What Is The Difference Between Standard Cost And Average Cost?

What Is The Difference Between Standard Cost And Average Cost?

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.

For more information standard cost and average cost, please don’t hesitate to call the Flux Connectivity team at 1-800-557-FLUX. You may also email us at connect@fluxconnectivity.com.

What Is Cost Of Quality?

What Is Cost Of Quality?

“You can’t afford to buy cheap.” This statement was recently uttered by a friend of ours who was explaining her need to buy a high-quality shower curtain for her bathroom. When asked what she meant, she explained that her previous purchases of “ten dollar shower liners” only resulted in use of the products for about a month each.

“The material was so thin, they kept ripping from the hangers,” she explained, “I’d had to keep buying them over and over until I realized that it was time I pay a higher price for better quality. It will end up saving me money in the long run.” Our friend is right. While paying for quality is a wise choice for pertinent household purchases, the cost of quality is an essential part of making the right manufacturing solutions choices.

What is the definition of Cost of Quality (COQ)?

As defined by ASQ.org, “Cost of quality (COQ) is defined as a methodology that allows an organization to determine the extent to which its resources are used for activities that prevent poor quality, that appraise the quality of the organization’s products or services, and that result from internal and external failures. Having such information allows an organization to determine the potential savings to be gained by implementing process improvements.”

By contrast, cost of poor quality (COPQ) is defined as the costs associated with providing poor quality products or services. There are various factors that can lead to quality costs in a company. Product design issues, for example, can lead to manufacturing defects. As well, if inferior components are supplied to manufacturers, product flaws can occur. Sending customers the wrong products also leads to quality costs.

Quality costs fall into four categories.

They are prevention costs, appraisal costs, internal failure costs and external failure costs.

Prevention costs are known as the least expensive of all quality costs. As its description implies, these costs are to help prevent quality problems from taking place. They entail adequate employee training (to ensure the correct assembly of products, for example) as well as the creation of plans for quality assurance.

Appraisal costs cover inspection processes that ensure the highest quality possible for all manufactured products. They involve having production workers inspect both incoming and outgoing parts to and from their workstations. As a result, they can catch problems quickly to ensure the proper functionality of products.

Internal failure costs are levied when defective products are manufactured. Costs are often associated with correcting the defects before the products are delivered to customers. They also cover the need to scrap products that cannot be repaired.

External failure costs are incurred to remedy defects that are discovered by customers. As Steven Bragg of AccountingTools.com explains, this includes “product recalls, warranty claims, field service, and potentially even the legal costs associated with customer lawsuits. It also includes a relatively unquantifiable cost, which is the cost of losing customers.”

Naturally, it’s important for companies to take measures to avoid unnecessary quality costs.

Obviously the higher the quality costs are for a business, the worse the impact is on the company’s bottom line. Of course, when quality issues are kept to a minimum, a business can become a lot more profitable. Not to mention, it also stands to enjoy high levels of customer satisfaction.

For more information about Cost of Quality, please don’t hesitate to give Flux Connectivity a call at 1-800-557-FLUX or email us at connect@fluxconnectivity.com.