Advantages and Disadvantages of the Standard Costing system

Advantages and Disadvantages of the Standard Costing system

Standard Costing system is an estimated or predetermined cost of performing an operation or producing a good or service, under normal conditions. They are generally related to a manufacturing company’s costs of direct material, direct labor, and manufacturing overhead.

The following are the advantages of the standard costing system:

  • Standard costing is a rule of measurement established by authority, which provides a yardstick for performance evaluation,
  • Standard costing system minimizes the wastage by detecting variance and suggesting for corrective actions,
  • Under the standard costing system, cost centers are established and responsibility is assigned to the concerned departments and persons and thus it helps to increase the effective delegation of authority.
  • A properly developed standard costing system with full participation and involvement creates a positive, cost-effective attitude through all levels of management.
  • The standard system encourages reappraisals of methods, materials, and techniques that help to reduce the unfavorable variances.
  • The standard costing system helps to draw management’s attention towards those items which are not proceeding according to plan.
  • Standard costing system makes the whole organization cost conscious as it gives the focus to the standard cost and variance analysis.
  • Standard costing system provides a basis for an incentive scheme to workers and supervisors.
  • Standard costing system simplifies the cost control procedures.
  • Standard costing acts as an effective tool for business planning, budgeting, marginal costing, inventory valuation etc.

Problems with Standard Costing

Cost-plus contracts: If you have a contract with a customer under whom the customer pays you for your costs incurred, plus a profit, then you must use actual costs, as per the terms of the contract.

Drives inappropriate activities: A number of the variances reported under a standard costing system will drive management to take incorrect actions to create favorable variances.

Fast-paced environment: A standard costing system assumes that costs do not change much in the near term, so that you can rely on standards for a number of months or even a year, before updating the costs.

Slow feedback: A complex system of variance calculations is an integral part of a standard costing system, which the accounting staff completes at the end of each reporting period.