Definition of Standard Overhead Cost
A Standard Overhead Cost is a predetermined cost used to allocate fixed and variable overhead expenses to individual operations or products based on a set standard. This calculation is typically derived from the standard time allowed for the performance of an operation or the production of a product and is multiplied by the standard overhead absorption rate. It helps companies estimate production costs, plan budgets, and analyze variances between actual and expected costs.
Key Components:
- Standard Time: The amount of time that should ideally be required to perform a specific operation or produce a certain quantity of product.
- Standard Overhead Absorption Rate: A rate that reflects the predetermined cost for overhead allocated per unit of time or activity.
Examples
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Manufacturing Company
- A company estimates that producing one widget takes one hour of labor.
- Standard overhead absorption rate is $5 per hour.
- Standard overhead cost per widget = 1 hour * $5 = $5.
-
Service Industry
- A consulting firm determines that each client engagement hour incurs $10 in overhead.
- If an engagement is estimated to take 20 hours, the standard overhead cost is:
- 20 hours * $10 per hour = $200.
Frequently Asked Questions
What is the purpose of standard overhead cost?
Question: Why do companies use standard overhead costs? Answer: Companies use standard overhead costs to plan budgets, estimate production costs accurately, control expenses, set performance benchmarks, and analyze variances between actual and standard costs.
How is the standard overhead absorption rate calculated?
Question: What is the formula for calculating the standard overhead absorption rate? Answer: The standard overhead absorption rate is generally calculated by dividing the total estimated overhead costs by the total estimated level of activity (e.g., machine hours, labor hours).
Can standard overhead costs change?
Question: Do standard overhead costs remain constant over time? Answer: No, standard overhead costs can be adjusted periodically to reflect changes in operational efficiency, overhead expenses, and production methods.
Related Terms
- Overhead Absorption Rate
- Definition: The rate at which overhead costs are allocated to products or services, usually based on labor hours, machine hours, or units produced.
- Standard Costing
- Definition: An accounting technique that uses standard costs to help manage and control expenses relative to actual costs incurred.
- Variance Analysis
- Definition: The process of comparing actual costs to standard costs and analyzing the reasons for any differences.
Online Resources
-
Investopedia - Standard Costing
- Link to article for comprehensive understanding of standard costing techniques.
-
AccountingTools - Overhead Rate
- Link to article explaining overhead absorption rates in detail.
Suggested Books for Further Studies
- “Cost Accounting: A Managerial Emphasis” by Charles T. Horngren
- A detailed guide on cost accounting practices, including standard costing.
- “Management and Cost Accounting” by Alnoor Bhimani, Charles T. Horngren, Srikant M. Datar, and George Foster
- Essential reading for advanced understanding of cost management and control techniques.
- “Advanced Management Accounting” by Robert S. Kaplan and Anthony A. Atkinson
- Explores advanced concepts in management accounting, including standard overhead costing.
Accounting Basics: “Standard Overhead Cost” Fundamentals Quiz
### What does the standard overhead cost consist of?
- [x] Fixed and variable overhead costs.
- [ ] Only fixed overhead costs.
- [ ] Only variable overhead costs.
- [ ] Direct labor and material costs.
> **Explanation:** The standard overhead cost consists of both fixed and variable overhead costs that are predetermined for cost control purposes.
### How is the standard overhead absorption rate determined?
- [ ] By estimating total direct labor cost.
- [x] By dividing total estimated overhead costs by total estimated level of activity.
- [ ] By dividing total estimated overhead costs by total estimated production units.
- [ ] By analyzing past actual overhead expenses.
> **Explanation:** The standard overhead absorption rate is calculated by dividing total estimated overhead costs by total estimated level of activity, such as labor or machine hours.
### Why are standard overhead costs used in budgeting?
- [x] To estimate production costs accurately.
- [ ] To calculate sales revenue forecasts.
- [ ] To allocate marketing expenses.
- [ ] To control financial statements.
> **Explanation:** Standard overhead costs are used to estimate production costs accurately and set performance benchmarks for budgeting purposes.
### What can be a result of significant variance between actual and standard overhead costs?
- [ ] Improved operational efficiency.
- [ ] Increased profitability.
- [ ] Need for variance analysis.
- [x] Both "c" and "d".
> **Explanation:** A significant variance will typically lead to a need for variance analysis to determine reasons for differences between actual and standard overhead costs and can result in identifying opportunities for improved efficiency.
### In which scenario would a company adjust its standard overhead cost?
- [ ] When there is a new product launch.
- [ ] When the company undergoes financial restructuring.
- [x] When actual overhead costs change significantly.
- [ ] At the end of every fiscal quarter.
> **Explanation:** Adjustments to the standard overhead cost are necessary when there are significant changes in actual overhead costs to ensure accurate cost control and budgeting.
### What role does the standard overhead cost play in pricing decisions?
- [x] Helps in setting competitive prices.
- [ ] Dictates the maximum selling price.
- [ ] Influences only the marketing strategy.
- [ ] Determines dividend payouts.
> **Explanation:** Standard overhead costs help companies in setting competitive prices by providing a basis for estimating total production costs and ensuring profitability.
### Which aspect does not affect the standard overhead absorption rate?
- [ ] Estimated overhead costs.
- [x] Current market price of the product.
- [ ] Level of activity (labor/machine hours).
- [ ] Standard time required for production.
> **Explanation:** The current market price of the product does not affect the standard overhead absorption rate. The rate is determined by estimates of overhead costs and production activity levels.
### What is the main benefit of using standard overhead costs in operation management?
- [x] Facilitates cost control and variance analysis.
- [ ] Guarantees profit margin increase.
- [ ] Eliminates the need for financial reporting.
- [ ] Simplifies tax computations.
> **Explanation:** The main benefit is facilitating cost control and variance analysis by comparing actual expenses to standard costs, helping manage operational efficiency.
### How frequently should standard overhead costs be reviewed?
- [x] Periodically, based on changes in the production process.
- [ ] Annually, regardless of changes.
- [ ] Only when preparing budgets.
- [ ] Only when implementing new projects.
> **Explanation:** Standard overhead costs should be reviewed periodically, especially when there are significant changes in the production process or overhead expenses.
### What impact can accurate standard overhead cost estimation have on a company?
- [ ] Increase liabilities.
- [ ] Decrease usable working capital.
- [x] Enhance budgeting and financial planning.
- [ ] Cause financial reporting errors.
> **Explanation:** Accurate estimation of standard overhead costs enhances budgeting and financial planning by providing a reliable basis for forecasting expenses and setting financial benchmarks.
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