Standard costing systems are widely used. For example, according to one survey, 74 percent of the respondents were using a standard costing system, with the usage emphasis being placed on planning and control.1 Several reasons for adopting a standard costing system can be mentioned: managing costs, improving planning and control, facilitating decision making, and facilitating product costing.
Cost Management
Standard costing allows managers to manage costs by establishing standards that reflect efficient operating conditions. Standards also help managers understand what needs to be done to improve current and future performance. Furthermore, for firms concerned with continuous improvement, kaizen standards are useful aids in achieving significant cost reductions.
Planning and Control
Standard costing systems enhance planning and control and improve performance measurement. Unit standards are a fundamental requirement for a flexible budgeting system, which is a key feature of a meaningful planning and control system. Budgetary control systems compare actual costs with budgeted costs by computing variances, the difference between the actual and planned costs for the actual level of activity. By developing unit price and quantity standards, an overall variance can be decomposed into a price variance and a usage or efficiency variance. By performing this decomposition, a manager has more information. For example, a manager can tell whether the variance is attributable to discrepancies between planned prices and actual prices, to discrepancies between planned usage and actual usage, or to both. Thus, in principle, the use of efficiency variances enhances operational control. Additionally, by breaking out the price variance, over which managers have little control, the system provides an improved measure of managerial efficiency.
Decision Making and Product Costing
Standard costing systems also facilitate decision making and product costing. For example, standard costing systems provide readily available unit cost information that can be used for pricing decisions. This is particularly useful for companies that engage in extensive bidding and for companies that are paid on a cost-plus basis. Standard product costs are determined using quantity and price standards for direct materials, direct labor, and overhead. In contrast, a normal costing system predetermines overhead costs for the purpose of product costing but assigns direct materials and direct labor to products by using actual costs. An actual costing system assigns the actual costs of all threemanufacturing inputs to products. Exhibit 9-1 summarizes these three cost assignment approaches
Cost Management
Standard costing allows managers to manage costs by establishing standards that reflect efficient operating conditions. Standards also help managers understand what needs to be done to improve current and future performance. Furthermore, for firms concerned with continuous improvement, kaizen standards are useful aids in achieving significant cost reductions.
Planning and Control
Standard costing systems enhance planning and control and improve performance measurement. Unit standards are a fundamental requirement for a flexible budgeting system, which is a key feature of a meaningful planning and control system. Budgetary control systems compare actual costs with budgeted costs by computing variances, the difference between the actual and planned costs for the actual level of activity. By developing unit price and quantity standards, an overall variance can be decomposed into a price variance and a usage or efficiency variance. By performing this decomposition, a manager has more information. For example, a manager can tell whether the variance is attributable to discrepancies between planned prices and actual prices, to discrepancies between planned usage and actual usage, or to both. Thus, in principle, the use of efficiency variances enhances operational control. Additionally, by breaking out the price variance, over which managers have little control, the system provides an improved measure of managerial efficiency.
Decision Making and Product Costing
Standard costing systems also facilitate decision making and product costing. For example, standard costing systems provide readily available unit cost information that can be used for pricing decisions. This is particularly useful for companies that engage in extensive bidding and for companies that are paid on a cost-plus basis. Standard product costs are determined using quantity and price standards for direct materials, direct labor, and overhead. In contrast, a normal costing system predetermines overhead costs for the purpose of product costing but assigns direct materials and direct labor to products by using actual costs. An actual costing system assigns the actual costs of all threemanufacturing inputs to products. Exhibit 9-1 summarizes these three cost assignment approaches
Standard costing also simplifies product costing for firms in process industries. For example, if a process-costing system uses standard costing to assign product costs, there is no need to compute a unit cost for each equivalent unit-cost category. A standard unit cost would exist for direct materials, transferred-in materials, and conversion costs categories.Usually, a standard process-costing system will follow the equivalent-unit calculation of the FIFO approach. That is, current equivalent units of work are calculated. By calculating current equivalent units of work, current actual production costs can be compared with standard costs (costs allowed for current production) for control purposes.
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