What is a standard cost and how is it used in budgeting?

• A. Actual historical cost
• B. Predetermined cost used for variance analysis
• C. Cost that is revised monthly
• D. Unit cost for external benchmarks

Answer: (B)

A standard cost is a predetermined amount set in advance for the cost of producing a unit, based on expected input prices and standard quantities of materials, labor, and overhead. In budgeting, this becomes the baseline you use to forecast total production costs and to measure performance. When actual costs are recorded, they’re compared to the standard to compute variances, revealing whether spending or usage diverged from expectations. This variance analysis typically separates price variances (differences in input prices) from usage or efficiency variances (differences in how much input was actually used). Standards are established ahead of time through engineering studies, supplier data, and historical performance adjusted for planned efficiency, and they provide an internal benchmark rather than simply reflecting past actual costs.