Standard Cost System

Standard costing is an important subtopic of cost accounting. Standard costs are usually associated with a manufacturing company’s costs of direct material, direct labor, and manufacturing overhead.

Rather than assigning the actual costs of direct material, direct labor, and manufacturing overhead to a product, many manufacturers assign the expected or standard cost. This means that a manufacturer’s inventories and cost of goods sold will begin with amounts reflecting the standard costs, not the actual costs, of a product. Manufacturers, of course, still have to pay the actual costs. As a result there are almost always differences between the actual costs and the standard costs, and those differences are known as variances.

Standard costing and the related variances is a valuable management tool. If a variance arises, management becomes aware that manufacturing costs have differed from the standard (planned, expected) costs.

  • If actual costs are greater than standard costs the variance is unfavorable. An unfavorable variance tells management that if everything else stays constant the company’s actual profit will be less than planned.

  • If actual costs are less than standard costs the variance is favorable. A favorable variance tells management that if everything else stays constant the actual profit will likely exceed the planned profit.

By exerting control over costs in prosperous times, the ability to weather more demanding times is improved. Comparing actual amounts with budgeted amounts is one approach to control.

A standard cost is the expected or budgeted cost of materials, labor, and manufacturing overhead required to produce one unit of product.

The unit standard cost is calculated as follows:

Price standard × Quantity standard

A price standard is the price that should be paid per unit of input (such as pound of material).

A quantity standard is the quantity of input allowed per unit of output (for example, pounds of material allowed per one unit of product).

A standard cost sheet calculates the total standard cost for one unit of product. It lists the standard costs for one unit of product for the following:

  • Materials (Price standard × Quantity standard)

  • Labor (Price standard × Quantity standard)

  • Variable manufacturing overhead (Price standard × Quantity standard)

  • Fixed manufacturing overhead (Price standard × Quantity standard)