Manufacturing companies implement cost accounting systems to determine the cost of each of their products. Understanding product costs allows the business to price its products at a level high enough to generate a profit, or analyze cost components for potential cost reductions. Companies that produce a continuous flow of identical products often choose process costing systems. Standard costing systems allow companies to determine their expected cost for each product.
Process Costing System
Process costing systems accumulate product costs for continuous production processes. During continuous production, businesses find it difficult to isolate each individual unit and calculate a cost. Process costing systems accumulate the materials, labor and overhead costs for the period along with the total number of units produced. The total number of units produced includes both completed units and partially completed units. The company determines the percentage of completion for each partially completed unit and adds these amounts to the total number of completed units to determine the equivalent units. The total material, labor and overhead costs are divided by the number of equivalent units to calculate a cost per unit.
Standard Cost Accounting System
Standard cost accounting systems start with the annual production budget. The total material, labor and overhead costs for the year are documented in the production budget. The annual production budget also includes the estimated production units for the year. The material, labor and overhead costs are divided by the estimated production units to calculate a standard cost. Throughout the year, managers compare the actual cost to the standard cost. The difference between actual and standard cost is the variance.
Pros of Combining Process and Standard Costing
Companies often use standard cost accounting systems in conjunction with a process costing system. The company experiences a couple of benefits from using the two systems together. First, the same accounts used to accumulate standard costs during the budget process can be used to accumulate costs during the year. Also, management can investigate variances between standard cost and the actual process cost by reviewing the actual activity in the process costing system.
Cons of Combining Process and Standard Costing
Combining standard cost accounting systems with process costing systems also has some disadvantages. First, while actual cost changes may occur during the year, the standard cost remains the same. This increases the variance reported during the remainder of the year. Second, if the total variance changes very little, the manager might not investigate any further. However, if the material cost increased significantly and the labor cost decreased significantly, the manager should check out these changes, even though the impact on the total variance is minimal.