Is standard costing still relevant?

Liesel Botha Centre for accounting studies University of the Freestate

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In the complex economic environment we find ourselves currently operating in, one of the very few things that remains certain is the “time is money” principle. This, together with the importance of accurate and useful information plays a pivotal role in effective internal decision-making.

Unfortunately the most accurate accounting information is in most instances historical and therefore of very little significance for internal decision making. Standard costing can aid in addressing this point to a large extent. The standard costing phenomenon is, however, often conceived as overly complex.

It might be worth it to first take a look at the basic principles of standard costing again, before jumping to hasty conclusions.

In the first instance, it is important to distinguish between a standard and a budget. Although the two are unavoidably interrelated, it is not the same thing. A budget relates to the ‘total’ concept, while a standard presents the same information on a per unit basis.

A standard is a pre-determined cost allocated to a single unit and can be further broken down into expenditure and volume parts. Such a standard should serve as a starting point in what has the potential to be an extremely effective performance management tool.

Standards should communicate the realistic expectation of the product, whether it is in relation to usage (volume) or costs (expenditure) or both. The way in which a standard is set, will greatly influence its relevance and usefulness.

A standard which sets the ultimate goal with no room for any inefficiencies might, except for the possible motivational value it might have, be irrelevant and have a far greater negative impact on morale.

A standard that remains unchanged over the long term, might also render itself irrelevant as it has been proven relentlessly that operating circumstances change continuously, especially in our beautiful country. Such a standard will not represent the current situation and will therefore not be used.

The best standard should therefore reflect an attainable target under current, normal operating conditions. In this case, it becomes a powerful performance management and cost monitoring tool.

Attainable standards enables the manager to do a detailed variance analysis on the difference between the budget/expected costs and the actual costs. By being able to identify the cause for any inefficiencies, a much more effective remedy can be instituted to avoid any significant losses.

Furthermore, an attainable and accurate standard also addresses the void that historical information leaves in respect of internal decision-making. If the standard is set correctly, it reflects current conditions and expectations to such an extent that a fair degree of reliance can be placed on it in making internal decisions.

Lastly, it should be kept in mind that a standard costing system will not necessarily be a perfect fit for all industries.  It is most suited for organisations with a series of common or repetitive activities of which the input per unit can be readily determined. It will be almost be impossible to set a relevant standard in an industry with non-repetitive activities as there will be no basis to observe in setting the standards. It is therefore more commonly used in manufacturing industries, although the use of it is not limited to manufacturing industries only.

Provided that standards are set correctly and continuously updated, it remains one of the most relevant and effective performance management tools.