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In this article the following items will be discussed:
* why standard costing systems are widely used;
* the key elements of a standard costing system;
* traditional overhead variance analysis;
* criticisms of traditional standard costing systems and
* how standard costing is changing to meet the requirements of the changing environment.
Introduction
Despite its widespread use, standard costing has recently come under attack for not providing the information that is needed for today's manufacturing and competitive environment and in the late 1980s commentators were beginning to predict its demise.
Purposes of standard costina
Standard costing is appropriate for organisations whose activities consist of a series of repetitive operations. It is therefore most suited to manufacturing organisations, since the processes involved are often of a repetitive nature.
It cannot be applied easily to activities of a non-repetitive nature, since there is no basis for observing repetitive operations and consequently standards cannot be set.
Standard costing systems are widely used because they provide cost information for many different purposes such as:
* providing a prediction of future costs that can be used for decisionmaking purposes;
* providing a challenging target which individuals are motivated to achieve;
* assisting in setting budgets and evaluating managerial performance. Standard costs are particularly valuable for budgeting, because a reliable and convenient source of data is provided for converting budgeted production into physical and monetary resource requirements;
* acting as a control device by highlighting those activities which do not conform to plan and thus alerting managers to those situations that may be 'out of control' and in need of corrective action. With a standard costing system, variances are analysed in great detail. Useful feedback is therefore provided in pinpointing the areas where variances have arisen;
* Simplifying the task of tracing costs to products for profit measurement and inventory valuation purposes. A data processing system is required which can track costs in a resource efficient manner. Standard costing systems meet this requirement by maintaining records at standard cost. Inventories and cost of goods sold are recorded at standard cost and a conversion to actual cost is made by writing off all variances arising during the period as a period cost (see Figure 1 for an illustration).
Key elements...