Budgeting for Standard Costs: Why Bother?

Recently I attended a conference addressing planning and budgeting. Most presenters and attendees wanted to reduce their reliance on formal budgeting processes. However, at lunch, I sat at a table with two attendees from one company. As our discussion evolved, they were worried about having to expand their budgeting processes. As this direction ran counter to the conference theme, I asked additional questions. Primarily, why were they expanding their budget process?

It turns out that they also had responsibility for product cost standards and for calculating actual product costs. The underlying trigger for their concerns turned out to be the fact that their company had recently installed a new ERP system from JD Edwards. The ERP system depended on standard costs for inventory valuation and transaction accounting. Their implementation of this ERP system had a highly structured standard cost creation system that, in turn, relied on an extensive budget system.

They were happy with their actual cost processes from before the new ERP. Managers and executives in their company were accustomed to making decisions based on actual costs. I agreed with my lunch companions that actual costs were the better base for product decisions than standard costs. But we also agreed that standard costs were the better cost basis for costing handled by their ERP system, specifically inventory valuation and inventory transactions. But setting standards was a new experience for them and compounded by the ERP system’s built-in standard creation process. Compounding their concerns, they did not want to expand their budgeting process. What they already had was simpler and certainly good enough for their management.

To them, while the JD Edwards system would benefit upper management somewhat, would improve financial consolidation, and would improve intra company inventory transactions and valuations. On the flip side, the new ERP would drive them into budget processes they did not want for seemingly the sole purpose of setting standards. Rather than reducing their reliance on budgeting, they were being forced to expand budgeting. My lunch companions were not happy. Their ERP tail was wagging their company dog.

As the conversation evolved, I asked if they had considered using their actual cost calculations to set standards instead of the new ERP. No, they had not.

Standard costs do not need to be complex. Auditors and others need to know that standards are set according to defined practices. Their actual cost calculations were robust enough to satisfy this requirement. They simply needed a way to periodically pull actual costs in to use as standard costs, bypassing the complicated budget based ERP system. They needed to challenge certain of their assumptions to go forward with what would benefit their company the most.

The bottom line, make sure systems work for you. Don’t work for the systems.