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When to Use Standard Costing

08-10-2009 | By: Len Reo | (0) Post comment » | Read comments »

Standard Costing has long been used in manufacturing and some distribution environments as a control for measuring variations from expected results. Everyone has expected results of some kind...purchase price of materials, amount of labor required for assembly, amount it will cost for outside processing, etc. So shouldn't everyone use Standard Cost?

After having developed and implemented dozens of cost systems for clients over the last 30 years, I've learned that the answer is "it depends" - on two issues.

First, are you a make to stock widget manufacturer, making the same things in the same way over and over? Or are you more of a job shop, make to order type of company?

Secondly, do you have the resources on staff that can manage standard costs in a timely manner, before any transactions happen? Make to stock environments make sense for standards since most things are made over and over again, and are supposed to use the same effort and have the same input costs. If they don't, management should know about it promptly to get things back on track. That's the role of standard cost variance reporting.

Make to order businesses rarely produce something in the same manner, since each job differs based on the customer's quote. In this case, it is important to understand the actual cost of a job once completed (or during the process) as compared to how the job was quoted. Usually not a lot can be done about the actual cost incurred, but a lot should be learned about improving the quoting process from the comparison of actual cost versus quoted cost.

Enterprise software that controls the accounting, inventory, procurement, fulfillment and manufacturing process (referred to ERP systems), provide a choice of cost methods to use. Mid-market systems such as Macola ES and Microsoft Dynamics GP (Great Plains) not only give you a choice of which inventory valuation method to use, but if you choose standard costing, you also get visibility into weighted average and last cost as well. Unfortunately, unless you are using a much more expensive software solution, you can't pick and choose costing methods at the item level. Once chosen, it applies to all inventory for the whole company,