How are standard costs developed?
Standard costs are an essential tool in cost accounting, providing a benchmark for comparing actual costs with expected costs. They help businesses in budgeting, planning, and performance evaluation. In this article, we will explore the process of developing standard costs, from determining the elements of a standard cost to applying it in various business scenarios.
The development of standard costs involves several steps, starting with identifying the key components that make up the cost. These components typically include direct materials, direct labor, and manufacturing overhead. Here’s a closer look at the process:
1. Direct Materials: The first step in developing standard costs is to establish the standard quantity of materials required for each unit of product. This is based on historical data, engineering specifications, and current industry standards. Once the standard quantity is determined, the standard price per unit is calculated by dividing the total annual material cost by the total annual material usage.
2. Direct Labor: Similar to direct materials, the standard time required to produce each unit of product is determined. This is based on historical data, current labor rates, and the expected efficiency of the workforce. The standard labor rate per hour is calculated by dividing the total annual labor cost by the total annual labor hours.
3. Manufacturing Overhead: Manufacturing overhead includes indirect costs such as utilities, rent, and depreciation. To develop a standard overhead cost, businesses often allocate overhead costs to each unit of product based on a predetermined overhead rate. This rate is calculated by dividing the total annual overhead cost by the total annual production volume.
4. Combining the Components: Once the standard costs for direct materials, direct labor, and manufacturing overhead are determined, they are combined to calculate the total standard cost per unit. This provides a baseline for comparing actual costs and identifying areas for improvement.
5. Applying Standard Costs: Standard costs are applied in various ways within a business. They are used for budgeting, pricing, performance evaluation, and cost control. By comparing actual costs to standard costs, businesses can identify inefficiencies and take corrective actions.
In conclusion, the development of standard costs is a systematic process that involves determining the standard quantities, prices, and rates for direct materials, direct labor, and manufacturing overhead. By applying these standards, businesses can gain valuable insights into their cost structure and make informed decisions to improve their financial performance.
