The concept goes back to Taylor in the 1920s, and it makes sense for a lot of organisations.
Like weighted average it assumes relatively stable business operations. for example predictable purchase prices because you have long term contracts with suppliers, consistent order sizes so that admin and overhead costs, costs of set up. delivery are all fairly stable. Similarly you may have a relatively stable price list or long term price agreements with specific customers. Within ' the normal' trading volume sales can quote without need to refer back to operations. i.e. they are shielded day to day , order to order, form day to day issues with purchasing or production. However we don't live in a perfect world so production will factor in costs for overheads, and BOMS and routes will reflect 'standard' usage with specific allowances for losses such as set up scrap./time.
Standard cost is much like a budget- supply chain need to work within the standard. They will get some economy of scale when they buy or produce above standard, and they will get some expediting costs, or rework costs. On balance the standard should be set to reasonably reflect the expectation for both. That provide s benchmark for continuous improvement in operations to e.g. buy better, reduce scrap, automate, etc. Positive and negative variances from standard focus management attention.
Of course all companies want to continuously improve. So why the different approaches? Some downsides of standard costing are that operations maybe tempted to set the standard too high so that they meeting standard is easier and reflects favourably, they may be tempted to overproduce or over-purchase to get economy of sale cost reductions. Sale s may similarly be tempted to over forecast to get lower budgeted standard costs from operations. On the one hand that is all extra profit for the bottom line. However, Sales do not then get the most competitive price and may also lose market share unless the standards are adjusted. When costs are rising its possible that sales prices will be too low. However, remember that standard is suitable for companies with standard operations, costs, and prices in which case there should not be significant day to day variances. Another downside of standard is that a successful product that beats its sales target tends to over absorb the share of overheads allocated and to subsidise weaker items.
For stable operations either standard or average will work OK. Standard has the advantage that month end closing is much faster, and variances are easier to identify. However, there is a need for periodic update of standards of both raw material, overheads, BOM roll ups etc.
Standards will not be so helpful for a commodity trading business, a very seasonal business, or one where there is wildly fluctuating exchange rates.
The problem for many industries is that the world real world is not so simple you make different products back to back, you buy more than one item on an order, you buy form more than one vendor, you make the same items manually and by machine, breakdowns happen.
Weighted Average costing effectively self adjust the costs based on actual - but as the conditions need to be similarly fairly stable the difference between weighted average and standard should be negligible. So both savings and increases in COGS are passed onto sales. Exceptional volume of transactions can be taken out of the average cost by marking. If stock has a long aging then its possible weighted costs of both components and finished goods will be out of date. I.e. you quote today based on the last weighted cost which was updated last year for an order due in 3 months time. The production costs is not known until it completes.
Weighted average costs need to be closed each period which can take a long time in.e.g a retail operation with many items and transactions. Transactions cannot be settled /closed until financial transactions are posted and completed. Often this is the next period so the COGS sued this period may not be what you expect for the sale this period. When an adjustment is calculated there may be little inventory left to which to apply the adjustment and that can give some anomalous weighted average costs until the inventory is increased by another transaction. For standard cost the transaction is settled on receipt, and adjustments on actual financial postings go to variance account not into inventory. Varinces go to P@L as a 'below the line' margin gap, not to cogs.
When conditions are not stable then LIFO of FIFO is an option. The idea then is to match the oldest inventory costs to the oldest sales orders, and the newest costs to the newest order , rather than the same average or same standard to all transactions in the period. The problem is that those values are not known until financial postings are complete. so day to day a running weighted average is used and adjusted once settled. So the month end complexity and processing time is a little more than for weighted average.
Summary it depends on "
your philosophy of whether operations and sales share gains and losses, and what goes tot he bottom line as a variance and what goes to the product cost.
how seasonal and stable are your product line and operations
When you make just one main product you may be able to decide on an optimum costing method but life is seldom that easy and you will find whatever your choice there will be many instances when it does not work so well. Then consider which puts most load on the system, which reduces overall admin, and what is the norm for your business vertical, and what will your auditors accept.
If that still does not give enough insight, then set up some test items and transactions and try different scenarios to see which works best for you.
My advice is don't use both standard for finished goods and average for ingredient - it almost guarantees variances. the assumption would be that production variances need to be investigated and that purchasing variances will not happen. It also means you will lose a lot of the benefits of standard and still have the overheads of month end close.
