PROBLEMS USING STANDARD COSTING TECHNIQUE
Introduction
Standard costing is widely used by manufacturing companies (1993). It is a system that absorbs direct materials, direct labor and factory overhead into the production costs. These three main costs are classified as standard costs which have close relationship with budgeted costs. Under the condition of normality in operations, it guides corporate managers to identify overall costs of production (2007).
First Problem: Lean production does not fit standard costing
For private firms that aspire to achieve economies of scale to minimize production costs, standard costing can be used when they are under mass production environment (2003). However, under lean strategy, using standard costing technique may be less functional and even destructive. As lean production reduces volumes produced as inventories are consumed only after determining amounts of quantity demanded, negative volume variance can ensue. At this phase, the production process is operating under less than full capacity. Lower volumes also caused higher per unit overhead costs allocations while lower profits results to negative variances. Sales team generates low volume of sales with high costs and manufacturing managers cannot justify the budget process due to discrepancies in volume variances.
The reason behind the incompatibility of lean production to standard costing is that use of evaluating the latter technique under the traditional costing that is designed to support mass production advantages not lean mechanisms ( 2003). Under lean production, the company is made profitable by having greater flow of production volumes on the same resources. In addition, standard cost measurements are labor efficiency, machine utilization, cost variances versus standard, earned value and departmental budget focus. In the contrary, lean measurements are throughput, cycle time, first time quality, inventory turns and value stream focus. As a result, standard costing principle is to manufacture more, keep more, utilize at maximum, optimize, track and allocate costs while lean principle is more or less the opposite. It is suggested that standard cost approach to be replaced by lean approach because the former does not account for available capacity due to the assumption that the company is operating under full capacity already. In effect, expansion in both geographical, product market and financial market sense would not be a lucrative engagement and growth of such companies is not considered.
Problem Two: Standard cost is too optimistic
Ideal cost is a type of standard cost which suggests the exclusion of any waste, scrap, inefficiency, delays and other hindrances to achieve full capacity (2000). However, these events hardly happen in real production process, and even through they merely serve as motivational guides to cost reduction, a profit-oriented company would readily incorporate it in their production principles as way as to discipline workers. In effect, creativity and self-esteem of employees are undermined. Physical assets and machineries cannot resist corporate goals to maximum productivity and efficiency which is opposite of humans. In earlier days of Ford supply chain, workers basically became “non-thinking laborers” due to too much formality and specialized day-to-day tasks aggravated by the introduction of conveyor belts and “man high” line wherein movements became unnecessary and timing was very crucial (2006). Such drowsy and unchallenging environment was the primary cause of high turnover in 1913 and the company needed to increase spending in retention projects just for the sake of supplier independence on top of production efficiency.
The classic example of Ford showed the inability of stand cost technique to focus on employee needs and exploit entrepreneurial skills to achieve profitable strategies. Budgeted targets used to specify the everyday cost level which is a source of managerial myopia. As a result, standard costing is dubbed as a technique that leads to inappropriate future decisions (2000). The main problem is that the technique does not provide enough information to control overheads and other indirect costs like those related to employee turnover or human resource benefits just to hold the current production policy. In addition, when production overheads multiplier is expressed as additional percentage of product indirect cost, the value would be calculated recursively allowing ever-increasing overheads for a new product. In effect, the same problems in non-support of direct costing to diversification and expansion are noticed.
Problem Three: Overly-focused on statistical applications
Predetermined cost is composed of standard cost and estimated cost (2000). Standard cost depends on statistical data and approach used as an index for cost management. On the other hand, estimated costs are highly subjective and depend of manager’s experience and intuition. As a result, there can be a conflicting boundary between standard cost and estimated cost which policy implementers may found difficult to address. For example, having a fixed overhead budget may lead to running a production line in its full capacity even if unnecessary. In effect, although the budget is obtained, holding costs for sizeable stocks rise which is an alternative disruption to the effectiveness of a budget system. This scenario is in accordance to (1995) that traditional systems transform managers to act in suboptimal manner. Further, over-emphasized with statistical variances lead to conclusions of (2000) on the inability of the management to select a more company-wide strategy rather local ones. Such admonition is in the case of managerial myopia to prefer static product base to prevent substantial product mix variances even if the market indicated market saturation for the current product lines.
Conclusion
For private sector, direct costing technique would not be applied simply because there are successful companies such as Dell Corporation that uses lean production. As Dell attributes its supply chain achievement to the Internet and networking capabilities, the continuously growing businesses will continue to use new technologies to be competitive. However, loopholes in direct costing principle may hinder such gain competitive advantage in this fast changing environment.
For the public sector, direct costing technique would be undermined because of the greater influence of leaders in decision-making. In effect, political aims will prevent internal control to use over optimistic and formal approach in success evaluation of governance. Projects and public investments will be allocated in areas that have been promised by elected candidates rather than allocating them in highly efficient industries or sectors that can give efficiency advantages and economies of scale.
Credit:ivythesis.typepad.com
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