Standard cost is an estimate of how much a product or service will cost to produce, used in planning. Actual cost is the final cost after production. Companies use standard cost to determine if a product is worth manufacturing and to compare with actual cost. Limitations include the need for research and changes in the marketplace.
In the manufacturing and service industries, the standard cost of a product, unit, or service rendered is an estimate of how much society thinks the product, unit, or service will cost to produce. It can be compared with the actual cost of the product, unit or service to help the company make choices about future output. Actual cost is the amount that the product, unit, or service ended up costing when all expenses were finally calculated, and can only be determined after the product has been manufactured. For this reason, standard cost is often used in planning.
If a company wants to release a new product, such as a pen, the company must first consider whether the pen is worth manufacturing. The company will consider whether it can make a profit from the sale of the pen once its production costs are paid. To determine this, the company will find the standard cost of the pen. This can include the cost of raw materials, labor and even the purchase or rental of a facility and the supply of energy to the facility. Other expenses, such as marketing and transportation of the pen, may also be calculated.
The company will look for all variables. A person or a committee of people will research the expense of ink, what it cost to manufacture similar pens in the past, and the overhead of a manufacturing facility. All of these factors add up to the standard cost. Once the pen is produced, the company will compare the standard with the actual cost.
If the deviation between the two is large, the company will do even more research to find out why the pen costs more than expected. The company can investigate procedures, suppliers and other aspects of production to find out where the extra expenses are coming from. This increases the company’s efficiency, allowing it to change its actions to reduce actual costs. In some cases, the company may decide that the product costs too much to produce and withdraw from the market.
The standard cost of a product, unit or service has some limitations. Finding an accurate estimate requires a lot of research, time and money. Changes in the marketplace, the cost of materials, and manufacturing or distribution lines can make a given figure inaccurate long before the actual cost has been determined. Finally, standard cost cannot be used for non-standard products, such as products made directly to consumer specifications, as their cost will vary according to customer requirements.
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