How Standard Costs Impact Company Behavior

There are many things wrong with standard costing, but perhaps the most dangerous is when standard costing begins to drive company behavior. Here is an example.

I was working with a company recently on implementing lean accounting. The company manufactures products at one location, and sells those products in its stores. The stores also provide service on the products. The company uses a standard costing system.

The stores view themselves as the “profit centers” of the business and manufacturing as a cost center. A standard cost for every product is then required so each store can calculate its profitability. The conversation between stores and manufacturing typically revolves around manufacturing lowering its costs to improve store (and company) profitability

Upon further discussion it was revealed that the store managers & the sales force is being compensated on store profitability. Because of this compensation policy, there was resistance on the part of the stores to defining the true value streams of the company (which would include manufacturing) and calculating value stream profitability rather than store profitability.

As of the writing of this blog, this issue is still under discussion within this company and has delayed the roll out of lean accounting.

What can you learn from this story? It is vital to identify how a standard costing system is used within a company and what impact it is having on company behavior. Company management must create an action plan to move the company off using standard costing at the beginning of the lean accounting implementation process.