The System of Standard Costing Work - Report Example

Standard Costing I. This paper discusses mainly on the topic standard costing. In gaining further information about the this paper critically analyze how the system works. Initially, the definition of standard costing is provided as a foundation in the better understanding and thorough analysis of the system. The critical evaluation of how standard costing works is very important in this paper's quest in finding proofs to support the claim of an author that standard costing is appropriate for organizations that are greatly involved in common or repetitive operation. This paper considers the other side or the side in which standard costing has found its inappropriateness and unsuitability. Furthermore, the outcome of the critical analysis of how standard costing works is also evaluated in terms of its effectiveness as a means of control in the global industry and the increase in consumer wealth. II. Introduction and Background As a general idea, standard costing is a system of cost ascertainment and control in which predetermined and preset standard costs and income for products and operations are set. This standard costs and income for products and operations are periodically and from time to time compared with the actual costs incurred and income generated for the purpose of establishing any variances. Standard costing system is used by many organizations as a management tool in estimating the overall and general cost of production with the assumption of normal operations. While it has standard costing has been widely used by most production and manufacturing companies, the system has found its great importance and appropriate significance in most organizations and firms whose operations involved are common and repetitive. Standard costing generally involves the development of a product or service cost wit the use of estimates of both the resources consumed as well as the prices of those resources. In producing a standard selling price, the standard cost may then be increased by an estimated profit margin. These estimates of cost and revenue then provide and build up a foundation for additional and supplementary planning and control (Mitchinson 2000 July 1). Traditionally, standard costing is often and frequently associated with manufacturing though it also can be used in other area like the service sector. In support to Drury's (2004) claim that standard costing is appropriate and suitable in common or repetitive operation of an organization, Mitchinson (2000) asserted and alleged that the system, as a method, is essentially apt and fitting to task which is repeated many times. To provide a rationale for this allegation, repeated tasks or operations give organizations and firms the means to estimate the nature of how tasks will be performed in the future and upcoming operation. Information gained previously in a repetitive operation can be used in predicting the income and expense for any period. 1. Problems with Standard Costing The reported setbacks and inappropriateness of standard costing have been spotted in the part of lean companies. Baggaley (2003) strongly argues that the system's measurements motivates and encourage behaviors that are harmful and inappropriate to lean environments. Additionally, standard costing does not provide reliable cost information for decision-making that is important in a lean situation. As a result, Baggaley (2003) suggested an alternative costing approach that goes in line with the goals of lean that also provides the basis for sound management decisions. There are problems with standard costing when used as a system of control in a lean environment that Baggaley (2003) has identified. First predicament is the problem regarding the people and the workforce. Naturally, standard costing sets standard performance that cause people on the shop floor to do the wrong things when just to meet the preset performance level. In further illustrating his contention, Baggaley (2003) specifies the in-depth reason for the first setback. With the use of "volume variance", standard costing has been mostly up for the measurement of the efficiency of the use of machinery or manpower. "In this variance, cost of the labor or machines essentially incurred by a production operation is compared to make a given number of items with the amount of cost that would have been incurred at the "standard" or planned volumes" (Baggaley 2003 August). The problem comes when fewer items are made than planned, then the actual cost per item will exceed the planned for the period and the amounts of labor and overhead consumed are less than exceed the amounts that were planned. This is considered a negative variance that indicates the production processes are produced at less than full capacity during a specified period. Consequently, negative variances are very detrimental and disagreeable in the environment of mass production. Nevertheless, Baggaley (2003) found the actual reason for the problem with standard costing in its inappropriateness in lean company. He said that it is due to the fact that standard costing is based upon a different and converse model of how companies make money in manufacturing. This greatly supports the philosophy of achieving economies of scale and lowest per unit cost for items produced with the maximum use of machines and people. Standard costing is indeed not suitable to lean companies as it seeks to make products one at a time encouraging the flow through the production process while standard costing works best on organizations involve in repetitive operations. To illustrate further the differences between the two measurements, the following table shows a summarized dissimilarity: (In terms of performance) Standard Costing Measurements Lean Measurements Labor efficiency Throughput Machine utilization Cycle time Cost variances versus standard First time quality Earned value Inventory turns Departmental budget focus Value stream focus Source: (Baggaley 2003 August) (In terms of behavioral consequences) Standard Costing World Lean World Make more product Eliminate barriers to flow Build inventory Focus on value stream rather than departments Utilize resources to the max Continuous improvements and teamwork Optimize department efficiencies Eliminate waste, inventory and over production Track direct labor Allocate other costs Source: (Baggaley 2003 August) Apparently, from the above table, standard costing is inappropriate for lean environment. With the differences between performance and behavioral consequences, it would be better if another costing system will be developed and created that will be especially suitable for lean environment. At the end of the article, Baggaley (2003) has recommended a much suitable and fitting costing system in lieu of standard costing. 2. How do Standard Costing Works With the intention and desire in reducing costs and expenses in the line of manufacturing and marketing products, most earning-oriented and profit-motivated companies rely on a certain and particular costing system. Such choice of costing system would be also under specific norms and conditions in normal times. Most of these kinds of companies consider the advantages of using the Standard Costing system in their manufacturing operations. Standard costing is a monetary value used as a basis for comparison and, as stated earlier, it is a norm that sets specific standards. It is commonly referred to as a unit cost and it may also be called a standard cost per unit of input. Direct labor, (or per unit of output) is an example of standard cost per unit of input. As standard costing enables companies to estimate production cost, large corporations use the system in basing their production budget estimates on the standard costs. There are three costing systems with respect to the incorporation of costs into production. These are the actual, normal, and standard. In demonstrating the manufacturing statements, the actual costing system is most appropriate. The normal costing is used in the illustration of the job-order costing system. And, standard costing will be the focus of the proceeding statement for further understanding of the terms and usage of the system (Lewis 1993). The three costing systems differ in terms of its absorption of costs into production especially in terms of direct materials, direct labor, and factory overhead. Out of the three systems, this paper focuses on the standard costing in and how it works on direct materials, direct labor, and factory overhead. 3. Standard Costing on Direct Materials Under the standard costing system, the direct material standards are being set by the policy of the company. The company similarly defines the standard cost of direct material. Within the list of direct materials predetermined by the company is the specification of the quantity and quality of materials to be purchased. One significant characteristic of standard costing with its relation to direct materials is the estimation of the normal delivered price per unit of material in determining the prices, apparently called standard price. By multiplying standard quantity to that of the standard price, the standard cost will then be calculated. 4. Standard Costing on Direct Labor Under standard costing's function towards direct labor, Lewis (1993) have identified two options for setting labor standards that are also commonly used. These are the estimated and the scientific labor standards. The first labor standard is also known as "engineered standard" which uses historical costs, past records of actual costs incurred in order to estimate future costs. Such practice is useful when it is too costly or unpractical to use time study or scientifically measured labor standards. On the other hand, scientific option is based on measurements of time in completing individual tasks. As the second author to support Drury's (2004) statement, Lewis (1993) claims that engineered time and motion studies are usually preferred for those operations that are repetitive and are measurable (p. 49). 1. Engineered or Estimated Standards This standard requires consistency with actual methods and processing relative to current production runs. Estimated time standards are specifically good enough for a new process or product although management should exert efforts in developing industrial engineering standards on a timely basis. . III. Conclusion From the above-mentioned statements, it is fairly evident and noticeable that although standard costing may have it inappropriateness and unsuitability in some areas, the system has found its exact and perfect use in the advantage of organizations whose operations involve common or repetitive. The negative segment about standard costing discussed in this paper also helps the development of this paper. Specifically, the article authored by Baggaley not just portrays the setbacks of using standard costing but it also creates argument that brings this paper into closer understanding about the subject. This paper is embedded from a statement of an author about his assertion on the appropriateness of standard costing in organizations that are involved in common or repetitive operation and has to look for proofs, whether in backing up or contrasting with the idea. As a final and closing point, this paper has created a clear and considerable answer to the argument - that standard costing really do functions well and is very much suited on organizations and manufacturing firms for their common or repetitive operation. References Baggaley, B. L. (2003 August). Solving the Standard Costing Problem. BMA, INC. Retrieved 13 April 2006 from http://www.nwlean.net/article0803.htm. Lewis, R. J. (1993). Activity-Based Costing for Marketing and Manufacturing. Westport, CT: Quorum Books. Mitchinson, B. (2000 July 1). Standard costing and fixed and flexed budgets. Retrieved 13 April 2006 from ttp://www.accaglobal.com/publications/diplomanewsletter/15631. Read More