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Sir below are some problems associated with standard costing
1. Continuous improvement maybe more important than meeting standards
2. Incentives to build inventories
Sir
Could you please explain it with examplesThank you
Suppose we make a product that has a standard cost of $20 per unit. We then think we have done OK provided the actual cost is not more than $20.
However we should be continually trying to improve the way we produce and should be wanting the cost to be lower than $20.With absorption costing, the standard cost includes the fixed cost per unit. It is absorbed by dividing the total fixed costs by the budgeted production. The more we produce then the lower the fixed costs per unit and therefore the lower the cost per unit (which means we record more profit). So it encourages managers to produce more, but if they produce more than they can sell then all that happens is they have bigger and bigger inventories.
Sir in the first para you stated that
we should be continually trying to improve the way we produce and should be wanting the cost to be lower than $20.
But what’s the problem if we continuously want to improve the way we produce and want the cost to be lower ?
It’s not a problem right sir ?
But if there is a problem what’s the exact problem..
Secondly
In the incentives to build inventories
If the management accountants are given incentives ( bonus ) based on profits then
Ultimately what happens is that
More inventories may be built
Provided that’s the case then the incentives or the bonus is given to the management accountants while inventories are so highAnd that is why it is a problem
Am I correct ?Firstly:
With standard variance analysis we are ‘happy’ provided we achieve the standard cost (and ‘unhappy’ if we end up spending more). The danger is that we do not have the incentive to spend much less than standard cost by continually improving the way we do things.
Secondly:
There is the incentive to produce much more than needed because this reduces the cost per unit (and therefore the profit per unit when the units are sold). This means that we will be building up inventories and the danger is that we might end up never being able to sell them.
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