How Are Standard Costs Determined by a Manufacturing Company?
Standard costs refer to the cost that management anticipates incurring to offer goods or services. The cost serves as a standard in which performance will be assessed. Manufacturing firms establish the standard costs of every unit of a product by determining the standard cost of direct labor, direct materials, and manufacturing overhead needed to produce that unit. The three costs are summed together to determine the standard cost (Berger, 1). Variance refers to the variation between the standard cost and actual cost incurred. There are two primary forms of variance from a standard cost. They include the volume variance and rate valiance. Rate variance refers to the variation between the actual price paid and the anticipated price, multiplied by the real quantity purchased. Rate variance is mostly used in labor cost that contains the actual direct labor cost and the standard direct labor cost. Volume variance refers to the variation between the actual quantity consumed or sold and the budgeted quantity, multiplied by the cost per unit or the standard price. In case the variance associates with the sales of goods, it is regarded as the sales volume variance.
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Two types of standard cost variances Used by management to assess both the efficiency and effectiveness of comparing actual price to standard price
The two variances are used by the management to assess the efficiency and effectiveness of comparing actual price to standard price (Berger, 1). For instance, the management can determine the standard cost of producing one unit of a product is $135. However, after carrying out the actual production, the actual variable cost is found to be $140. This helps in determining that the standard cost may be inefficient and may need to be adjusted for accuracy purposes. The organization may also determine that it needs to produce about 2000 units to satisfy the market. However, the produced amount is consumed within a short period and more customers come asking for the good, but the company cannot offer due to shortage. This can be regarded as volume variance and it demonstrates inefficiency in the standard quantity.
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