Table of Contents

1. Introduction.................................................................................................................2
1.1 Modern Accounting Systems...................................................................................2
2. Criticism on Standard Costing....................................................................................3
2.1 Cost Drivers.............................................................................................................3
2.2 Performance Evaluation...........................................................................................4
2.3 Direct and Indirect Costs..........................................................................................4
2.4 Cost Objectives........................................................................................................4
3. Answering the Critics..................................................................................................5
3.1 Volume related Costs...............................................................................................5
3.2 Need for Real-time Quantitative Feedback..............................................................5
3.3 Too much Focus on Cost Control.............................................................................6
3. 4 Evaluation of Performance......................................................................................6
3.5 Continuous Improvement.........................................................................................6
3.6 Single Cost Driver....................................................................................................6
3.7 Standard Costing causing Dysfunctional Behavior..................................................7
3.8 Time and Money.......................................................................................................7
4. Validity of Johnson and Kaplan Statement.................................................................7
5. Conclusion..................................................................................................................8
6. References................................................................................................................10

1.

Introduction
Standard costing has often been considered as an essential tool in product costing,
planning and controlling, and performance evaluation (Zoysa and Siriyama 2007;
Sulaiman, Nik Nazli and Norhayati 2005). Standard costing involves estimation of output
cost which compared with the cost incurred in reality to find variances which are useful
in putting managerial control into practice (Rao and Bargerstock 2011).
Standard costing was designed to fulfill the requirements of mass manufacturing
industries, represented by high machinery and plant costs and producing large volumes
of repetitive outputs. Badem, Ergin and Drury (2013: 80) defined the aim of standard
costing as to provide the cost information relating to controlling costs, providing
convenience and quickness to compute product costs, preparing business budgets,
pricing products and measuring the performance of division managers.
Following are considered to be the four elements of standard costing system;
1. Setting standards for each operation
2. Comparing actual with standard performance
3. Analyzing and reporting variances arising from difference between actual and
standard performance
4. Investigating significant variances and taking appropriate competitive actions
(Edwards-Nutton and Technical Information Service 2008: 4).

1.1 Modern Accounting Systems

Having served the industries for more than seventy five years the standard costing
system has come the under the scanners and in now being questioned about its
usefulness in the modern era of advance automated production involving minimum
labor resources focusing on customer needs. The new manufacturing philosophies like
Just-In-Time (JIT), Total Quality Management (TQM) and Activity Based Costing (ABC)
Management are results of shortened product life cycle and high variety need.

2.

Criticism on Standard Costing

Johnson and Kaplan (1991) have regarded the use of standard product cost system as
dangerous in making important decisions on product pricing, product mix, product
sourcing and market response as it provides distorted information on product costs.
In recent times, many researchers have argued compatibility of standard costing and
variance analysis for performance evaluation and cost control. It is believed that the use
of this system is not in line with todays strategic and competitive manufacturing
objectives of companies.
Increase in employment of advanced manufacturing technologies (AMT), the cost
control through standard costing has substantially decreased (Zoysa and Siriyama
2007). The advanced manufacturing technologies employ concepts like JIT, total quality
control, etc. which involves low inventory, high product variety, complex design, high
indirect cost, more automation, reduce labor hours, low product volume, etc. According
to Badem, Ergin and Drury (2013: 81)

standard costing is criticized especially in

advanced production environment that results in declining direct labor and material
costs, reduced inventories and just-in-time production methods.
After mid 1980s the criticism on standard costing increased. Johnson and Kaplan
(1991), Ferrara (1995) and Monden and Lee (1993) assert that there is a decrease in
importance of standard costing for performance evaluation and cost control because of
aggressive competitive environment. Strategic signals are inefficiently detected by this
method (Fleishman and Tyson 1998). Shank and Govindarajan (1992) censured the use
of standard costing in competitive environment as it pays little attention on external
environment.
Now the report will shed light on the shortcomings of different attributes of standard
costing and variance analysis in modern manufacturing environment.

2.1 Cost Drivers

Traditionally standard costing system charges product overheads to a single cost driver
which is recognized as a limitation by Bowhill and Lee (2002). This cost diver

encompasses direct material, machine or labor cost which are based on product
volume, and therefore the cost driver fails to incorporate indirect cost (Patxi, Jordi, and
Llus 2013). The modern manufacturing environment believes in low volume high
variety, resulting high more changeovers and use of automatic or robotic machines,
resulting in high indirect fixed cost. The standard costing system should consider cost
drivers in terms of batches which will incorporate frequent changeover cost and it
should also increase the number of cost drivers to represent indirect cost also to enable
more accurate product cost estimation.

2.2 Performance Evaluation

According to Zoysa and Siriyama (2007), in JIT environment, evaluating performance
through standard costing induces dysfunctional behavior. In JIT system, efforts are
made to reduce inventories and setup times and to produce small batches
economically, whereas accountants using standard costing would like to buy material in
bulk to get discounts and to produce in large batch sizes. This type of opposite behavior
induces dysfunctional behavior.

2.3 Direct and Indirect Costs

In modern manufacturing environment it is essential to consider both direct and indirect
expenses as cost to services or products. Standard costing system used to allocate
direct machine and labor hours cost (direct cost) to services and products expenditure
(Banker et al. 2008). This exclusion of indirect cost would have an adverse effect on the
estimation of product costs, product pricing and product sourcing and would alter the
decision making.

2.4 Cost Objectives

In modern environment of flexibility and variety it is imperative that organizations
understand and applies cost on objects (design, features, on-time delivery, etc.) rather
than estimating only for the complete product. This will allow manufacturers to better
understand and respond to customers and markets needs. This ability of ABC system
makes it more applicable in making decisions on product mix, product pricing and
responses to rival products, than standard costing (Kee 2008).

3.

Answering the Critics

Standard costing system is still used in number of organizations mainly because of the
reason that the basic principle of the system is still very sound (Lucas 1997). Scapens
(1988) supports the companies who have modified the standard costing system by
stating that in this environment of technological changes it is more important emphasize
how the technique should be applied rather than emphasizing on the nature of
technique. Noreen (1991) mentioned that the modern costing system like ABC proved
beneficial under certain specific conditions. This clearly shows that it is more important
to learn how to modify already employed costing system according to the environment
need.
Some researchers have also answered the criticism on standard costing by suggesting
modifications.

3.1 Volume related Costs

Patxi, Jordi, and Llus (2013) criticized standard costing system, stating that it cannot
work in modern manufacturing environment as the overhead or indirect costs have
increased and direct costs have reduced. However researches show that cost of
overheads is not more thirty percent, out of which some is volume related and the
remaining seventy percent is direct cost which is volume related (Drury et al. 1993). It
could happen that the standard costing and modern costing systems coexist and
estimate for direct cost and indirect cost respectively.

3.2 Need for Real-time Quantitative Feedback

Some researchers feel that in JIT environment working teams require real time
quantitative response instead of financial feedback and the non-financial feedback is
beyond the scope of standard costing (Rasiah 2011). Lucas (1997) strongly opposes
this criticism and states that financial feedback is necessary for managerial controls
over the work teams and with the introduction of computerized integrated manufacturing
real-time feedback is also possible.

3.3 Too much Focus on Cost Control

Zoysa and Siriyama (2007) states that standard costing focuses too much on controlling
cost which could prove detrimental to quality of product. For example, in order to satisfy
purchase price variance, management would try to increase the order quantity to lower
the price which would lead to purchasing of low cost material. Lucas (1997) answers
this criticism by suggesting that the ensuring the quality is the responsibility of the
management and should not be the reason for its abandonment. This reiterates the
need of measuring performance through range of key point indicators (quality, inventory
levels, cost, etc.).

3. 4 Evaluation of Performance
Evaluating performance through standard costing provides numerous benefits;
Standard cost variances provide feedback information designed to help managers
control operations in accord with the plans they have set. They highlight the difference
between the planned costs of a period and the actual costs incurred over that time. Cost
variances comprise several different elements that together male up the total reported
variance: 1. Costing system errors, 2. inappropriate standards, 3. Uncontrollable
random factors, and 4. controllable variances with operational causes (Mitchell 2005:
33).

3.5 Continuous Improvement

Zoysa and Siriyama (2007) pointed out that the standard costing system doesnt help in
continuous improvement. Sulaiman, Nik Nazli and Norhayati (2005) argued that
standard costing system could help in continuous improvement if companies can base
their standard costs on the actual cost during last period rather than pre-identified
engineering standards.

3.6 Single Cost Driver

Bowhill and Lee (2002) recognized the limitation of single cost driver in standard costing
system while working in a company called Cableco. They modified the system and
introduced one more cost driver to incorporate setup costs. Those two cost drivers were
enough to meet Cablecos overhead cost.

3.7 Standard Costing causing Dysfunctional Behavior

The tendency of purchasing manager to buy material in bulk as discussed above can be
countered by devising a cost variance of inventory levels (Lucas 1997).

3.8 Time and Money

Rasiah (2011) suggested that the implementation of new modern costing systems could
be very costly and time consuming. First it is very necessary to understand which
system would best for the company and second to train employees to extract the best
results from the new system.

4.

Validity of Johnson and Kaplan Statement

About twenty five years ago Johnson and Kaplan (1991) suggested that
The standard product cost systems typical of most organizations usually lead to
enormous cross-subsidies across products. When such distorted information represents
the only information on product costs, the danger exists for misguided decisions on
product pricing, product sourcing, product mix and responses to rival products. Many
firms seem to be falling victim to the danger.
Contrary to many arguments leveled at standard costing system as mentioned above
(Johnson and Kaplan 1991; Shank and Govindarajan 1992; Monden and Lee 1993;
Ferrara 1995; Fleishman and Tyson 1998; Bowhill and Lee 2002; Zoysa and Siriyama
2007; Kee 2008; Patxi, Jordi, and Llus 2013), Sulaiman, Nik Nazli and Norhayati (2005)
conducted a literature review which clearly shows that the standard costing system is
not completely abandoned.
Studies conducted by Garg et al. (2003) and Marie et al. (2010) suggest that the
standard costing and variance analysis is still employed in different firms across the
world. Badem, Ergin and Drury (2013) affirm that the standard costing is also used for
product pricing and budgeting purposes.

Countries

Percentage Utilization of

Japan
Sweden
England
Ireland
USA

Standard Costing
64
73
76
84
86

Table 1 Adopted from Horngren et al. (1997)

Sulaiman, Nik Nazli and Norhayati (2005) concluded that 70% of the local companies in
Malaysia and 76% Japanese companies in Malaysia use standard costing for cost
control and performance evaluation, and costing inventories respectively. Badem, Ergin
and Drury (2013) provided an evidence of usage of standard costing technique in 100%
automotive manufacturing (primary) companies and 71% supplier (secondary)
companies, where primary companies used it for cost control and performance
evaluation, costing inventories, computing product cost for decision making and as an
aid to budgeting, whereas secondary companies use it for cost control and performance
evaluation.
This high adoption rate reflects that the companies have learnt to modify standard
costing system to fulfill their needs of current manufacturing environment. The extent to
which the literature has been covered in this report suggests that the statement of
Johnson and Kaplan (1991) is not completely valid. However it does hold true in a
sense that the original standard costing system without any modifications was not
applicable in modern manufacturing environment.

5.

Conclusion
The report was commissioned to analyze the extent to which the statement of Johnson
and Kaplan (1991) holds true after twenty five years. The report starts with describing
the standard costing system and its objectives. The report then discusses the criticisms
on standard costing system employed in modern manufacturing environment, after
which criticisms were countered with help of articles present on the topic. In the end it
was concluded that statement regarding standard costing was too harsh and it doesnt
hold completely true.

6.

References

Badem, A., Ergin, E., and Drury, C. (2013) 'Is Standard Costing Still used? Evidence

from Turkish Automotive Industry'. International Business Research 6 (7), 79-90

Banker, R. D., Bardhan, I. R., and Chen, T. (2008) 'The Role of Manufacturing
Practices in Mediating the Impact of Activity- Based Costing on Plant Performance'.

Accounting, Organizations and Society 33 (1), 1-19

Bowhill, B. and Lee, B. (2002) 'The Incompatibility of Standard Costing Systems and
Modern Manufacturing: Insight Or Unproven Dogma?'. Journal of Applied

Accounting Research 6 (3), 1-24

Drury, J., Braund, S., Osborne, P. and Tayles, M. (1993) A Survey Of Management
Accounting

Practices

In

UK

Manufacturing

Companies.

London:

Certified

Accountants Educational Trust

Edwards-Nutton, S. and Technical Information Service, (2008) Standard Costing and

Variance Analysis. Topic Gateway Series No. 24. London: CIMA

Ferrara, W. (1995) Cost and Management Accounting: the 21 st Century Paradigm.

Management Accounting, 30-36

Fleischman, R. K. and Tyson, T. N. (1998) 'The Evolution of Standard Costing in the

U.K. and U.S.: From Decision Making to Control'. Abacus 34 (1), 92

Garg, A., Ghosh, D., Hudick, J., and Nowacki, C. (2003) 'Roles and Practices in

Management Accounting Today'. Strategic Finance 85 (1), 30

Johnson, H. T., and Kaplan, R. S. (1991) Relevance Lost : The Rise and Fall of

Management Accounting. Boston, MA: Boston, MA : Harvard Business School Press

Kee, R. (2008) 'The Sufficiency of Product and Variable Costs for ProductionRelated Decisions when Economies of Scope are Present'. International Journal of

Production Economics 114 (2), 682-696

Lucas, M. (1997) 'Standard Costing and its Role in Today's Manufacturing

Environment'. Management Accounting (British) 75 (4), 32

Marie, A., Rao, A., Cheffi, W., and Louis, R. J. (2010) 'Is Standard Costing Still

Relevant? Evidence from Dubai'. Management Accounting Quarterly 11 (2), 1

Mitchell, F. (2005) 'Management Accounting - Performance Evaluation'. Financial

Management, 33-34,37
Monden, Y., and Lee, J. (1993) How a Japanese auto maker Reduces Costs.
Management Accounting 75 (2), 22-26

Noreen, E. (1991) Conditions under which Activity-Based Cost Systems Provide

Relevant Costs. Journal of Management Accounting Research, 159-168.

Patxi Ruiz-de-Arbulo-Lopez, Jordi Fortuny-Santos, and Llus Cuatrecasas-Arbs
(2013) 'Lean Manufacturing: Costing the Value Stream'. Industrial Management &

Data Systems 113 (5), 647-668

Rasiah, D. (2011) 'Why Activity Based Costing (ABC) is Still Tagging Behind the
Traditional Costing in Malaysia?'. Journal of Applied Finance and Banking 1 (1), 83-

106
Rao, M. H. S. and Bargerstock, A. (2011) 'Exploring the Role of Standard Costing in
Lean Manufacturing Enterprises: A Structuration Theory Approach'. Management

Accounting Quarterly 13 (1), 47

Scapens, R. W. (1988) Research into Management Accounting Practice.

Management Accounting, 26-28

Shank, J. and Govindarajan, V. (1992) 'Strategic Cost Management: The Value

Chain Perspective'. Journal of Management Accounting Research 4, 179

Sulaiman, M., Nik Nazli, N. A., and Norhayati, M. A. (2005) 'Is Standard Costing
Obsolete? Empirical Evidence from Malaysia'. Managerial Auditing Journal 20 (2),

109-124
Zoysa, A. D. and Siriyama, K. H. (2007) 'Standard Costing in Japanese Firms;
Reexamination of its Significance in the New Manufacturing Environment'. Industrial
Management & Data Systems 107 (2), 271-283