Standard cost is an estimate used to value production materials (both finished and semi-finished goods) at a predetermined cost. Typically, standard costs are based on one of the following:
- Budget values: Standard costs are established annually.
- Forecast values: Standard costs are updated after each forecast period using the most recent prices.
The standard cost of a material is determined by two main components:
- Material costs: These are calculated based on the raw material purchasing cost and the Bill of Materials (BOM). The BOM details the usage of each raw material.
- Indirect costs: These include operating expenses allocated to cost centers and distributed to materials via recipes (or routing) and cost center rates.
Why is Standard Cost important?
As an estimate, standard cost is calculated after the budgeting process and reflects the cost a company would incur under normal conditions. It serves as a benchmark for comparing actual costs and assessing deviations caused by unforeseen factors during the fiscal year, such as volume decreases, raw material price fluctuations, quality issues, equipment maintenance, or logistical shortages.
Three Advantages of Standard Costs
- Useful for planning and forecasting: Facilitates better decision-making and financial planning.
- Improves cost management: Aids in analyzing cost variations and managing expenses.
- Simplifies inventory handling: Makes inventory management more straightforward.
