Definition: A standard overhead cost, also called a rate, is the amount of budgeted overhead expenses for a period. In other words, this is the amount of costs that management anticipates and plans to incur in the next period.
What Does Standard Overhead Cost Mean?
Standard overhead rates are used during the budgeting process to prepare the future production and output plans for the company. For instance, if management wants to see an increase in production of 20 percent in the next period, overhead costs like utilities will increase as well. Keep in mind that not all overhead is tied directly to production levels. Rent and insurance is a good example. Neither one of these expenses are affected by the total number of pieces produced during the period.
After the budget is prepared and the production period has begun, the standard costs can be used determine how reasonable the actual costs were for the period. Remember, the standard overhead rates are just estimates of what management anticipates will happen.
Since present costs and actual costs are rarely identical, management can evaluate how close the actual expenses matched what they should have been. If the actual expenses were higher than the preset expenses, the company would have an unfavorable variance. On the other hand, if actual is less than the standard, the difference is said to be a favorable variance.
Management can use these variances twofold. It can evaluate the efficiencies or inefficiencies that led to the variances and adjust them. For instance, utility prices might have increased drastically from the beginning of the period to the end resulting in an actual cost that is double the budgeted cost.
Likewise, insurance prices could increase at a mid-year renewal date affecting the actual costs for the period. Management can analyze and evaluate the differences between the budgeted and actual costs to be prepared for future periods.