For any business, proper inventory management is critical. To ensure that a company is profitable, it must have a good handle on how to control and measure its inventory levels. A company’s inventory, after all, is its biggest asset and having a strong understanding of how its inventory moves directly impacts profitability and maintaining a cash flow.
There are two different types of costing methods used to help manage cash and understand inventory costing: standard costing and average costing.
What is standard cost?
Standard costing is generally used to measure cost control and performance. This method enables an organization to value their inventory at a predetermined cost. It can help to determine profit margins based on projected costs as well as evaluate production costs that are relative to standard costs. In addition, standard costing helps to measure a company’s performance based on the predefined product costs.
When a standard costing method is utilized, the inventory and the cost of the products sold will reflect the standard cost as opposed to the actual cost of the goods.
What is average cost?
Average costing is typically used for the distribution of goods. This cost can change depending on where items are sold. By utilizing this method, a company can have the value of its inventory fluctuate. In addition, it can track its inventory and manufacturing costs without adhering to the predetermined costs.
With the average cost method, profit margins are determined by the actual costs of goods. Businesses can measure their performances against the historical costs of their inventory. Many professionals consider the average cost method to offer a more reliable understanding of cost.
It is sometimes referred to as “weighted average cost” since it assigns a unit cost to items that are taken from inventory in order to sell to the public. The unit cost is represented by an average of all of the units in a company’s inventory.
What are the advantages and disadvantages of standard costing?
There are five main benefits that result from using a standard cost system. They include improved cost control, more useful information for managerial planning and decision making, more reasonable and easier inventory measurements, cost savings in record-keeping and potential reductions in production costs.
There are, however, some disadvantages that can result from using the standard cost method. They include controversial materiality limits for variances, the non-reporting of certain variances and even lower morale for some workers.
What are the advantages and disadvantages of average costing?
The average cost method is the much easier way to go. It enables you to store inventory without having to designate which batch it belongs to. This method is also a known money saver. Because tracking inventory costs money, it’s important to note that the average cost method requires less time to maintain.
One of the problems with the average cost method is that the varying prices of inventory sometimes result in not having the costs recovered. This is especially true for the more expensive units. Some companies take losses due to their sales prices. In some cases, non-identical batches are mispriced. This is because the average cost method assumes all units are identical. But this is not always necessarily the case.
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