What is Standard Cost?
A standard cost is a measure of how much the cost of an item should be in comparison to the record of how much it actually was. In other words, standard cost is used to describe what the cost of one unit of product should be. On the other budget cost also a part of standard cost. However, budgeted cost is used to describe what the total cost of many units or of a time period should be.
So, a standard costing system is a system for product costing that records standard costs either in addition to or instead of actual costs. Standard cost represent what the cost should be. Therefore, if actual costs are higher than standard costs, the variance is said to be unfavorable. Unfavorable variances appears as debits in variance account. Similarly, if actual costs are below standard, the variance is a favorable variance.
Standard Cost Entries
Following are the entries in which standard has been introduced –
Entry 1 – Purchase of Materials
The actual cost was the actual quantity received times the actual price paid per unit of material. Whereas material inventory was debited for the actual quantity received times the standard unit price. Both amounts are based on quantity received. Thus, the variance occurs solely because the standard and actual unit prices of material were different. So, material price variance is –
Material Price Variance = (Actual Quantity × Standard Price) – (Actual Quantity × Actual Price)
Entry 2 – Usage of Materials
In usage of materials, the variance occurs solely because the standard and actual quantities of materials issued were different. Thus, the material usage variance is –
Material Usage Variance = (St. quantity × St. Price) – (Actual quantity × Standard Price)
Entry 3 – Direct Labor
The actual labor cost was the actual hours multiplied by actual rates. Whereas work in process inventory was debited for standard for standard hours multiplied by standard labor rates.
Uses of Standard Cost
A standard cost system is used for several reasons –
- It provides a basis for controlling performance.
- Provides cost information useful for certain types of decisions.
- It may provide a more rational measurement of inventory amounts and of cost of sales.
- It also reduces the cost of record keeping.