A standard- cost system
is designed to alert management when the actual costs of production differ significantly
from target or standard costs, it uses standard costs and standard cost variances in the formal accounting system
A standard cost -
is calculated prior to the beginning of each year and it is based on the estimated costs and the
expected level of activity or production
-Is an estimate of the cost the company expects to incur in the production process
Are monetary measures with which actual costs are compared, it’s similar to par on a golf course.
-It’s not just an average of past costs but an objectively determined estimate of what a cost should be, it may be
based on accounting, engineering, or statistical quality control studies.
-Can be used with both job-order and process costing systems to isolate variances.
-Comparing actual and standard costs permits an evaluation of the effectiveness of managerial performance.
- Because of the impact of fixed costs in most businesses, a standard costing system is usually not effective unless the
company also has a flexible budgeting system. Flexible budgeting uses standard costs to prepare budgets for multiple
-Standard costs are an excellent example of the control loop in a performance monitoring system.
The difference between standard costs and budgeted costs
In the long run, these costs should be the same, in the short run they may differ because standard costs represent
what costs should be, whereas budgeted costs are expected actual costs. Budgeted costs may vary widely from
standard costs in certain months, but for an annual budget period, the amounts should be similar.
The control loop
consists of establishing standards, measuring actual performance, comparing actual performance
with standards, investigating the cause of variances, taking corrective action when needed, and occasionally revising
A flexible budget
is a budget that is prepared using the standard costs and the actual level of output.
Variance is the difference between actual costs and standard costs.
- A favorable variance arises when actual costs are less than standard costs, causes actual net operating income to be
higher than the budgeted amount.
- An unfavorable variance occurs when the actual costs are greater than standard, causes actual net operating income
to be lower than the budgeted amount.
Level of Activity
It is important to use the correct level of activity when developing the standards. If the standard level of activity is set
too high, there will be no motivation among the workers.
Ideal, perfect or theoretical level of output
assumes that there are no breakdowns, no waste and no time lost to
illness, and that the workers are already working at maximum efficiency.
The practical, or currently attainable, level of output