Standard Cost Accounting System: Advantages, Disadvantages and Limitations

This report discusses the advantages, disadvantages and limitations of Standard Cost Accounting System. It also reviews the use and importance of Standard Cost accounting in the business world and small and medium sized organization. The report draws attention to the area where this system plays a significant role in competitive cost calculation especially in the manufacturing industry. It includes a discussion on two journals and their findings on the topic.

Managerial
Accounting
Assignment

1
By student name
Professor
University
Date: 5th Sep, 2018.
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Executive Summary
Here in the given report we are discussed on the topic of Standard Cost accounting system
analyzed the same. To review the use and importance of Standard Cost accounting in the
business world and small and medium sized organization we have been selected two research
based journal articles. With the help of this report it is also inferred what are the advantages of
the Standard Cost accounting system and what are the limitation of this costing system and what
are the steps should be taken to resolve those limitation. The report also draw attention to the
area where this system plays a significant role in competitive cost calculation especially in the
manufacturing industry. From the in depth study of Standard Cost accounting system and after
considering the advantage and limitation of this system it has been concluded that how this
costing system can be useful in business environment.
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Contents
Executive Summary.....................................................................................................................................2
Introduction.................................................................................................................................................4
Advantages of Standard costing technique.................................................................................................5
Disadvantages of Standard costing technique.............................................................................................5
Discussion on the two journals....................................................................................................................6
Explanation of the Selected Management Accounting Topic..................................................................6
Purpose of the studies and the research questions set out to be explored............................................6
Similarities and differences between the findings of the 2 studies.........................................................9
Specific outcomes and relevant learnings from the research findings....................................................9
References.................................................................................................................................................10
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Introduction
There are various cost accounting techniques which are followed by different organizations for
different purpose like price fixation, calculation of budgeted cost or for many other objective.
Standard costing is also a cost accounting technique which is used to calculate expected cost
which is substituted for an actual cost in the accounting record and then helps to recognize the
difference between expected cost and actual cost are calculated and recorded in the books of
account. In recent days this technique is being widely used by many manufacturer to analyze the
variance between the actual cost of the product being produced and the cost that should have
been incurred for producing such product (Bailey, et al., 2017). Standard costing is mostly used
to determine the deviation in the cost from the standards set by an organization and also helps to
recognize the reason of deviation so the matters in regard to which steps are required to be taken
to resolve the limitation should be informed of to the management. Standard costing technique
involves the following step to get the effective results. Initially calculate or ascertain the standard
cost; secondly, determine the actual cost; thirdly, evaluate the variances by comparing the
standard cost with actual cost; fourthly, examining the resulting variances and lastly, by
reviewing the results of variation, determining the appropriate action that are required to be taken
to eliminate that differences. The primary objective of standard costing system is to help the
management to taken effective decision on various matters of business that effect the financial
position of company like price fixation of goods produced, decisions in relation to make-or-buy
which will prove more beneficial to the organization, evaluating the performance level of
different individual and also helps in implementing the system of budgetary control which is
very cost effective for the entity (Barnes, 2015). The standard costing system has many
advantages as well as disadvantages. The same has been discussed in brief below in this report.
However this system of costing has many limitation still in current days many large companies
adopted this system of cost accounting. Here we have considered two journals on standard cost
accounting system for a better research. From the comprehensive study of both journal we can
conclude that how this costing system can be useful in business environment (Bennuona, et al.,
2010).
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Advantages of Standard costing technique
There are various advantages of standard costing technique, which are enlisted below:
1. This system of costing works as a controlling tool, hence helps the management as
controlling device.
2. It helps the organisation in imposition of budgetary control system for effective
management of the business.
3. It also provide assistant to management in several function like price formulation and
policies relating to production (Calvasina & Calvasina, 2017).
4. Standard costing highlights the variances between budgeted and actual cost and also
helps in the management to identify the area of inefficiencies and reason behind that.
5. Standard costing is considered as an effective technique s it helps in budgeting and
planning as these cost are predetermined. It also helps in analysing the effect of change in
the relationship of cost price volume which is useful for effective future decision making.
6. It also provide the mean in the prompt preparation of profit & loss account for short
period foe analyse business trends which is very effective for prompt decision making.
7. This system of costing also helps in evaluating the performance of the staff of different
cost centres with the help of in depth analysis of different variances (Werner, 2017).
Disadvantages of Standard costing technique
In addition to the advantages discussed above, standard costing technique suffers from few
limitations as well. These drawbacks are as enlisted below:
1. The variance analysis highlight the controllable or non-controllable variance and stressed
upon to recognise the reason of deviation and allocate the mistake accordingly. However
the liability of executive is very limited which are authorised to be controlled by them. In
order to effective allocation of liability responsibility it is important to segregate the
variance into two aspects which is very difficult. Because of that sometime the staff
behave reluctantly and hence it increases the work load (Truong, et al., 2008).
2. The standard generally follow the entity’s average past result, maximum theoretical
efficacy or its obtainable good yield, which are either too extensive or too brief. These
gives a negative effect on the motivation and morale of the employees if these standard
are too high, then it becomes very difficult for the employee to achieve the targets and
thus possess undue pressure on the employees and create a negative impact in business
environment. However something the management of the organisation set standards
which are very high and practically impossible to be achieved, this lowers the confidence
and morale of the employee and not able to give effective result.
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3. The business condition of an organization keeps on changing because of which the
standards is changing accordingly. Hence it is very important to constant revision in
standard so that the actual results are become reliable to compare with the standard.
However due to constant revision of standard many problem arise especially in
adjustment of inventory. But the revising the standard on timely basis add value to the
organisation and it also require management attention for better result but it is difficult
for the management to give proper attention on regular basis.
4. Standard costing system is an expensive as well as time consuming technique. Since the
degree of technical skill required in this system is very high. Due to continuous change in
technology these system require regular update which also increases the cost of
organisation along with involvement of huge cost in the implementation of system at the
initial stage. Hence it is not beneficial for small and medium sized organisation to
implement this system of costing as their financial resources are very limited. However
the benefit of this system of costing is very high in comparison of cost involved in the
initial implementation of system (Erik & Jan, 2017).
Discussion on the two journals
The two journal articles which have been considered in this report for discussion on the given
topic are “Standard Costing Games that Managers Play” by Calvasina, Richard V and Calvasina,
Eugene J and “How to Tell If Standard Costs are Really Standard” by Barnes, John L.
Explanation of the Selected Management Accounting Topic
In the first journal paper the matter of discussion is related to disadvantages and limitation of
standard costing technique and misleading information provided by the system and damage
caused because of those information is comparatively higher than the advantage it is believed to
give to the organization. Hence from the above discussion one thing is cleared that the main
sufferer of the system is the organisation (Gooley, 2016). And the first journal paper emphasizes
on the matters relating to evaluation of improvements in the standard costing methodologies in a
textile industry. The main focus on the updating the method and procedure continuously of
standard costing in order to keep this system of cost updated.
Purpose of the studies and the research questions set out to be explored
The main objective of first case study is highlight the flaw of standard costing technique. The
author initially observed from the study that there are three basic functions of standard costing
technique. These are: initially the collection of actual costs of the manufacturing operations;
secondly; achievement of the above manufacturing operation at expected cost and lastly the
performance evaluation from the standard by comparing with actual and by reporting the
variances (Calvasina & Calvasina, 2017). The manager place heavy reliance on those data for
decision making purpose and for detecting the area of non-compliance or which are not at par
with the budget and keep a continuous review of work of cost center to check whether they are
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running efficiently to achieve the goals of organization planned for success of organization. In
addition to that the author has also discussed the standard costing technique in reference various
games, the first one of which is “Everlasting Standard Game”. Under this game the author has
discussed the circumstances where either the company is small with nonexistent department of
industrial engineering or with nonexistent department of industrial engineering or the manager of
which thinks that implementation of standard costing technique is one time process and once
implemented, no revision in standards are required (Jefferson, 2017). At the time of formulation
of company one standard quantity of material and labor was set if the company and continue the
same for several years and not made any change. But after numbers of year revision is made only
in respect of value that is labor and material cost but completely ignored the area of material
quantity and labor hour where only the revision is required for effective results. This results in
the manager’s reluctance to review the reports since the same data is being produced every year
without any changing in value to the standards which are conventionally followed by the
organization. Consequently, the significance of efficiency variance and material variance are
ended. The second game is the “Unbreakable Schedule Game”, the author has discussed the
standard costs are revised but only on the scheduled time set for such revision. No relevance is
being given to the major changes in the costing or production techniques that are occurring
between the dates set for revision. In many companies where the management of the company
does not want to spend much time on accounting function of the company as the resulting
variances are misleading (Knechel & Salterio, 2016). The third game is the “Methods Change
Variance Game” as per which disclose the problem associated with the labor efficiency variance.
The main objective of calculating labor efficiency variance to calculate the difference between
the labor efficiency based on the old traditional system that is currently followed by the company
and the labor efficiency variance that would have been calculated based on the new standard, if it
was currently employed. And report both the result to the manager to the organization. But the
cost of making both report are not fully evident. The fourth game is named as the “Material Mix
Game”, this is basically the other version of the method change variance game, and the only
difference is that it is in respect of material mix variance (Barnes, 2015). Under this system, in
the production of goods different ingredients is used and the quantity of different ingredients are
different. Only the total amounts of the ingredients are reduced with a change in their proportion.
Hence the result of material mix variance turns out to be favorable. The fifth game is the “All
Encompassing Standard”, material mix game under this game, company produces variety of
goods which looks similar on outside but differ on its uses. However the average cost of the
product are same but the proportions of the ingredients are calculated on the basis of strength that
is provided by each product. In this game, the strength of the product does not match the
standard strength as per the cost card. The sixth and the last game is the “Full Figure Standard
Game”, in this game a very less addition in quantity of material and hours of labor made. Hence
the result of variance turns out to be favorable. This method is adopted so that the expected
standards are actually achieved by the organization (Sithole, et al., 2017).
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In the second case the author focuses on the necessity of the continuous updating of the system
of standard costing, especially in the textile manufacturing companies. The author was the chief
accounting and controlling officer in Graniteville Company. The studied the system of standard
costing adopted by the company and limitation observed by the author in the system. He raised
some basic important question faced by the team in respect of the system. Like, cost accounting
goals and objective of company, problem with respect to cost accounting system, what are the
plans of company to achieve their goals and what are the actions taken by the company to
resolve their problems. Here the author observed the various goals and objectives of the cost
accounting and review the system whether the system have the capability to provide which are
accurate and reliable for timely result. So, that the management take effective decision in a
timely manner at all segment. It is necessary to exclude to all intracompany profit centers from
the cost system to get the appropriate result and incorporate all the activities in the cost system.
The standard cost relating to the activity is shown along with the optimum practical capacity of
the plant to judge the efficiency and tom review whether the goals of operating management is
achievable or not and how much difficult for the organization to achieve those targets. In order to
forecasting the gross margin and evaluating the performance by comparing expected cost with
actual cost. The information become more reliable if company considers standard cost with
respect to estimated sales price (Hansen, et al., 2003). For the development of standard cost
relating to inventory it is mandatory to evaluate the carrying cost of the inventory. The author
has also discussed the major area of limitation of standard costing which reduces its value. These
are: documentation of system of cost accounting, incorporation of significance of cost
accounting system in general accounting system where the general costing system not able to
capture all the data and provide inappropriate results which effect the decision of management.
The payroll and data collection system provides inaccurate information. In order to eliminate all
these limitation the author has done the extensive study of the system and provide
recommendation that it is necessary to implement various control techniques for data relating to
payroll data collection and reporting; production reporting; dyes and chemicals; maintenance and
capital expenditure, supplies and raw materials; and update the system on regular basis used by
the project team. In addition to all the author also suggest that the system is managed by a set of
skilled staffs so that they can utilize the system properly. Hence the management plan to develop
an automated mechanisms that collect data automatically and for the purpose of inquiry so that
the flow of basic information could be done without any clerical error associated with the
process (Willcocks, 2017). Apart from that management also develop an automated mechanism
for variance calculation, cost determination and cost revision as per market change.
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Similarities and differences between the findings of the 2 studies
The similarities between the two studies are enlisted below:
1. In the given both case studies the main area of focus is on the updating of the standards of
the standard costing system on a continuous basis.
2. The primary objective of both the case studies was improvising the cost accounting
system.
The differences between the two case studies are enlisted below:
1. The first case studies have emphasized on more different approach that could be adopted
in the standard cost for better results whereas the second case study emphasized on the
way how to enhance the standards of cost accounting system (Marques, 2018).
2. The first case study has talks about considering the application of standard costing system
in any organization while the second has talks about the requirement of costing system in
textile industry.
Specific outcomes and relevant learnings from the research findings
From the extensive study of both the case studies many thing learned which would be highly
beneficial for the Australian Companies who have adopted or look forward to adopt this costing
system. The key points which might be useful for the Australian companies learned from first
case study are listed below:
1. The standard should be reviewed and update on continuous basis rather than waiting for
the date set for revision. The revision in the standard made according to the major
changes that occur in the costing system.
2. The standard must be relevant. If any change in made in the layout of plant as per
management decision simultaneously change in cost card relating to material mix is also
required to get the appropriate and reliable result (Solicitors, 2016).
3. The standards followed must be realistic and there is not space of ambiguity. The
standards set for overheads like material, labour and manufacturing overheads must
practical which is achievable.
4. Standards followed must be based on future. And the standard set for future based on past
performance and if necessary it should be update accordingly.
From the second case study the point noted which might be useful for the Australian companies
are as follows:
1. The textile manufacturing company, Graniteville Company suffered from some limitation
regarding the costing system, and to overcome from those limitation some automation
mechanism is required for costing system that automate the process of documentation and
simplify the complex task (Félix, 2017).
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2. The efficiency of the standard cost system can be further increased by preparing the
standard cost reports and the cost ledgers in the budget formats.
References
Bailey, C., Collins, D. & Abbott, L., 2017. The Impact of Enterprise Risk Management on the Audit
Process: Evidence from Audit Fees and Audit Delay. Auditing: A Journal of Practice & Theory, 37(3), pp.
25-46.
Barnes, J. L., 2015. How to Tell If Standard Costs are Really Standard. Journal of Management
Accounting Research, 25(3), pp. 130-143.
Bennuona, K., Meredith, G. & Marchant, T., 2010. Improved capital budgeting decision making: Evidence
from Canada. Emerald Management Division, 48(2), pp. 225-247.
Calvasina, R. V. & Calvasina, E. J., 2017. Standard Costing Games that Managers Play. Journal of
Management Accounting Research, 12(2), pp. 33-65.
Erik, H. & Jan, B., 2017. Supply chain management and activity-based costing: Current status and
directions for the future. International Journal of Physical Distribution & Logistics Management, 47(8),
pp. 712-735.
Félix, M., 2017. A study on the expected impact of IFRS 17 on the transparency of financial statements of
insurance companies. MASTER THESIS, pp. 1-69.
Gooley, J., 2016. Principles of Australian Contract Law. Australia: Lexis Nexis.
Hansen, S., Otley, D. & Stede, W., 2003. Practice Developments in Budgeting: An Overview and Research
Perspective. JOURNAL OF MANAGEMENT ACCOUNTING RESEARCH, 15(2), pp. 95-116.
Jefferson, M., 2017. Energy, Complexity and Wealth Maximization, R. Ayres. Springer, Switzerland.
Technological Forecasting and Social Change, pp. 353-354.
Knechel, W. & Salterio, S., 2016. Auditing:Assurance and Risk. fourth ed. New York: Routledge.
Marques, R. P. F., 2018. Continuous Assurance and the Use of Technology for Business Compliance.
Encyclopedia of Information Science and Technology, pp. 820-830.
Sithole, S., Chandler, P., Abeysekera, I. & Paas, F., 2017. Benefits of guided self-management of attention
on learning accounting. Journal of Educational Psychology, 109(2), p. 220.
Solicitors, S., 2016. The Principles of Contract. Contract, p. 13.
Truong, G., Partington, G. & M, P., 2008. Cost of Capital Estimation and Capital Budgeting Practice in
Australia. Australian Journal of Management, 33(1), pp. 95-121.
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Werner, M., 2017. Financial process mining - Accounting data structure dependent control flow
inference. International Journal of Accounting Information Systems, Volume 25, pp. 57-80.
Willcocks, L. P. L. M. C. &. S. C., 2017. Introduction. In Outsourcing and Offshoring Business Services.
Cham: Palgrave Macmillan,.
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