Standard cost is a term used in standard costing, a branch of costing. It is compared with actual costs. And are used to understand why costs or volumes increase or decrease. This term is mostly used by manufacturing companies.
Definition of standard cost
Standard cost is an estimated cost that is expected to be incurred per unit of activity under efficient production conditions.
It is an estimate. The manager in charge does the estimate of the cost of the item. The estimate is based on the prevailing market price and the experience of the manager. Also, it is based on the number of expected units.
The expected units are also pre-determined. Specifically, it is based on a single unit of the material or other resources required for producing the goods or rendering the service. This makes standard cost differs from predetermined costs.
More so, the resources that are usually assigned a standard cost are materials, labor, and overheads. Manufacturing entities are known to use standard costs. However, service firms are currently using this type of cost.
They are used in budgeting. Here, management predetermined the amount to spend periodically. However, the problem with using standard cost on budgeting is that it is an estimate based on per-unit cost. But the budget uses total cost for each item of expenses and expenditure.
It is used for performance appraisal and control mechanisms. The standard set by the management is used to access employees’ performance. In the case of control, when there is variance between the standard cost and actual cost, the manager must examine what causes the difference and take corrective action.
Finally, it works under efficient production conditions. When setting this cost, management does not consider machine breakdown, the possibility of buying low-quality materials, or employees absent from the job, among other things.
Standard costs are mere estimates based on per unit of materials, labor, and overhead inputs required to produce goods or render service. Although they are pre-determined, it is different from predetermined costs because of the use of per-unit cost.