January 26, 2022


Accounting + Finance Blog

Meaning of Predetermined Cost and Key Explanations

Meaning of Predetermined Cost and Key Explanations

The predetermined Cost is already decided on. In most cases, they are mere estimates and will be used to compare the actual cost incurred. It is also used in standard costing and budget. Let’s go there.

Definition of Predetermined Cost

Predetermined Cost is an estimated cost computed for an expenditure of expenses in advance of the actual spending. According to the ATSWA study pack, it is the cost estimated and computed in advance of production based on specifications of all the factors affecting cost.

Key Explanations of Predetermined Cost

It is an estimated cost. However, it is different from an estimate in some ways. Here the cost is needed for comparisons with an actual cost that will be made in the future. The term is used mostly by manufacturing firms but is also used by service businesses in preparing budgets.

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These costs are computed in advance of the actual spending. And it usually includes all specifications with regards to the cost in question. In manufacturing firms, they are estimated for raw materials, labor and Overheads. When the actual costs are included during the period, the actual is compared with the predetermined to get the variance. A favorable variance means the actual cost is lower while an unfavorable variance implies that the actual cost was higher.

The term is also used in standard costing. In this situation, the standard cost is said to be the predetermined cost which is then compared with the actual cost. Variance is used to understand the cost item. So that adjustments can be made.

Using predetermined cost improves management efficiency. It also reduces the cost of production. Furthermore, it serves as a key performance indicator. A manager spending above the predetermined cost may imply that he or she is not performing well in terms of managing the entity’s finance.

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They are estimated costs that include all specifications of a particular cost element. It is usually compared with the actual costs. And are used to measure the performance of employees.