Agreed, not advocating or recommending this method. Just sharing. I personally prefer some variation of Average or FIFO costing. Then Batch + Serial if you want to see actual.
For the Standard Cost method I mentioned, the companies that typically used this were discrete manufacturers. Especially ones who manufactured the same items, every day.
For example, manufacturing a Basketball. There are standard sizes and specifications. So you’d have an assembly line consuming the same raw materials, every day. You might create a few variations. But mostly you’re doing the same thing, thousands and thousands of times.
Because you’re always making the same product, and that product has a long shelf-life, you can:
- Purchase in bulk.
- Write blanket orders and longer-term agreements with suppliers.
In this kind of environment, some companies don’t want the hassle of dealing with Average or FIFO costs. For the next 6-12 months, they know the cost of their the cost of their raw materials, labor, and other overhead. They do the math, and decide that $9.50 is the Standard Cost for making a basketball.
Their ERP now uses $9.50 all the time. They don’t have to worry about fluctuation that might happen due to transferring between Warehouses, reversing receipts, reversing sales, Journal adjustments, or the myriad of other ways that Average and FIFO cost can be “broken”.
When they do have to cut a special Purchase Order, or pay for overnight freight, that fluctuation is recorded 1) On the Purchase Orders, and 2) In the General Ledger, as Purchase Price Variance. It’s available for analysis and reporting. But it doesn’t change the $9.50.
At some point (6 months, 12 months, etc), the company decides that $9.50 is no longer sufficiently accurate. Perhaps rubber prices have gone up, compared to last year. So they submit a new Standard Cost of $9.80, effective January 1st, 2023.
The fixed cost makes life a bit easier on accounting and sales people. You don’t have today’s basketballs at 25% margin, but tomorrow basketballs at 24.5% margin, because some orange dye had to be expedited last weekend.
This cost method is definitely not for everyone. But when you make the same Finished Goods every day, all day? Sometimes tracking Weighted or FIFO costs is more hassle than it’s worth. Noise. You’re only concerned about long-term shifts or changes in supply.