Definition of Standard Cost
A standard cost is described as a predetermined cost, an estimated future cost, an expected cost, a budgeted unit cost, a forecast cost, or as the "should be" cost. Standard costs are often an integral part of a manufacturer's annual profit plan and operating budgets.
When standard costs are used in a manufacturing setting, a product's standard cost for a future accounting period will consist of the following:
- Direct materials: a standard quantity of each material and a standard cost per unit of material
- Direct labor: a standard quantity of labor and a standard cost per hour of labor
- Manufacturing overhead: a budget for the fixed overhead, the standard variable overhead rate, and the standard quantity for applying a fixed and variable overhead rates
In a standard costing system, the standard costs of the manufacturing activities will be recorded in the inventories and the cost of goods sold accounts. Since the company must pay its vendors and production workers the actual costs incurred, there are likely to be some differences. The differences between the standard costs and the actual manufacturing costs are referred to as cost variances and will be recorded in separate variance accounts. Any balance in a variance account indicates that the company is deviating from the amounts in its profit plan.
While standard costs can be a useful management tool for a manufacturer, the manufacturer's external financial statements must comply with the cost principle and the matching principle. Therefore, significant variances must be reviewed and properly assigned or allocated to the cost of goods sold and/or inventories.
AccountingCoach PRO includes forms to assist in a better understanding of standard costs and their related variances.