Standard costs are actually estimates of the actual costs in a company’s production process. These estimates are used because knowing the exact costs would be impossible until the process is performed. Another way to think of standard costs is as the target or budgeted costs involved in a businesses processes. Standard costs usually include: material costs, labor costs and overhead costs.
One of the benefits of using standard costs is so the company can quote, estimate and budget more efficiently. Using standard costs allows a company to see variance in the estimates once the actual data has been collected. As was mentioned already no company can predict all the variables that will occur during manufacturing, so they use standard costs. Typically as the actual costs are collected a company should go back and check the estimates by entering the appropriate actual costs. If at the end of the accounting period, the standard costs are higher than the actual expenses, then the company has a favorable variance. On the other hand, if the company’s actual costs were higher, then the company would have an unfavorable variance. If the company's variance was unfavorable the company must then analyze the data and find where in the manufacturing process the actual cost differences lie. Some areas they may analyze are labor cost variances, material cost variances and overhead cost variances. By doing this it will reduce the variance in your estimates and help keep them more accurate. You may also hear standard costs referred to as preset costs, preset pricing, expected costs, predetermined costs or preset costing. As a reminder you should speak with a CPA, professional accountant or accounting attorney before deciding on different methods of valuation.
What are the Advantages of Standard Costs?
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