in highlighting exceptions or variances. This provides a starting point for evaluating the effectiveness of cost control measures.
How does a standard costing system aid in managerial planning and decision-making?
By setting appropriate cost standards and effectively controlling production costs, management can use standard costs to prepare more accurate budgets and estimate costs for bidding on jobs. This helps in planning and decision making at the managerial level.
How does a standard costing system simplify inventory measurements?
A standard cost system assumes that all units of a given product produced during a particular time period have the same unit cost, making inventory measurements more reasonable and consistent.
How does a standard costing system save costs in record-keeping?
Contrary to the perception that a standard cost system requires more detailed record-keeping, it actually saves costs in this area. A standard cost system shows cost flows between inventory accounts and into cost of goods sold at consistent standard amounts during the period, eliminating the need for special calculations to determine actual unit costs.
How can a standard costing system lead to reductions in production costs?
Implementing a standard cost system can make employees more cost-conscious and encourage them to seek improved methods of completing their tasks, ultimately reducing production costs.
Is a standard costing system suitable for all industries?
Standard costing is applicable in diverse conditions and is widely used in various industries that produce standardized products or follow process costing methods. However, it may not be advantageous in jobbing industries or industries that produce non-standardized products.