What are Standard Costs?

Standard costs are costs that management expects to incur to provide a good or service. They serve as the “standard” by which performance will be evaluated. 

Manufacturing companies have a standard quantity of direct materials to be used to produce one unit of product.

What is the Difference between Standard Costs and Budgeted Costs?

The term standard cost refers to a specific cost per unit. 

Budgeted cost refers to costs in total given a certain level of activity. 

Standard variable production costs 

These standard costs can then be used to establish a flexible budget based on a given level of activity. 

The standard cost presented shows the variable production costs expected to produce one unit. 

How do you Establish a Standard Cost?

Managers needed to establish a standard cost for direct materials, direct labor, and variable manufacturing overhead.

Notice in that direct materials has two separate standards necessary to calculate the standard cost: 

• standard quantity to produce 1 unit of product, and 
• standard price

Direct labor has two separate standards as well: 

• standard hours to produce 1 unit of product, and 
• standard rate

Variable manufacturing overhead also has 2 separate standards: 

• standard hours to produce 1 unit of product, and 
• standard rate.

Thus there are two separate standards necessary to establish each standard cost or six standards in total to establish a standard cost for direct materials, direct labor, and variable manufacturing overhead.

Direct Materials Standard Quantity and Standard Price

 The standard quantity for direct materials represents the materials required to complete one good unit of product (i.e., a product with no defects), and it includes an allowance for waste and spoilage. 

Companies might adds a certain amount to the recipe quantity for waste and spoilage. 

Similar to this approach, companies might find the standard quantity in the product specifications outlined by product engineers. 

Some companies review historical production information to determine quantities used in the past and use this information to set standard quantities for the future.

The standard price for direct materials represents the final delivered cost of the materials and includes items such as shipping and insurance. 

As an alternative to this approach, companies might use historical data or look at price trends in the marketplace.

Direct Labor Standard Hours and Standard Rate

The standard hours for direct labor represents the direct labor time required to complete one good unit of product and includes an allowance for breaks and production inefficiencies such as machine downtime. 

Companies established this standard using historical information. 

In addition to this approach, companies might use time and motion studies performed by engineers who observe production workers and analyze the time required to perform production activities.

The standard rate for direct labor represents the average cost of wages and benefits for each hour of direct labor work performed. 

Companies also review labor contracts to estimate the costs associated with direct labor.

Variable Manufacturing Overhead Standard Quantity and Standard Rate

The standard quantity for variable manufacturing overhead represents the time required to complete one unit of product. 

This time is often measured in direct labor hours or machine hours, depending on how the company chooses to allocate overhead.

The standard rate for variable manufacturing overhead represents the variable portion of the predetermined overhead rate used to allocate overhead costs to products .

Thus the standard cost per unit for variable manufacturing overhead is calculated as follows:

 standard cost per unit =  direct labor hours per unit × $ per hour

Ideal Standards and Attainable Standards

In the process of establishing standards, managers must decide between using ideal standards or attainable standards. 

Ideal standards are set assuming production conditions are perfect. 

Although ideal standards may provide motivation for workers to strive for excellence, these standards can also have a negative impact because they may be impossible to achieve.

As an alternative to ideal standards, most managers use attainable standards. 

Attainable standards take into consideration the likelihood of encountering problems in production such as machine downtime, electricity outages, materials waste, and employee illnesses. 

Most managers feel attainable standards have a positive behavioral impact on workers because the standards are reasonable and attainable under normal production conditions. 

Controlling Operations through Standards

Companies typically use standards to analyze the difference between budgeted costs and actual costs. 

The process of analyzing differences between standard costs and actual costs is called variance analysis. 

Managerial accountants perform variance analysis for costs including direct materials, direct labor, and manufacturing overhead.

Standard costs are also used to determine product costs. 

Companies using standard costing systems are able to estimate product costs without having to wait for actual product cost data, and they often record transactions using standard cost information. 

Related Topics

• Job Costing vs Process Costing
• Assign Direct Material and Direct Labor to Job
• Assign Manufacturing Overhead Costs to Job
• Assign Overhead Costs to Products
• Plantwide Cost Allocation
• Department Cost Allocation
• Activity-Based Costing
• Weighted-Average Cost of Products
• Production Cost Report
• Fixed, Variable, and Mixed Cost Estimations
• Contribution Margin Income Statement
• Cost-Volume-Profit Analysis
• Margin of Safety
• Contribution Margin per Unit of Constraint
• Absorption Costing vs Variable Costing
• Differential Analysis and Decisions
• Cost Decisions for Joint Products
• Capital Budgeting
• Life Cycle Costing
• The Master Budget
• Activity-Based Budgeting
• Standard Costs
• Imputed Value
• Variance Analysis for Product Costs
• Absorption Pricing
• Price Variance
• Absorption Variance 
• Responsibility Centers
• Comparing Segmented Income
• Using ROI to Evaluate Performance
• Using Residual Income to Evaluate Performance
• Use Economic Value Added to Evaluate Performance
• Transfer Pricing