The major disadvantages of standard costing includes its inherent reactive nature, its non-suitability when a product or process is not uniform, the difficulty in ascertaining standard costs, and the assumption that external conditions remain constant.
Standard costing is a system of cost accounting that first works out the standard cost of a product under existing conditions, and then compares this standard cost with the actual costs accrued during the production process. Any management strives to take corrective action to eliminate any variables between the actual and standard costs.
Here, we look at the top 3 disadvantages of standard costing.
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1. Reactive Nature
The major disadvantages standard costing faces is its reactive nature. Companies following a standard costing methodology tend to react to issues rather than take a proactive approach to prevent problems. Standard costing allows for the production process to run its inefficient course and then compares the actual cost with the optimal standard course.
The corrective actions from the management side to bridge the variable between standard costs and operational cost, aims at eliminating variances for a repeat process. This approach assumes that conditions remain the same. In the real world, especially under the fast changing external environment, prices and technology remain in a constant state of flux, leading to everyday change of prices and usage patterns. This leads to the cause of variances at one time become irrelevant during the next time, where other causes might lead to variance.
Management can fix responsibility only for the variance caused by controllable factors. It cannot fix responsibility when the nature of variance keeps changing with time. The standard costing reactive nature thereby, forces managers to revise standard costs to reflect new realities rather than take corrective actions most of the time.
2. Limitations in Applicability
Standard costing works only where the work processes, elements, and components used are uniform, and the process is consistent and repetitive, leading to homogeneous or standardized products. Production or customization of orders based on customer preference means each job requires a different set of work elements and components, and varying expenses. Standard costing limitations means that it remains incompatible to cater to such customization.
In a similar vein, the application of standard costing is difficult where a production process takes place in more than one accounting period.
3. Resource Consumption
The process of standard costing simplifies inventory costing and budgeting activity, but the actual cost of determining standard costing is time consuming and expensive, requiring much technical skills and various interventions such as a time and motion study.
The demand on resources such as time and money is taxing even for large companies, and practically inviable for small companies, making it the major disadvantage of the standard costing methodology.
Finally, the standard costing approach might not always align itself with business strategy or tactics. For instance, setting high standards when the external environment is in the state of a major change, though ideally desirable, might not be the immediate priority of management. Insistence on such standards might create discontent in the minds of workers and lead to low morale or turnover when the labor market is tight and the economy is strong enough for the customers to absorb the increased prices of inefficiency.
The limitations notwithstanding, standard costing helps cost control and improves efficiency in industries producing standardized products and repetitive work processes. Many companies prefer this cost accounting methodology over other methods such as process costing, historical costing, ABC costing, and other methods.