What is Standard Cost?

Standard Cost

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Standard Cost

Standard cost is a predetermined or calculated cost that is used as a benchmark to compare with the actual cost incurred for a product or service. It’s a managerial accounting tool that helps companies set expectations, manage budgets, control costs, and analyze variances.

Standard costs are often developed based on historical data, industry benchmarks, or detailed time and motion studies. They provide a consistent basis for valuing inventory, setting prices, and making performance evaluations.

Key components of standard cost typically include:

  • Direct Materials: The standard cost and quantity of materials expected for each unit of finished product.
  • Direct Labor: The standard rate (wage) and hours expected to manufacture each unit of finished product.
  • Manufacturing Overhead: The indirect costs associated with producing a product, allocated on a per-unit basis.

Once standard costs are established, they are regularly compared to the actual costs. The differences between the standard costs and actual costs are referred to as “variances.” Variances can be favorable (when the actual cost is less than the standard cost) or unfavorable (when the actual cost is greater than the standard cost). Analyzing these variances helps management in identifying areas that need attention or improvement.

Example of Standard Cost

Let’s craft a detailed fictional example around a company that manufactures gourmet chocolate bars.

Scenario: “CocoaDelight Chocolates”

CocoaDelight Chocolates produces artisan chocolate bars. They set standard costs for each bar to help manage their production costs and measure performance.

Standard Costs:

  • Direct Materials: The high-quality cocoa, sugar, and other ingredients required for each chocolate bar are expected to cost $1.50.
  • Direct Labor: Each bar takes 10 minutes (0.1667 hours) to produce. Given that the standard wage rate for workers is $12 per hour, the labor cost per bar is $2 (0.1667 x $12).
  • Manufacturing Overhead: Based on past data and the allocation method they use, the standard overhead cost assigned to each bar is $0.50.

Thus, the total standard cost per chocolate bar is $4 ($1.50 + $2 + $0.50).

Actual Costs in June:

By the end of June, CocoaDelight reviews its production costs:

  • Due to a spike in cocoa prices, the actual material cost per bar was $1.70.
  • Labor efficiency improvements resulted in a labor cost of $1.80 per bar.
  • Manufacturing overhead was as expected, at $0.50 per bar.

Variance Analysis:

Now, let’s calculate the variances between standard and actual costs:

  • Material Variance: ($1.70 – $1.50) x number of bars produced = $0.20 unfavorable variance per bar.
  • Labor Variance: ($1.80 – $2) x number of bars produced = $0.20 favorable variance per bar.
  • Overhead Variance: No variance, as the actual cost matched the standard cost.

If CocoaDelight produced 10,000 bars in June:

  • Material variance would be $2,000 unfavorable (10,000 bars x $0.20).
  • Labor variance would be $2,000 favorable (10,000 bars x $0.20).
  • No overhead variance.

Management Action:

Given this data, management at CocoaDelight might:

  • Investigate the cause of the increase in material costs. Was it a supply issue, or are cocoa prices expected to remain high? Depending on the findings, they might adjust their pricing, look for alternative suppliers, or consider modifying their product mix.
  • Applaud the production team for their labor efficiency and possibly study the changes that led to improved labor performance. This knowledge can be documented and implemented as a best practice.
  • Feel confident in their overhead predictions since the actual costs matched their standards.

This example showcases how standard costs, when compared with actual costs, provide valuable insights to management and assist in decision-making.

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