Question

What is the impact on an organization if the standard costs are inaccurate? What are the criteria for determining the accuracy? What should the company do?

Answer 1

Answer:

Standard cost:- standard cost is a method of setting targets for evaluating the actual performance of an enterprise in a Accounting period.

These targets are set as per the expectation against the actual performance of a company, required criteria and as per the trend based on historical performance.

The use of standard costing is to evaluate the actual results against the targets and to apply constant control over the various operations of the organization where the management observe significant variances.

Criteria for determining the accuracy of standard costing:-

There are various criteria on the bases which expected cost of producing the product is determine:-

1. Historical cost of producing the product.

2. What are the trend of growth/ decline in the per unit cost of the product.

3. Development in the capabilities used for producing the product.

4. Cost trends as per the segment like:- material cost, Labor cost, Factory overhead cost,etc..

5. What is the expected future performance as per the management.

6. What are the current economic condition of the industry.

7. Development in the technologies.

8. What are the opportunity cost of producing the product etc.

The impact on an organization if the standard costs are inaccurate:-

  There will be severe impact on the organization's some of them are:

1. Direct material price standards which create the incentive to purchase materials in large volume to get price discounts will not meet it's purpose and will either create over-stocking or over- costing.

2. Direct material quantity standards create the incentive to reduce the quantity of the material purchased will increase the chance of over-stocking and increase the holding and carrying cost.

3. Standards create the incentive for cross monitoring. If the standards are inaccurate then the managers are held responsible for costs that are outside of their control.

4. Managers will not get the incentive to control costs as the wrongly computed standard will not meet the objective.

5. If the standards computed inaccurately it will lead to excess cost cutting which can effect the quality of the product produced.

6. Quality can effect the market reputation of the company and the demand of the product in the market can be adversely impacted.

7. It may also lead to production cost over the actual cost which will at the end fail the objective of whole process of standard costing.

what should the company do:-

The company should follow the step to accurately compute the standard cost related to various segments and the per unit cost.

1.cost center identification and establishment: the purpose of setting cost center is cost ascertainment and cost control. So while identifying a cost center, the person who is responsible for that particular cost center should be ascertain so that person should be held accountable for the performance of that particular cost center. A cost center is a person, location or an equipment in respect of which costs are to be allocated directly or indirectly related to the process.

2.​​​​Classification of the accounts:-

Accounts are classified on the basis of functions, revenue item, assets and liabilities items to meet a required purpose. To meet speedy collection and analysis of accounts.

3. Types of standards:-

Standards indicate the level of performance of the production process which must be improved and lead to effective utilization of resources and quality improvement.standards can be various types:

Ideal standard

Normal standard

Aggressive standard

Basic standard

Expected standard.

4. Setting the standards by using standard costing:-

The success of the standard costing system in an enterprise depends upon the reliability and accuracy of standards. Hence care should be taken while setting standards. Standards must be accurate,based on reality, historical performance, growth/ decline treads, motivational, current and meet able target setting and as per industry economical conditions.