This report is divided into two parts. The first part will explain how a standard costing system works and how a variance analysis is used properly. Furthermore, the statement “Standard Costing and Variance Analysis are appropriate to any type and size of organisation” will be critically evaluated. The second part determines factors, which must be considered in the decision-making process. In addition, four scenarios of decisions will be provided and analysed.
One of the main objectives of an organisation is to minimise the cost of production and to control the costs as they are limited resources within a business (Gupta, 2010). Management accounting literature provides several tools in order to achieve these objectives. In this context, the system for collecting and reporting revenue and cost information by areas of responsibility is called responsibility accounting (Siegel & Shim, 2006). It is based on the assumption that managers should be held responsible for their performance. A well-designed responsibility accounting system integrates responsibility centers within the organisation.
In addition, responsibility centers are units within the organization, which have control over costs and revenues (Siegel & Shim, 2006). There are different types of responsibility centers such as profit centers, investment centers, revenue centers and cost centers. In the following report, the focus is on cost centers. Here, a variance analysis based on standard costing is a performance measure of a cost center (Siegel & Shim, 2006). In addition, a standard costing system is a useful tool facilitating decision-making.
Table of Contents
1 Executive Summary
2 Introduction
3 Standard Costing and Variance analysis
4 Decision-making
4.1 Pricing products or services
4.2 Product mix and limiting factor analysis
4.3 Shutting down or keeping open part of the business
4.4 Make or buy decisions
5 Conclusion
Objectives & Core Topics
This report explores the mechanisms of standard costing and variance analysis as control tools within organizations, while critically evaluating their universal applicability. Furthermore, it addresses the essential factors involved in managerial decision-making by providing and analyzing specific business scenarios.
- Standard costing systems and the derivation of cost estimates.
- Methods of variance analysis for performance measurement.
- Relevant versus irrelevant costs in decision-making processes.
- Strategic implications of pricing, product mix, and outsourcing.
- The impact of qualitative factors on operational business decisions.
Excerpt from the Book
4 Decision-making
In general, decision-making involves choosing between alternatives. Here, it is important that only those costs and revenues are considered that are relevant to the alternatives. Considering irrelevant cost and revenues might lead to wrong decisions. In this context, relevant costs are those expected future costs that differ between the different alternatives being considered. According to Horngren (2005), there are two key aspects to this definition that are: the cost must occur in the future and they must differ among the alternative courses of action. Here he states, “Every decision deals with the future – nothing can be done to alter the past” (Horngren, 2005, p. 303). Furthermore, there must be a difference in future cost between the different alternatives otherwise there will be no difference in costs no matter what decision is made. In addition, opportunity costs are also relevant costs that must be considered in decision-making. They represent “the lost contribution to profits arising from the best use of the alternative foregone” (Drury, 2009, p. 82). Similar to relevant costs, relevant revenues are those expected future revenues that differ between the different alternatives being considered.
Summary of Chapters
1 Executive Summary: This section provides an overview of the two-part structure, covering standard costing/variance analysis and the factors influencing managerial decision-making.
2 Introduction: It outlines the objective of minimizing production costs and introduces the concept of responsibility accounting within cost centers.
3 Standard Costing and Variance analysis: This chapter explains how to establish standard costs and perform variance analysis to control costs, while discussing the limitations in non-repetitive environments.
4 Decision-making: This chapter categorizes costs as relevant or irrelevant and analyzes scenarios including pricing, product mix, business segment discontinuation, and outsourcing.
4.1 Pricing products or services: It discusses short-term versus long-term pricing, the impact of excess capacity, and the role of incremental costs in one-time special orders.
4.2 Product mix and limiting factor analysis: This section details how managers prioritize production when faced with capacity constraints to maximize the contribution margin.
4.3 Shutting down or keeping open part of the business: It evaluates the impact of discontinuing unprofitable segments, noting that fixed costs often remain relevant to the overall company income.
4.4 Make or buy decisions: This chapter explores outsourcing by comparing internal production costs against external purchase costs while considering qualitative factors.
5 Conclusion: The conclusion synthesizes the findings, highlighting that while standard costing is a useful planning tool, its effectiveness depends on the stability of the business environment.
Keywords
Standard Costing, Variance Analysis, Management Accounting, Decision-Making, Relevant Costs, Opportunity Costs, Responsibility Centers, Cost Control, Pricing Strategy, Limiting Factors, Outsourcing, Make or Buy, Contribution Margin, Incremental Costs, Qualitative Factors
Frequently Asked Questions
What is the primary focus of this work?
The work examines the effectiveness of standard costing systems and variance analysis as tools for cost control and their role in facilitating informed managerial decision-making.
What are the central thematic fields?
The report centers on management accounting, operational efficiency, resource allocation, and the financial analysis of strategic business alternatives.
What is the core research goal?
The goal is to explain how standard costing works and to determine which factors must be considered during complex decision-making processes in a business context.
Which scientific methods are employed?
The paper utilizes literature review and critical analysis, supported by practical examples and mathematical modeling of business scenarios like special orders and outsourcing.
What topics are discussed in the main part?
The main part covers the implementation of standard costing, the categorization of variances, and four specific decision scenarios: pricing, product mix, shutting down segments, and make-or-buy decisions.
Which keywords define this study?
Key terms include Standard Costing, Variance Analysis, Decision-Making, Relevant Costs, Opportunity Costs, and Responsibility Accounting.
How does the author define relevant costs for decision-making?
Relevant costs are defined as future-oriented costs that differ between the available alternatives; past costs (sunk costs) are considered irrelevant to current decision-making.
Why might a company choose to outsource even if internal costs seem lower?
Outsourcing may be chosen due to strategic benefits, such as accessing innovation, reducing technological obsolescence risks, or optimizing the use of facilities for more profitable activities.
What is the risk of shutting down an unprofitable business segment?
The author warns that shutting down a segment does not always increase total company income, as fixed costs may remain and qualitative factors like loss of brand recognition or employee morale may suffer.
- Quote paper
- Alexander Berger (Author), 2011, Standard Costing, Variance Analysis and Decision-Making, Munich, GRIN Verlag, https://www.hausarbeiten.de/document/174806
