Understanding Standard Costs and Process Costing in Manufacturing

Posted on Dec 23, 2024 in Economy

Standard Cost

Standard costs are those we hope to achieve in a particular production process under normal conditions. They represent the planned costs of a product and are often established before the start of production.

Standard Cost Benefits

  • Measure and monitor the efficiency of the company’s operations because it reveals situations or abnormal operations, which allows setting responsibilities.
  • Determine the unused capacity in production, causing losses periodically.
  • Know the value of the item at every step of the manufacturing process, allowing for valuing inventories at cost in the process right.
  • Thorough analysis of operations, helping to reduce manufacturing costs.
  • Reduce the work of the administration to clearly show the abnormal operations, which deserve much more attention.
  • Facilitate the preparation of budgets.
  • Standard costs are the essential complement to sound budgetary organization.

Standard Cost Disadvantages

  • The degree of rigidity or flexibility of the standards cannot be calculated specifically.
  • Often, the rules tend to become rigid, even in relatively short periods. While the manufacturing conditions are constantly changing, the revisions of the standards can occur at infrequent intervals. These reviews create special problems associated with inventory.
  • When the rules are revised frequently, their effectiveness in assessing the performance weakens.
  • If the rules are not revised when major manufacturing changes occur, we obtain an inappropriate or unrealistic assessment.
  • Inflation forces constant changes to these standards.
  • Isolating controllable and non-controllable elements in variations is an extremely difficult task.

Nature of Standard Cost

Generally, cost data can be divided into two main categories: historical and default costs. Historical costs are calculated upon completion of the manufacturing process or at a later date. The default costs are data to endeavor not only the cost experience to predict future costs but also methods of measuring current production. Standard costs are widely used because they represent an effective tool of administrative control.

Production Cost Report

The production cost report is an analysis of the activity of the department for the period. The costs attributable to a department are presented according to the cost elements. In addition to the total and unit costs, each cost item is listed separately, either in the report or in a support plan. The level of detail depends on the needs of planning and control management. The cost of the production report is to summarize the source entries in the logbook for the period. A report of the production cost for each department can be prepared following a 4-step approach. Each step represents a separate plan, and the four plans together constitute a report of the cost of production.

  1. Step 1: Count the physical flow of units (quantity plan).
  2. Step 2: Calculate equivalent units of production (equivalent production plan).
  3. Step 3: Accumulate costs, total and per unit, which will be accounted for by the department (accounting plan costs).
  4. Step 4: Assign the accumulated costs to the units transferred or still in the process (plan costs accounted for).

Nature of Process Costs

Process costs are better understood when compared to the costs for manufacturing orders. In a specific order of costs, materials, labor, and indirect costs are accumulated in batches or manufacturing orders. You cannot have unit costs until the batch is completed or the full order. When the order is completed, manufacturing costs per unit are calculated by dividing the total cost of work done in the order in question by the number of complete units produced. In general, each job is independent of all other work, and costs can vary considerably from one production order to another, even if you are making the same product.

Features of Process Costs

  1. Costs are accumulated and reported by departments or cost centers.
  2. Each department has its own work in progress in the general ledger. This account is charged with processing costs incurred in the department.
  3. Equivalent units are used to determine the work process in terms of completed units at the end of a period.
  4. Unit costs are determined by departments in each period.
  5. The completed units and associated costs are passed on to the next department or finished goods. At the time the units leave the last department in the process, the total costs of the period have been accumulated and can be used to determine the unit cost of finished goods.
  6. The total unit cost of each department is added periodically, analyzed, and calculated through the use of production reports.