Standard cost estimates how much a product will cost to produce, while actual cost is the final cost. Standard costing is used in planning and can help companies determine if a product is worth making. Limitations include the need for research and changes in the market.
In the manufacturing and service industries, the standard cost of a product, unit, or service provided is an estimate of how much the company thinks the product, unit, or service will cost to produce. It can be compared to the actual cost of the product, unit or service to help the company make choices about future production. Actual cost is how much the product, unit, or service ended up costing when all expenses are finally factored in, and can only be determined after the product has been produced. For this reason, standard costing is often used in planning.
If a company wants to introduce a new product, for example a pen, it must first consider whether it is worth making. The company will analyze whether it can profit from selling the pen, once manufacturing expenses are paid. To determine this, the company will find the standard pen cost. This can include the cost of raw materials, labor, and even buying or renting a facility and powering the facility. Other expenses such as marketing and shipping the pen may also be considered.
The company will research all variables. A person or committee of people will research ink expenses, how much it has cost to manufacture similar pens in the past, and the overhead costs of a manufacturing facility. All these factors add up to the standard cost. After the pen is produced, the company will compare the pattern with the actual cost.
If the deviation between the two is high, the company will do even more research to find out why the pen cost more than projected. The company can investigate procedures, suppliers, and other aspects of production to find out where the extra expenses came from. This increases the company’s efficiency, allowing it to change its actions to result in a lower real cost. In some cases, the company may decide that the product costs too much to produce and withdraw it from the market.
The standard cost of a product, unit or service has some limitations. Finding an accurate estimate takes a lot of research, time, and money. Changes in the market, the cost of materials, and production or distribution lines can make a given value inaccurate long before the actual cost has been determined. Finally, standard costing cannot be used for non-standard products, for example products made directly to the customer’s specifications, because the cost varies according to what the customer requires.
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