In accounting, a standard costing system is a tool for planning budgets, managing and controlling costs, and evaluating cost management performance. Standard costing is an important subtopic of cost accounting. Standard costs are usually associated with a manufacturing company’s costs of direct material, direct labor, and manufacturing overhead.
The disadvantages include that implementing a standard costing system can be time consuming, labor intensive, and expensive. If the cost structure of the production process changes, the standards have to be updated.
Three of the disadvantages that result from a business using standard costs are:
- Controversial materiality limits for variances.
- Nonreporting of certain variances.
- Low morale for some workers.
Controversial materiality limits for variances: Determining the materiality limits of the variances may be controversial. The management of each business has the responsibility for determining what constitutes a material or unusual variance. Because materiality involves individual judgment, many problems or conflicts may arise in setting materiality limits.
Nonreporting of certain variances: Workers do not always report all exceptions or variances. The standards cannot be fixed for all the products. It means that there may be some products which cannot be fixed as standard products. If management only investigates unusual variances, workers may not report negative exceptions to the budget or may try to minimize these exceptions to conceal inefficiency. Workers who succeed in hiding variances diminish the effectiveness of budgeting.
Low morale for some workers: The management by exception approach focuses on the unusual variances. If the standards are reasonable and attainable, there is no problem on the part of workers. The incorrect standards may lead to constant labour problems. Management often focuses on unfavorable variances while ignoring favorable variances. Workers might believe that poor performance gets attention while good performance is ignored. As a result, the morale of these workers may suffer.
The following are the notable limitations or disadvantages of standard costing system:
- Standard costing system may be tedious, expensive and time consuming to install and keep up to date.
- The standard costing system controls the operating part of an organization only as it ignores the other items like quality, lead-time, service, customer satisfaction and so on.
- The standard costing system will become less useful in modern factories where the just in time principles are adopted.
- The standard costing system may not be applicable in case of small firms as it requires high degree of skill.
- The standard costing may not be very effective in those organizations where non-standardized products are manufactured and services are rendered.