In short, standard costing takes the direct labor, direct materials, and manufacturing overhead, and estimates the cost over a quarter, year, or whatever the period may be. This is similar to budget costing, but is different in that budget costs account for a total cost while a standard cost estimate is on a per unit basis. Therefore, if a standard cost estimate turns out to be correct, then the total cost would turn out to be equal to the budget cost. But, this sort of thing never happens.
The standard cost method can be broken down using the following formula:
Direct Labor = Hours Worked * Hourly Rate
Direct Materials = amount of materials * market price
Manufacturing Overhead = Fixed Salary + (Machine hours * Machine rate)
Note: All but the fixed salary component of overhead must be predicted given the market conditions on demand and cost of the materials. It should also be noted that this is the same formula for the manufacturing costs, but the difference lies in the fact that Standard costs accounting is done on a predictive basis.
For example, Jenny is an accountant. Her boss, Craig the CFO, gave her a task to calculate the standard cost of the company for the upcoming year 2010. She was given the following past information for Wawadoo Co. to try and calculate the standard cost for Wawadoo’s product (widget).
Avg. Market Price= $20
Total Cost= $400,000
Fixed Salary per Manager= $80,000
Number of Managers= 5
Number of Machine hours= 1,000
Hourly Machine rate= $2
Jenny’s Boss, Craig, believes that the overall demand for widgets will increase by 5% and the price and number of units needed will increase by the same amount. He also believes that there will be a need for 8 new employees as well as a new manager.
Jenny finds the following:
Total Standard Cost= $2,011,000 cost for the year