In the production and service industries, the standard cost of a product, unit, or service rendered 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 to make choices about future production. The actual cost is how much the product, unit, or service ended up costing when all the expenses were finally tallied and can be determined only after the product has been produced. For this reason, standard cost is often used in planning.
If a company wants to release a new product, for example a pen, the company must first consider if it is worthwhile to make the pen. The company will consider whether it can make a profit from selling the pen once the expenses to manufacture it have been paid out. To determine this, the company will find the standard cost of the pen. This may include the cost of the raw materials, labor, and even of buying or renting a facility and providing power to the facility. Other expenses, such as marketing and transporting the pen, may also be figured in.
The company will research all of the variables. A person or committee of people will research the expense of ink, how much it cost to manufacture similar pens in the past, and the overhead cost of a manufacturing facility. All these factors add up to the standard cost. Once the pen has been produced, the company will compare the standard to the actual cost.
If the deviation between the two is high, the company will do still more research to find out why the pen cost more than projected. The company may investigate procedures, suppliers, and other aspects of production to find out where the extra expenses came from. This adds to the company's efficiency by allowing it to alter its actions to result in a lower actual cost. In some cases, the company may decide that the product costs too much to produce and take it off the market.
The standard cost of a product, unit, or service does have 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 figure inaccurate long before the actual cost has been determined. Finally, the standard cost cannot be used for non-standard products, for example products that are made directly to consumer specifications, because their cost will vary depending on what the customer requires.