Standard cost definition
/What is Standard Cost?
A standard cost is a planned or budgeted cost. A standard cost is based on engineering designs and production methodologies, which can be attained under normal operating conditions. It is comprised of material, labor, and overhead components, and is typically recorded within a bill of materials.
How are Standard Costs Used?
Standard costs are commonly used to derive cost variances, particularly in regard to production and inventory costs. Any material unfavorable variances should be reviewed by management to see if any corrective actions can be taken. In some cases, they will find that the real problem is an incorrectly-derived standard cost that generates unfavorable variances even when there is no underlying problem.
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Examples of Standard Costs
Here are several examples of standard costs within different cost categories:
Direct Materials
Steel for automobile production: $2.50 per pound
Flour for a bakery: $0.40 per pound
Fabric for garment manufacturing: $3.00 per yard
Direct Labor
Machine operator in a manufacturing plant: $18.00 per hour
Software developer in a tech company: $50.00 per hour
Construction worker on-site: $25.00 per hour
Manufacturing Overhead
Electricity cost for running machinery: $0.08 per kilowatt-hour
Depreciation on factory equipment: $5,000 per month
Factory supervisor salary allocation: $6,000 per month
Selling and Administrative Expenses
Advertising costs: $500 per campaign
Office supplies: $100 per employee per month
Customer service cost per interaction: $2.00 per call
Transportation Costs
Shipping cost for products: $0.50 per mile per pallet
Fuel cost for delivery trucks: $3.00 per gallon
These standard costs are determined based on historical data, industry benchmarks, and anticipated market conditions, and they are adjusted as necessary to reflect changes in the business environment.
Advantages of Standard Costs
There are multiple advantages to using standard costs. They are as follows:
Management by exception. A standard cost sets a benchmark for what a cost should be, so as long as actual results are close to the standard cost, management can assume that the incurred cost is reasonable. This allows them to focus their attention on large variances, which is at the core of the management by exception concept.
Outcome comparison. Having a complete system of standard costs in place makes it easier to compare actual results to expectations, and is the foundation for budget vs. actual reporting.
Simplified job costing. It is much easier to charge standard costs to jobs than to charge actual costs to them. This simplifies the work of the accounting staff, as long as standard costs are set close to actual cost values.
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