Your Manufacturing Standards And Costs: To Change Or Not To Change?

Jan 15, 2015

One re-occurring topic at our cost forums and other seminars involves the frequency in which standards and costs should be changed.

I believe this is really a two-part question. The first part should be, without any radical changes in cost or activities, how frequently should you schedule standard cost revisions? The general rule of thumb is annually. I usually suggest that businesses go through their budgeting process in the fourth quarter of the old year, to determine expectations for activity levels and costs. As those are approved by senior management and then implemented, it provides the foundation to do a standard cost revision. This revision usually takes place in the latter part of the fourth quarter of the old year, or sometimes very early in the first quarter of the new year.

Further, it’s my recommendation that cost managers keep an open file relative to issues or problems they see with standards or costs throughout the year. This offers pertinent information in an organized fashion, so that part of the annual cost revision process can be to review those issues that are most problematic and create difficulty during the old year.

That’s not to say the only issues that require change are those that create the most difficulty during the year, but they certainly are high on the priority list. I believe the entire standard cost process should be reviewed and changes made as standards cost rates are adjusted due to changing conditions.

changeHowever, there is also a second part to this question, which has to do with costs or standards that have changed due to radically changing conditions. This could relate either to material costs that are fluctuating because of market conditions related to a raw material that is dramatically driving prices up or down. Or, it could relate to operating standards that have been radically affected because of a change in operations, new equipment, or other fundamental changes that affect the output of a manufacturing process, whether it be greater or lower output.

My general advice on that subject is that if rapidly changing prices or standards change modestly, even if frequently, those can likely be held off until the end of the year. However, as standards or costs change more than 30% up or down from the previous standard cost, I believe those modifications should be made on the fly during the year to provide accurate guidance for management.

Fluctuating prices or standards will be reflected in positive or negative variances, which generally should be manageable, and thoroughly analyzed to gain a good understanding of what the effects of these modestly changing prices are doing to the total cost of the product. However, radically changing prices in large amounts should be revised as they change to avoid large variances and to properly cost the product in spite of rapidly changing prices for standards.

Every operation is different and many times today’s manufacturing businesses rely on their standard cost for limited uses such as inventory valuation. As long as those costs are modified for these materially changing prices or standards, the risk of a financial misstatement is reduced. Ignoring such radical changes opens the door for financial statement errors that could be material.

Just like most questions in accounting when should you revise your standards is answered with….it depends. There are different scenarios to look consider, but it’s important to note, the answer “never” should not be an option.

Categories: Cost Accounting