Standard Overhead Cost

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:

1. Standard Time: The amount of time that should ideally be required to perform a specific operation or produce a certain quantity of product.
2. Standard Overhead Absorption Rate: A rate that reflects the predetermined cost for overhead allocated per unit of time or activity.

Examples

1. 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.

2. 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

1. 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.
2. Standard Costing
   • Definition: An accounting technique that uses standard costs to help manage and control expenses relative to actual costs incurred.
3. Variance Analysis
   • Definition: The process of comparing actual costs to standard costs and analyzing the reasons for any differences.

Online Resources

1. Investopedia - Standard Costing

   • Link to article for comprehensive understanding of standard costing techniques.

2. AccountingTools - Overhead Rate

   • Link to article explaining overhead absorption rates in detail.

Suggested Books for Further Studies

1. “Cost Accounting: A Managerial Emphasis” by Charles T. Horngren
   • A detailed guide on cost accounting practices, including standard costing.
2. “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.
3. “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

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