Every company prepares a budget plan for their accounting period. This helps firms to stay focused, and ensure resources are managed at an optimal level. If companies did not have a budget plan before beginning a project, they would face with difficulties that would limit the effectiveness of their performance. Standard costing is used alongside actual costing and is used in; budgeting, inventory costing, overhead application, and price formulation.
A budget always consists of standard costs as it is impossible to create a budget with actual costs. At the time of budget preparation, companies have to forecast costs and then these are compared at the end of the accounting period. Comparisons between the actual and forecasted budget may show slight discrepancies. However, if a major event has occurred during the period then costs may show significant variances. Standard costing helps in the comparison between the forecasts and actual result variances. (Principles of Accounting)
Comparing the actual accounting records with previous year results is not the best available option for managers to compare a performance. Today’s economy is continually changing, and nothing is moving at a constant rate. Companies are faced with novice challenges and situations which have a differing affect on the costs of the company. Thus, comparing the financial or accounting performance is not preferred because the situation is different.
There is no common ground for making the comparisons; consequently, conclusions may not be valid.
If the company takes into account the external changes that the company encounters then, they may be able to make use of the collected accounts. Keeping external variables constant while making comparisons with past year performance may be one option of over-coming this flaw.
References
Principles of Accounting (2 ed.). (2012). San Diego, CA: Bridgepoint Education.
