How do you adjust standard costs to reflect input price changes?

1 Why adjust standard costs?

Adjusting standard costs is necessary to maintain the accuracy and relevance of the cost information for decision making and reporting purposes. If the input prices change significantly, the standard costs may become outdated and misleading, resulting in variances that are not representative of the actual performance or efficiency of the business. For example, if the standard cost of a raw material is based on an old price that is lower than the current market price, the business may report a favorable material price variance, even though it is paying more for the material than expected. Similarly, if the standard cost of labor is based on an old wage rate that is higher than the current wage rate, the business may report an unfavorable labor rate variance, even though it is paying less for the labor than expected. By adjusting standard costs to reflect input price changes, the business can ensure that the variances reflect the true differences between the actual and standard costs, and not the changes in the input prices.

2 When to adjust standard costs?

The frequency and timing of adjusting standard costs depend on several factors, such as the volatility of the input prices, the significance of the variances, the complexity of the costing system, and the reporting requirements. Some businesses may adjust standard costs annually, quarterly, monthly, or even more frequently. However, there are some general guidelines to follow when deciding when to adjust standard costs. For instance, businesses should adjust standard costs when the input prices change by more than a certain percentage or amount that is deemed material or significant for the business. Additionally, it is important to adjust standard costs at the end of an accounting period to align with the financial reporting cycle and avoid mid-period changes that may complicate variance analysis. Finally, businesses should adjust standard costs before making any major decisions or changes that may affect production or sales volume. Doing so provides them with updated and relevant cost information to support their decisions and plans.

4 What are the benefits of adjusting standard costs?

Adjusting standard costs to reflect input price changes can bring several benefits to the business, such as improving the accuracy and reliability of cost information, reducing distortions and errors in variance analysis, and enhancing the motivation and accountability of managers and employees. Accurate cost information allows for better decision-making, planning, and reporting. Updated standard costs can be used as realistic targets and benchmarks for employees, while variances can be used to provide fair feedback and incentives.

5 What are the challenges of adjusting standard costs?

Adjusting standard costs to reflect input price changes can present some challenges and limitations for the business. This may include increasing the complexity and cost of the costing system, creating confusion and inconsistency in the cost information, and introducing uncertainty and variability in the cost information. Monitoring, updating, and maintaining the standard costs and variances require more resources, time, and expertise. Frequent or irregular changes in the standard costs and variances may affect the comparability and continuity of cost information across different periods and units. The fluctuations and unpredictability of input prices can also affect the reliability and validity of standard costs and variances.