Standard Costs Managerial Accounting Prepared by Diane Tanner University of North Florida Chapter 43

Standard Costs  What is a standard cost?  The ‘cost’ that management believes should be incurred to produce one unit of a good or service under anticipated conditions  Primary benefit  Allows for comparison of standard versus actual costs  Differences are flagged for investigation if significant  Reduces the cost of accounting for product costs during an accounting period A budgeted cost is the cost of the total number of budgeted units Can be a standard cost or not A budgeted cost is the cost of the total number of budgeted units Can be a standard cost or not

How are Standard Costs Developed?  Materials  Formulas or recipes  Price lists provided by suppliers  Analyses of past data  Labor  Time and motion studies conducted by industrial engineers  Union contracts  Analyses of past data  Overhead  Various sources  Primarily past data

Ideal Versus Attainable Standards Two attitudes about developing standard costs:  Ideal standards  Assumption that no obstacles to the production process will be encountered  Called ‘perfection’ standards  Attainable Standards  Assumption that there will be occasional problems in the production process  Such as equipment failure, labor turnover, and materials defects

Components of Direct Standard Costs Standard P rice is the budgeted price of the material (per RM unit), labor (per hour) Standard Q uantity is the budgeted quantity of material (in RM quantities), labor (in hours)

Determining a Material Standard Cost  Units for materials  Based on the unit in which the company orders its raw materials  E.g., pounds, feet, tons, ounces, kilograms  Prices for materials  Based on the price quoted to buy each unit of materials  E.g., $1 per pound, or $2 per square foot  Standard cost of materials :: 6 Standard cost of materials = Standard quantity allowed per unit × Standard price per raw material denomination

Determining a Labor Standard Cost  Units for labor  Based on hours because that is how direct labor wages are paid  Minutes must be converted to hours  Prices for labor  Based on the hourly wage rate  Fringes are included  Standard cost of labor :: 7 Standard cost of labor = Standard hours allowed per unit × Standard price per labor hour

Determining an Overhead Standard Cost  Not quantitatively determinable using a price and quantity calculation because some overhead costs are fixed and some are variable  Often separated into fixed and variable components  Based on manufacturing overhead rates  Variable overhead  The unit variable overhead cost a company expects one unit of product to cost to produce  Fixed overhead  The total cost a company expects all units of product produced to cost divided by the number of units produced 8

Investigation of Standard Cost Variances  Variances are not a clear sign of good or bad performance –If actual cost is greater than the standard cost, the variance is unfavorable. – If the actual cost is less than the standard cost, the variance is favorable.  Indicate a potential problem  Must be investigated if material in amount  Management by exception  Many reasonable explanations Breaking a variance into two components allows us to isolate the cause of the variance and is called variance analysis.

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