State and explain TWO (2) approaches that can be used in setting a standard within an organisation. (5 marks)
View Solution
In general, two approaches may be used when establishing standard costs, i) historical records and ii) engineering studies.
Historical records
With this approach, records of the company’s operations, purchase and use of materials and labour serve as a basis for establishing current standards. This approach is often used in practice. The advantages of this approach are that it is relatively inexpensive; it uses actual company data to compute standard costs and provides a reference for future improvement. The disadvantages of using past historical records are that there is the possibility that past inefficiencies will be incorporated in the standard costs; if the production process changes the historical data will be irrelevant and if the company introduces new products then using this approach to develop cost standards will not be possible.
Engineering studies
This approach requires a detailed study of each production operation to be conducted, so that standard costs are based on observed, recorded activity. Engineering studies may also require input from operating personnel to provide estimates about future activities and consumption levels. The advantages of this approach are that it is future-oriented; it aims to ensure that past inefficiencies are not incorporated in standard costs. In addition, this approach facilitates allowance for expected changes such as alterations to the production process or product redesign. The disadvantages of this approach are that it is time-consuming and expensive to employ. Engineering studies require a comprehensive team approach combining input from production, human resources, sales and finance staff. While such an approach may improve the reliability of cost estimates and increase commitment and motivation, there is the possibility of data bias to set easier to achieve standard costs.