The Use of Standard Costing and Variance Analysis in Modern Organization - Case Study Example

Modern organizations in today’s world operate in a competitive environment and look towards corrective strategies in relation to their pricing decision and cost estimation. Different organization adopts different costing techniques to lower their cost of productions. One such very popular costing technique adopted by many organizations is Standard Costing and Variance Analysis. Selection of the best suited costing technique for a modern organization is of prime importance as it will ensure cost correctly and help the organization to develop a system through which the business will be able to identify true cost of its products and services and charge a price matching with the competitors and book profits from its future growth. This report throws light on the use of standard costing and variance analysis in today’s modern organization with examples of different companies using the same as a mean to support their costing structure. The report also highlights how standard costing and variance analysis help the management to control their cost structure in relation to materials, labor and other production related variables (Forbis & Mehta, 2000). It also summarizes the limitations and difficulties that the management faces while applying standard costing and variance analysis techniques in a particular modern organization and ways and means for management to overcome on the same and estimate the correct cost structure of their products. Standard costing and variance analysis are often used together to find the actual cost of production and measure the performance of the organization in achieving the standards set by the company (Flint & Woodruff, 2001). Standard costing is a costing technique to find the standard cost that is required to be incurred for a particular product or service and then comparing its actual performance with the set standards to find any deviations from the same. Deviations if any are critically examined and reasons for such deviations are figured out. Strategies are then developed to minimize and eliminate such deviations in order to ensure correct cost and cut down wasteful expenditures. Standard costing technique is thereby used for projects that require the same work to be carried out on a continuous basis as it works on predetermined standards so that correct cost estimations and benefits can be identified on a regular basis (Hilton, Michael and Setto, 2000). Organizations usually deal with four types of standards: Attainable standards: These standards are based on efficient operating environment and are the most frequently encountered type of standard. This standard may motivate employees to work harder as they provide realistic and challenging tasks (Dunn, 2010) Basic standards: These are usually long term standards that remain fixed over a long period of time. They further do not highlight the current efficiency (Dunn, 2010). Current standard: These standards are based on current operating environment and are most meaningful when current conditions are abnormal and other standards does not show realistic goals (Dunn, 2010) Ideal standard: These standards are based on perfect operating conditions which mean no breakups, no wastage and scrapes, no idle time, in short no inefficiency. Japanese companies usually target this standard to achieve maximum returns (Dunn, 2010) Standard costing technique is most suited for organizations with mass production of homogenous or same products and organizations with repetitive works. Production on large scale with repetitive works helps to determine the average uses of resources and cost estimation in a correct manner. Modern organizations with non-homogenous products and high intervention of human usually does not prefer standard costing and variance analysis technique Example: Restaurants usually find it difficult to apply standard costing techniques as each dish slightly varies with the previous one and high level of human intervention is involved in the same. McDonalds try to overcome this problem to assist itself with standard costing as each of its product are produced identical to the previous one. For example each Big Mac contains a pre-measured amount of sauce and two gherkins in it. It further tries to reduce human intervention by using fountain drink machines instead of staff pouring the drink. Standard costing and variance analysis has its own advantages to the modern organizations which are listed as below: Standards set help the management to make a continuous review of the performance and guide the employees towards the right direction (Blocher, Chen & Lin, 2000). Since modern organizations work in a turbulent environment, variances become more relevant. Operational variances give a clear view of the actual results achieved in realistic and actual operating conditions. It helps in motivating employees and ensures better production with minimal cost (Cokins, 2009) Variance analysis helps in setting future standards which proves to be more realistic. Example: Nestle ltd. in its milk powder category used machines to churn the powder which were obsolete before its useful life and resulted in delay of productions which were rightly discovered by the management of the company and machines were replaced on an immediate basis. Standard costing and Variance analysis has its own set of limitations which has been highlighted as under: Not suitable for manufacturing environments where products are non-standardized or customized as per customer specifications. Products with shorter product life cycle require standards to be reviewed frequently thereby becoming outdated at a rapid pace. JIT and TQM business often set ideal standards to maintain high quality , therefore adverse variances with ideal standards have a different meaning from adverse variances calculated with current standards (Horngren, 2011) Modern organizations are more automated with lesser use of human interventions to cut down cost which results in lesser application of standard costing techniques (Horngren, 2011) Example: If a company is afflicted with Toyota, it does not use much of standard costing and variance analysis techniques since labors in such companies no longer exist in large numbers, fully automated machines are used which has its own set of standards. Standard costing and variance analysis requires that standards are setup in an unbiased manner taking into consideration all internal and external factors. Standards should be stated in a manner that it is not skewed on either side (Brucks, Zeithaml & Naylor, 2000). While setting up the standards it is important that different heads like production head, sales head, procurement head coincides with the same. Example: Suzuki Industry has developed well set standards for its production head, and production was ideally met with the standards however the company has to lower its efficiency due to failure of its procurement of raw materials from its suppliers thereby inviting adverse variances in its standard costing techniques. Standard costing increases the role of cost accountants to ensure that cost is estimated and determined in a correct manner and strategies are developed as per the adverse variances. Standard costing and variance analysis has its own advantages and limitations and management in today’s modern environment considers the use of this technique as an effective cost control method (Iwarere, 2000). Setting standards as per realistic conditions is of prime importance taking into consideration different heads involved in the same. Variances should be reviewed at regular intervals and strategies to overcome the adverse variances should be planned in an effective manner without much changes or alteration to the set standards. It is to be noted that standard costing can be equally applied in service industry and modern organizations implementing TQM and CIM find it useful to use standard costing techniques as it enables them to estimate the true and fair cost structure and develop pricing strategies accordingly in order to compete in today’s competitive environment with lesser difficulties and generate higher profits and growths for their respective organizations. References Brucks, M., Zeithaml, V., & Naylor, G. (2000). Price and brand name as indicators of quality dimensions for consumer durables. Journal of the Academy of Marketing Science, 28(3), 359– 374 Blocher, E., Chen, K. Lin, T. (2000). Cost Management – A Strategic Emphasis. USA, Irwin, McGraw Hill Cokins, G. (2009). Advantages of activity Based Costing. Global Product Marketing Manager, SAS Institute Inc Dunn, A. (2010). Activity Based Costing. Industrial Relation Centre, California Institute of Technology. Retrieved November 9, 2012 from www.irc.caltech.edu Forbis, J. & Mehta, N. (2000). Economic value to the customer. McKinsey Quarterly, 3, 49– 52 Flint, D., & Woodruff, R. (2001). The initiators of changes in customers’ desired value—Results from a theory building study. Industrial Marketing Management, 30, 321– 337 Hilton, R., Michael, W. & Setto, F. (2000). Cost Management Strategies for Business Decisions. Illinois, New York: McGraw-Hill Horngren, C.T. (2011). Cost Accounting: A Managerial Emphasis (1st Australian Edition) Iwarere, H. (2000). Contemporary Managerial Cost Accounting, Egbe: Bhoti International Publishing Ltd Read More