Standard Costing And Variance Analysis - Essay Example

STANDARD COSTING AND VARIANCE ANALYSIS Student’s name Course code + name Professor’s name University name City, State Date of submission Introduction The use of standard costing and variance analysis in the contemporary economic entities has suffered increasing criticism based on the fact that the techniques provide misleading information to decision-makers. Using the technique to make decisions about product sourcing, product pricing, and response to rival products yields lapses in the decision-making functioning of the organisation thereby threatening the profitable existence of the business in the market. Surviving in the current competitive business environment necessitates the inclusion of other techniques that govern performance evaluation and cost control such as just in time (JIT) and activity based costing (ABC) to complement standard costing and variance analysis. The essay discusses the setbacks exhibited by the standard costing and variance analysis technique as measures of performance and cost control. The paper also discusses the alternative techniques that modern business entities can use to guarantee their positive performance in the market. The last section of the essay focuses on the relevance of the standard costing and variance analysis technique in the modern business environment. Arguments against the use of standard costing and variance analysis Business writers have raised several arguments against the use of standard costing and variance analysis in measuring the performance and controlling the costs of modern businesses. The arguments have reclined on the fact that the techniques induce behaviour that is inconsistent with the current manufacturing objectives needed by companies for their success in the competitive business landscape. As a result, they recommend alternative techniques that may either replace standard costing and variance analysis or complement the technique in the evaluation of business performance or controlling the costs incurred by firms. Some scholars such as Carole Cheatham and Leo Cheatham also reiterate the declining effectiveness of SCSs in measuring the performance and controlling the costs of businesses (Cheatham & Cheatham 1996). However, they hold a slightly different opinion regarding the issue. They recommend the introduction of system upgrades to enhance the relevance of the SCSs to the modern-day businesses rather than the complete overhaul of the system and its subsequent replacement with an alternative system. It is evident that the operational principles of SCSs do not meet the needs of the modern business entity. For instance, contemporary business firms consider responses to the immediate needs of the customer and continual improvement as the major drivers of competitive advantage (Stephanie 2008). As a result, the use of standardised systems with the objective of cost reduction is inapplicable to the modern business. In fact, a firm that continues to use SCSs exhibits individuality and reduced customer service. The issue emanates from the simple fact that the quest to reduce costs accompanies a reduction in the quality of the products, externalisation of costs, and the failure of the business to cater for the individual needs of its customers. Prior to asserting that SCSs result in the above-mentioned drawbacks, it is necessary to understand the principles under which the standard costing systems (SCSs) operate. Firstly, the systems operate on the principle that standards set prior to the onset of a period are effective during the entire period until its termination. At the time of the introduction of the system, firms used it effectively since the levels of competition were low. Moreover, there were few instances that required the immediate adjustment of the production and costing patterns as is the case in the modern business environment. Secondly, SCSs operate on the principle that the mere fact that the performance meets the set standard is a guarantee for its acceptance. The assumption does not consider the multiple variables associated with the manufacturing and production processes of a firm that necessitate their inclusion prior to making critical management decisions (Kaplan 1990). However, the modern manufacturing sector implements the Just in Time (JIT) manufacturing among other systems that use different principles. The principles differ from the operational principles of the SCSs. Rather than anticipating normal levels of efficiency and wastage as is the case under SCSs, JIT manufacturing anticipates high level of efficiency and minimum levels of wastage to cut down costs of inventory and production. As a result, methods such as JIT manufacturing are appropriate for modern-day manufacturing. The necessity of replacing the conventional SCSs with the modern techniques also emanates from the high costs associated with implementing the systems. The use of the system is also time-consuming. In the event of outdated or incorrect standards, the resultant comparisons are also misleading or incorrect. The business environment exhibits frequent changes in the conditions that render standards obsolete or out of date easily (Hansen et al. 2007). As a result, the standards end up losing their intended motivational and control effects. The understanding of overhead variances; particularly those that are elaborate and complex is a difficult task for the managers (Emsley 2001). Since the managers are responsible for making business decisions, the use of such variances may compel them to make poor or misleading decisions that may have an adverse impact on the actual performance of the business. The notable discrepancies between the expected results from the SCSs and the actual results emanate from a number of possible reasons. For instance, variances may arise from errors associated with determining the measure of the actual outcome. Moreover, changes in the operating conditions may also render some standards obsolete. Both efficient and inefficient operations can also serve as sources of variances. Uncontrollable and random factors also yield variances (Stephanie 2008). Alternative or Complementary Cost Control and Performance Measurement Techniques Just-In-Time (JIT) and its implication on Accounting The advent of JIT technique traces its root from the necessity of process engineering in the contemporary competitive business environment. As a result, modern firms should update their accounting information systems in tandem with the innovations exhibited by the modern manufacturing system. Using the JIT system in accounting is simpler and easier as compared to the standard costing and variance analysis that poses challenges to managers that do not have a professional background in accounting (Talha 2002). The system applies production costs to the already sold products. The implementation of JIT in manufacturing considers waste reduction as one of its principle aims. As a result, the system ensures that the firm produces only the required units to avert incidences of excess production. Rather than producing the required units, the system also ascertains that the produced units are in their right quantities, align production rates with the market demands and avail the products at the necessary time. The system minimises the costs required to produce and sell the product by reclining on the main operational functions. The functions encompass improving the layout of the plant, minimising the set up time, targeting zero deficit and the development of a flexible workforce (Dalci 2006). It is evident that such systems optimise the performance of modern-day businesses without having to undergo the necessity of implementing complex standard costing and variance analysis systems. The proper implementation of the JIT system requires factories to improve the layout of the manufacturing flow lines. JIT systems in manufacturing use the “focused factory” plant layout. As a result, the implementation of the system results in the establishment of “mini-factories” within the main factory. The system groups together all the activities carried out by different machines using one worker and joins the grouped machine systems in a coherent manner to avert incidences of shifting work processes from one place to another within the factory (Talha 2002). However, the use of the system may delay the distribution of the products to the consumers in the event that there is a defective unit. A defective unit requires a fresh restart of the production process to deal with the issue (Talha 2002). Such systems require all stakeholders (particularly production workers and suppliers) to monitor the supplies and materials as well as the production processes thereby ensuring that there are no defective units. Therefore, flexibility and having multiple skills is a basic necessity for workers under JIT systems (Radisic 2009). Apart from operating on the flow line equipment only, the workers should also engage in minor repairs of the equipment. The company can also implement JIT system in its purchasing function. By so doing, the firm minimises its inventory of finished goods. This also prevents raw material delays at receiving, inspection and ordering points. Therefore, the use of JIT in purchasing ensures the prompt delivery of materials as and when required by the firm (Talari et al. 2013). From observable attributes of the JIT system, it is proper to argue that it best suits the contemporary business environment as opposed to the standard costing and variance analysis that determines standardised input and output quantities to serve the entire production period without considering the regular changes in the market demand. Activity Based Costing (ABC) ABC is an alternative costing measure that modern firms can use in the contemporary business environment. The technique allocates arbitrary values for fixed overheads including labour (Polimeni et al 1991). As a result, it does not introduce a linear relationship between such arbitrary factors and the production process. The method uses single pools of overhead application bases and indirect tools such as direct labour hours. For instance, the system does not consider the direct labour hours to be enough for costing since there is no direct relationship between resources and direct labour in the current manufacturing environment. According to the developers of the system, associating direct labour hours to the allocation of resources within the firm may lead to the placement of wrong products by the management. As a result, the maximisation of profits under the system requires a firm to adopt two options. Firstly, the company can endeavour to cut its costs. However, it is apparent that firms that consider cutting costs as their primary target and prerequisite of maximising profits are on the verge of experiencing a downfall due to the constant need of incurring overhead costs in all manufacturing processes (Blaxill & Hout 1991). The other alternative entails lowering the prices of products. However, a compulsory reduction of the product prices that should accompany an increase in the profits realised by the firm necessitates the implementation of the ABC system. Information requirements suffice to be the other incentive behind the need for the ABC system. The executives of a firm depend on the information availed by the cost accounting systems to execute their duties associated with cost management. As a result, the accounting systems ought to coincide with the new processes before the managers can use their information to redesign and improve the manufacturing processes within the firm. As a result, the proper management of the manufacturing activities results in the cutting down of costs thereby yielding competitive products (Cardos & Pete 2012). As compared to the SCSs, it is evident that the systems exhibit more focus on financial accounting rather than the real activities of the firm. Such systems have failed to provide pertinent information such as the prices of the products, making decisions associated with the product mix (Polimeni et al. 1991), and an evaluation of the performance of the plant. Advances in technology associated with the gathering of information have enhanced the process of obtaining and processing information necessary for the ABC system (Hilton 1994). In essence, the implementation of the ABC technique guarantees better management of costs and accurate product costing (Roohm et al. 1992). Target Costing Target costing is the other costing approach that firms in the modern business environment can use in product costing and performance evaluation. Target costing begins with the determination of target prices with regard to the existing competition and market needs (Ghafeer et al. 2013; Al-Awawdeh 2012). Under the approach, it is also imperative that the firm should determine the anticipated profit margin as well as the compulsory costs that are necessary in the manufacturing process. The firm should also estimate the costs of the current processes and products. Finally, the firm should establish the target cost that entails the appropriate amount of price reduction that the company should impose on its products. However, the implementation of the target cost necessitates the establishment of a cross-functional team that should oversee the implementation process (Idowu 1993). The design process also requires the use of certain tools such as value engineering. Following the onset of the production process, the implementation team should use “kaizen costing technique” to pursue the cost reductions. The competitive nature of the modern marketplace necessitates the setting of product prices at the planning stage of the production process. The predetermined product prices should guarantee return on capital and an acceptable profit margin (Briciu & Capusneanu 2013). The Continuing Relevance of the SCSs Irrespective of the increasing competitive nature of the modern market, the use of standard costing and variance analysis is still relevant under certain business conditions. As a matter of fact, SCSs are still important costing and performance evaluation tools (Marie et al. 2010); particularly in less competitive business environments and markets that exhibit stable demand of products. The systems are still relevant in the computation of the costs of inventory. Moreover, modern business entities can still use the system as an aid to budgeting and the computation of product costs thus enabling executives to make proper and accurate business decisions (Badem et al. 2013). Conclusion The implementation of standard costing and variance analysis impacted positively on the management accounting function of firms. However, recent changes in the business environment characterised by increasing competition and regular changes in the demand of products has rendered the technique obsolete. Modern writers argue that there is need for firms in the contemporary business environment to adopt alternative techniques such as activity based costing (ABC), target costing and Just in Time (JIT) techniques in accounting. As a result of the additional roles that the SCSs play in the management accounting function of an organisation, executives that intend to make proper management accounting decisions should use the later techniques as complements to the SCSs. 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