Advantages and disadvantages of using a standard cost system

Cost systems can be based on control of production, sourcing of products, or cost elements. Companies calculate product costs to determine inventory values, to calculate sales prices, and to determine cost of goods. goods sold, and that is why they resort to these systems and their methods.

At the end of the day, operating expenses and costs are reflected in a total cost, which will then be subjected to time studies, movements and engineering estimates typical of the standard cost system, and this is how the production of an industry can be anticipated or large company before starting production, thus generating an expectation of efficiency.

This affects all executive decisions: the sale or purchase of a good, the increase in sectors of the company, the elimination of production lines and other issues related to the cost of production. So we should know the advantages and disadvantages of this particular system, before addressing its application.

What are the main advantages of this cost system?

A standard cost system consists of its ability to provide a benchmark where the company can evaluate its performance. The company compares the standard cost with other systems for each product, and the difference that results from this comparison represents the variation. High variance means that the company is performing very differently than expected and requires additional investigation to find the cause of this. Unexplained high variations identify performance problems.

Another advantage that can be pointed out is that the standard costs can be calculated in advance of the production process or at the beginning of the accounting period and determines each of the products of each production process by cost element.

According to the specialist Virginia Hernández, a university professor in the Apuntes de Costos III chair, this system allows good control and budget planning. In this way, two methods can be thought of: that of basic standard costs, which serve as a reference point that are then compared with real results, allowing the reduction of real costs and relative percentages; and the current standard cost method, which functions as a real cost that can be used in financial statements.

Regarding the benefits of this last method, the one that the author points out as the most appropriate, the calculated costs facilitate the setting of sales prices, so the production procedures are standardized, in such a way, it allows to know the idle capacity and its value as well as collects timely information that will lead to solid budgeting.

What disadvantages can be found in this system?

A study by the Committee for Research Development of the University of Antioquia determined that many companies in Colombia are unaware of the management and scope provided by standard costs, so they do not know how to follow the methodology and therefore prefer calculations that face cost standard with actual cost. Which could be a disadvantage for those companies in the region that wish to use only this system.

The standard cost system methods have a lack of flexibility. Once the year begins, the company may experience changes that influence the costs of the products, so that the results of the standard cost would be uncertain in situations like these.

Another disadvantage of standard cost systems is their impact on profitability. A business that uses a standard cost system calculates profitability by subtracting the standard cost of an item from the selling price. When actual costs vary from standard costs, the calculated profit presents an inaccurate picture of the company’s performance. This same effect occurs when the company analyzes different pricing scenarios.

The implementation of the standard cost system is expensive in the beginning, being cheaper to sustain due to the tools and instruments that are constantly applied. Also, only companies with extraordinary internal control will be able to run the system properly, however, many have chosen to choose other systems because it yields a lot of useless data that wastes their own resources.

What other systems can be used to calculate costs?

The choice of the system will always depend on the legislation of the country where the company operates. Although one can manage their own procedures ignoring the other factories or industries, you must first investigate what cost system the external auditor requires of you and what comparative methods you must follow so that the figures of the chosen system are taken into account.