A fully integrated standard costing system uses standard costs for all the elements of product cost: direct materials, direct labor, and overhead. Inventory accounts for materials, work in process, and finished goods, as well as the Cost of Goods Sold account, are maintained and reported in terms of standard costs, and standard unit costs are used to compute account balances. Actual costs are recorded separately so that managers can compare what should have been spent (the standard
costs) with the actual costs incurred in the cost center.A standard unit cost for a manufactured product has the following
six elements:
Price standard for direct materials
Quantity standard for direct materials
Standard for direct labor rate
Standard for direct labor time
Standard for variable overhead rate
Standard for fixed overhead rate
To compute a standard unit cost, it is necessary to identify and analyze each of these elements. (A standard unit cost for a service includes only the elements that relate to direct labor and overhead.)
Standard Direct Materials Cost
The standard direct materials cost is found by multiplying the price standard for direct materials by the quantity standard for direct materials. For example, if the price standard for a certain item is $2.75 and a specific job calls for a quantity standard of 8 of the items, the standard direct materials cost for that job is computed as follows:
Standard Direct Direct Materials Direct Materials
Materials Cost = Price Standard x Quantity Standard
$22.00 = $2.75 x 8
The direct materials price standard is a careful estimate of the cost of a specific direct material in the next accounting period. An organization’s purchasing agent or its purchasing department is responsible for developing price standardsfor all direct materials and for making the actual purchases. When estimating a direct materials price standard, the purchasing agent or department must take into account all possible price increases, changes in available quantities, and new sources of supply. The direct materials quantity standard is an estimate of the amount of direct materials, including scrap and waste, that will be used in an accounting period. It is influenced by product engineering specifications, the quality of direct materials, the age and productivity of machinery, and the quality and experience of the work force. Production managers or management accountants usually establish and monitor standards for direct materials quantity, but engineers, purchasing agents, and machine operators may also contribute to the development of these standards.
Standard Direct Labor Cost
The standard direct labor cost for a product, task, or job order is calculated by multiplying the standard wage for direct labor by the standard hours of direct labor. For example, if the standard direct labor rate is $8.40 per hour and a product standard direct labor hours to produce, the product’s standard direct labor cost is computed as follows:
Standard Direct Direct Labor Direct Labor
Labor Cost Rate = Standard x Time Standard
$12.60 = $8.40 x 1.5 hours
The direct labor rate standard is the hourly direct labor rate that is expected to prevail during the next accounting period for each function or job classification. Although rate ranges are established for each type of worker and rates vary within those ranges according to each worker’s experience and length of service, an average standard rate is developed for each task. Even if the person making the product is paid more or less than the standard rate, the standard rate is used to calculate the standard direct labor cost. Standard labor rates are fairly easy to develop because labor rates are either set by a labor union contract or defined by the company. The direct labor time standard is the expected labor time required for each department, machine, or process to complete the production of one unit or one batch of output. In many cases, standard time per unit is a small fraction of an hour. Current time and motion studies of workers and machines, as well as records of their past performance, provide the data for developing this standard. The direct labor time standard should be revised whenever a machine is replaced or the quality of the labor force changes.
Standard Overhead Cost
The standard overhead cost is the sum of the estimates of variable and fixed overhead costs in the next accounting period. It is based on standard overhead rates that are computed in much the same way as the predetermined overhead rate that Unlike that rate, however, the standard overhead rate has two parts, one for variable costs and one for fixed costs. The reason for computing the standard variable and fixed overhead rates separately is that their cost behavior differs. The standard variable overhead rate is computed by dividing the total budgeted variable overhead costs by an expression of capacity, such as the number of standard machine hours or standard direct labor hours. (Other bases may be used if machine hours or direct labor hours are not good predictors, or drivers, of variable overhead costs.) For example, using standard machine hours as the base, the formula is as follows:
Variabl = Budgeted Variable Overhead Cost
Overhead Rate Number of Standard Hours
The standard fixed overhead rate is computed by dividing the total budgeted fixed overhead costs by an expression of capacity, usually normal capacity in terms of standard hours or units. The denominator is expressed in the same terms as the variable overhead rate. For example, using normal capacity in terms of standard machine hours as the denominator, the formula is as follows:
Fixed = Budgeted Fixed Overhead Costs_
Overhead Rate Normal Capacity of Standard Hours
Recall that normal capacity is the level of operating capacity needed to meet expected sales demand. Using it as the application base ensures that all fixed overhead costs have been applied to units produced by the time normal capacity is reached.
