Managerial Accounting Course

Managerial Accounting Course

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Setting Standard Costs

Managers and supervisors make estimations of what a given job function or unit will cost. They perform this through considering many factors and ensuring the relevant managers and employees are involved to come up with a near to actual estimation.

When setting standard costs, managers look at historical data of the relevant costs, assess quality and quantity of production, assess age of machinery, looks at number of employees in the relevant departments, etc. Analyzing all the factors ensures that the managers make informed and near-perfect estimates.

Setting standard cost for direct labor

To set the standard cost for direct labor, the wage rate and direct labor hours needed to complete a given product are required. The standard cost of making a product is thus calculated by multiplying the hourly wage and the direct labor hours or the time needed to finish the product.

For example, if a suit requires 2 hours to be produced and the direct workers are paid $12 per hour. The direct labor cost of producing the suit will be $24 (12 x 2). Thus, the formula for the direct labor standard cost is:

  Direct labor standard cost = Standard Wage Rate X Hours

Setting standard cost for direct materials

To set the standard cost for direct materials, the cost of the raw material and the quantity of the raw material are required. The standard direct material cost of making a given product is thus calculated by multiplying the cost of raw materials and the quantity of the materials used.

For example, a suit requires 12 square fit of material and one square fit of material costs $0.8. The direct material cost for producing a suit will be $9.6 (12 x 0.8). Thus, the formula for standard cost of direct material will be calculated by the formula:

  Direct Material Standard Cost = Cost of Material X Quantity of Material Needed.

Setting standard cost for overhead costs

To set the standard overhead costs, the management must identify both activities relevant to cost and all various cost drivers. The setting of overhead cost can take a form of many approaches - but it is important to note that overhead costs are not direct costs and thus they cannot follow the same procedure as direct materials or direct labor as shown above.

However, management can use overhead application rate in calculating the standard overhead costs used. Overhead application rate is computed by dividing the estimated total overhead cost, by the cost drivers identified by the company e.g. machine hours or labor hours.

Formula for Overhead Application Rate

The formula for calculating overhead is:

  Overhead = total overhead for the period / number of machine (labor) hours

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