Standard Cost
Standard Cost

Standard Costs Definition

Standard cost accounting is a goal or budget costs that is associated with variable costs. They are also used to measure the cost that management believes that it will incur over a period.

Standard Costing Explained

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.

Standard Cost Formula

The standard cost method can be broken down using the following formula:

Standard Costs = Direct Labor * Direct Materials * Manufacturing Overhead

Where:
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.

Standard Cost Example

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).

Direct Labor-2009
AVg. Labor Hours= 1,960 hours per employee
Avg. Hourly Wage – $10
Number of employees = 47
Total Costs= $92,120

Direct Materials-2009
Material Units=20,000
Avg. Market Price= $20
Total Cost= $400,000

Overhead-2009
Fixed Salary per Manager= $80,000
Number of Managers= 5
Number of Machine hours= 1,000
Hourly Machine rate= $2
Total Cost=$410,000

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:

Direct Labor= 1,960 hrs.* $10/hr* 55 employees= $1,078,000
Direct Material = $21 mkt price* 21,000 units= $441,000
Overhead= ($80,000* 6) + (1,000 hrs.* $2/hr* 6) = $492,000

Total Standard Cost= $2,011,000 cost for the year

standard cost
See Also:
Manufacturing Cost
Cost of Goods Sold (COGS)
Overhead Definition
Direct Cost vs. Indirect Cost
Variable Cost

ARTICLES YOU MIGHT LIKE

The Accounting Gap Between Large and Small Companies

The Accounting Gap: It’s unfortunate, but true. A large gap exists between the accounting departments of large or publicly traded companies and smaller or private companies. In our past 25 years of consulting we’ve noticed that more often than not, these smaller/private companies will fill the gap with Bookkeepers, rather than the degreed Accountants/CPAs they

Read More »

The Struggles of Private Company Accounting

Building your Accounting Department… When I meet a business owner operating at a successful $10+ mil in revenue I often hear them say “My CPA…” and I immediately know they are referring to a tax CPA. One thing ALL entrepreneurs have in common is that they have to file a tax return. So from day

Read More »

Financial Ratios

See also:Quick Ratio AnalysisPrice to Book Value AnalysisPrice Earnings Growth Ratio AnalysisTime Interest Earned Ratio Analysis Use of Financial Ratios Financial Ratios are used to measure financial performance against standards. Analysts compare financial ratios to industry averages (benchmarking), industry standards or rules of thumbs and against internal trends (trends analysis). The most useful comparison when

Read More »

JOIN OUR NEXT SERIES

Financial Leadership Workshop

MARCH 28TH-31ST 2022

THE ART OF THE CFO®

Financial Leadership Workshop

Days
Hours
Min

June 12-15th, 2023

SHARE THIS ARTICLE
WIKI CFO® - Browse hundreds of articles