The diminishing value of standard costing systems

April 11, 2012

Using your standard costing system can prove to bring very little benefit to your business.  When you look at the item maintenance time and how infrequently the system information is used well, it is easy to wonder why companies bother with this approach to financial management.

Standard costing is an “old manufacturing” industry practice.  Company leaders can remember when you could set a standard cost in January and use it to compare to actual prices throughout the year.  Or, in a rare instance, change it once a year despite criticism from purists.  With the prices of raw materials and quantity of purchase changing so frequently, both up and down, more companies are changing standard costs continuously so as to not analyze fictitious variances.  Why have a full blown standard costing system when you can manage variance against individual job production standards?

Actively managing variances for purpose of continuous improvement happens infrequently.  When prior month financial statements are issued the middle of the following month, discussing company level material purchase price variance from two to six weeks late is hardly effective management.  Analyzing variances at the work order or job level timely easily replaces a full standard cost system.  Next day or weekly review of process variation actually allows management to identify valid  improvement opportunities.

Quoting jobs or pricing products at standard cost is potentially ineffective.  Quoting custom work often requires smaller quantities at higher unit price points.  Shorter run production to customer order or stock may involve higher inventory prices and less accurate profit margin planning and achievement.  Using the “old philosophy” of buying large quantities to earn a better unit cost are infrequent today as the cost of storage and handling, and hurting cash flow, are concerns.

Consider using an alternative inventory valuation method such as FIFO or LIFO for weighted average inventory values.  Charging the most accurate cost of material to a quote or work order will yield the best measure of production performance and real profitability.  Why have the management and clerical overhead of reporting multiple material and labor variances just to report gross margin at actual and the “bottom line” at actual?  And if you are well into your lean journey seriously consider lean accounting.

Ultimately companies succeed and grow value because they know how to price their products and services with adequate margin.  They produce products with continuous improvement activities that make them more efficient.  They manage only what needs to be managed.  If costing is a factor in your management practices, consider replacing your standard costing system with accurate and timely analysis of information that is actionable.

For more information about DVIRC’s Costing Service contact Harry Landsburg at hlandsburg@dvirc.org or call 215-552-3800.