Criticisms of Standard Costing and Variance Analysis - Essay Example

? By; Criticisms of Standard Costing and Variance Analysis Standard Costing is the costs that a company believes each productcosts the company based on direct material, direct labor, and overhead (Accounting Coach, LLC). The company predicts these costs based on the various components that go into making the product. An example would be the standard cost of a McDonald’s hamburger. We know that the costs would be based on the price of lettuce, onions, buns, and ground beef but the cost would also be based on how long it takes an employee to make one as well as what equipment is being used to make it. Other factors such as transporting the materials, utilities, etc could also be used however as stated before it is only an example. Variance Analysis is the difference between what is actually paid and the standard cost. The variance is used as a means for management to discuss performance and to review them. One of the major criticisms of standards is that some forms of standards are outdated and not as widely used as others. Another criticism is that the standards are not attainable. This means that the standards are not within reason. Considering that most standards are outdated and incorporate many different components, it is easy to see how mistakes can be made. If the company uses the wrong information on any of the components than it is guaranteed that a variance will be revealed upon further analysis. The standards are also not changed over a period of time and therefore are prone to be incorrect due to changes in technology or even by inflation. Standards are said to give employees the motivation to meet goals and to push his/her self to meet or exceed the goals of the company. This motivation is also said to benefit the company as a whole because it increases efficiency and productivity. The best way for standard costing to be effective is to have someone from every level to participate. There has traditionally been a problem trying to get enough people to participate so that the results are reasonable. Participants will look for the easy target and this can pose a problem. The easy target is not necessarily the optimum target or the most cost efficient. Participation in the costing or analysis would require a lot of time and knowledge that the participants do not have. Also the more time they spend on it the more it will cost the company in the form of salaries and benefits. There is also the risk of the participants being out for their own individual gain. They could feel as if their participation could help them further their own agenda instead of that of the company. They could also spend too much time talking and not enough time coming up with solutions. Lack of knowledge can also factor into this because if the participants do not understand the goal they are trying to reach, then time can be spent teaching them instead of getting down to business. Management of Time is also another criticism of standard costing and variance analysis. The process is time consuming to say the least and most managers already feel as if they don’t have enough time to carry out their day to day activities let alone deal with standard costing or variance analysis. Managers in particular might feel as if this is something that someone else should be doing, namely someone in the corporate office if there is one. Absorption costing fuels another criticism of standard costing and variance analysis. Absorption costing assumes that all costs of the production of a product are included in the final price of the product (AccountingCoach, LLC). This type of costing can create some problems because it could lead to extremely high standard costing which in turn would always lead to variances. If a product includes all of the fixed costs such as utilities of the entire building, rent of all buildings, etc than the standard cost could be extremely high and overstated. The costs are not allocated over all of the products that are produced in the same area but instead the costs are absorbed into the price of each product. This can also lead to other products being made in the same area having extremely high standard costs. Direct costs are normally costs that are essential to the production of the product. These costs are normally materials, labor, and overhead. The materials are anything that is used to make the product such as ground beef being necessary to make a hamburger. The labor is basically any man hours that are needed to produce the final product. The overhead is usually the utilities of the factory, rent of the factory, depreciation of the equipment, and other factory supplies. Direct labor is said to be a significant part of the direct costs. Direct labor costs can be less significant today due to technology and the automation of many processes that use to be performed by humans. The jobs that humans use to spend countless man hours performing are now being cut short by the use of machinery, equipment, and modern technology. This is also a criticism of standard costing and variance analysis because if it uses a standard cost that is outdated then the variances would be based on these costs. If these variances are used for performance purposes, then this could lead to goals and expectations that are not reasonable. In conclusion, we can see that standard costing and variance analysis does have their purpose but they can also be outdated and antiquated. Management needs to make sure that the factors being used are updated as often as technology causes them to be. Criticism of Traditional Budgeting A budget is a plan of what you have and how you plan to use it. In the world of business, it is a plan that shows what your revenues and expenses will be based on the past performance and what is expected to happen in the future. The budget is said to motivate everyone to achieve the goals that the budget outlines. It provides goals for revenues, expenses, and profit. The budget has been a subject for criticism because of various reasons. One of those reasons is that even though the budget is to be based on realistic expectations, most times it is not. The budget is basically a guess of what events will impact the revenue, expenses, and profit of the company. These guesses are based on everything being as equal as they were the previous year. World events can’t be predicted such as the impact of the current recession. Also suppliers increasing expenses anytime during the year can’t be predicted as well such as Netflix increasing their price the way they did this year. It was completely unexpected. The budgeting process takes up a lot of time and hours from management. Management must go through their departments with a fine tooth comb and try to uncover everything they can find that needs to be added or subtracted from the budget. Most times this can lead to many man hours being used to come up with a budget that is basically subject to many inaccuracies. The budget has also been criticized as being a way for management and upper management to exercise a control over their employees. The budget has been used as a mechanism for performance reviews. By using the budget and comparing it to the actual numbers, managers and upper management can determine if their department is doing well or missing the mark. Misinterpretation of the variances can lead to inaccurate performance reviews which could then lead to low employee morale. The budget also has a tendency of not being adjusted due to events within the business or even in the world as a whole. This can pose a big problem because if the budget is based on one set of assumptions that change over a period of time. If this is the case then the budget needs to be flexible. For example, if the budget is based on sales remaining the same or increasing from year to year and a recession occurs that directly affects the business, then the budget numbers should be adjusted accordingly. Most times we see budgets that predict the same revenue and expenses for every month of the year. This would be acceptable in a company that did not have seasonal fluctuations however most companies have peak sales months and off peak sales months so it would not be reasonable to adopt this type of budget. The budget also has criticism coming from those who oppose to the legwork that goes into it simply because they do not have the accounting knowledge to understand all of the different components that go into it. This also holds true if certain components do not apply to them and if they do not understand accounting then they might include it in their budget. This could lead to a delay in the budgeting process. Budgeting also is criticized because it leads to an emphasis on sales figures and neglects the rest. Companies tend to place an importance on the sales figures and allow these to be a foundation for the rest of the budget. If sales numbers are not met, the company tends to stop right there and make an attempt to figure out why instead of analyzing the rest of the budget information. Sales have become more of a priority than the budget as a whole and the budget allows this notion to continue. Budgeting also can be criticized for allowing overspending. Most times the budget includes the maximum amount that can be spent. Some managers would not spend this amount in a normal setting however once they see that they can spend more they most likely will. As long as the spending is below the budget they feel justified in doing so. Zero budgeting is also a problem. In this type of budgeting every cent has to be justified and this can be very time consuming and expensive. It can also be said that communication of the budget may not be as forthcoming. Managers can build cushion into their budgets but this may not be communicated to anyone else. Also one department’s budget might not be in line with a supporting department’s budget if goals and expectations are not communicated. Bibliography Accounting Coach, LLC. Standard Costing. 2011. 20 November 2011 . AccountingCoach, LLC. What is absorption costing? 2011. 21 November 2011 . Read More