Both standards and budgets are predetermined costs, and both contribute to management planning and control. There is a difference, however, in the way the terms are expressed. A standard is a unit amount. A budget is a total amount. Thus, it is customary to state that the standard cost of direct labor for a unit of product is, say, $10. If the company produces 5,000 units of the product, the $50,000 of direct labor is the budgeted labor cost. A standard is the budgeted cost per unit of product. A standard is therefore concerned with each individual cost component that makes up the entire budget.
There are important accounting differences between budgets and standards. Except in the application of manufacturing overhead to jobs and processes, budget data are not journalized in cost accounting systems. In contrast, as we illustrate in the appendix to this chapter, standard costs may be incorporated into cost accounting systems. Also, a company may report its inventories at standard cost in its financial statements, but it would not report inventories at budgeted costs.
SETTING STANDARD COSTS
The setting of standard costs to produce a unit of product is a difficult task. It requires input from all persons who have responsibility for costs and quantities. To determine the standard cost of direct materials, management consults purchasing agents, product managers, quality control engineers, and production supervisors. In setting the standard cost for direct labor, managers obtain pay rate data from the payroll department. Industrial engineers generally determine the labor time requirements. The managerial accountant provides important input for the standard‐setting process by accumulating historical cost data and by knowing how costs respond to changes in activity levels.
To be effective in controlling costs, standard costs need to be current at all times. Thus, standards are under continuous review. They should change whenever managers determine that the existing standard is not a good measure of performance. Circumstances that warrant revision of a standard include changed wage rates resulting from a new union contract, a change in product specifications, or the implementation of a new manufacturing method.