The default costs are those that are calculated in advance of the actual costs of the company in question.
In other words, the predetermined costs are those that the company has not yet occurred, but is expected to incur during the period.
For example, a company that is dedicated to delivering packages knows that it will have predetermined costs in relation to the vehicles in its fleet.
Default cost targets
These costs are mainly characterized by helping in the following functions:
- Establish prices and / or necessary magnitudes.
- Make comparisons between the predetermined costs and the actual costs.
- Develop strategies without having to wait for immediate real data.
In short, the predetermined costs essentially undertake theoretical or standardized forecasts of the company that help its correct operation from the beginning of the period without the need to know an exact amount. On the other hand, it is also true that these forecasts have deviations in most cases that we must correct.
Formula for default costs
Although the default costs do not have a calculation formula, their deviations do:
Deviations occur when the end of the period has been reached and the predetermined costs are compared with the actual costs obtained at the beginning and at the end of the period respectively.
Default cost types
There are two types of default costs. Each one has a specific objective and function:
- Standard default costs: These are the average or average costs that a process usually gives without any unforeseen events during the year, that is, in a theoretically normal year.
- Estimated predetermined costs: In this case, these are costs based on purely theoretical forecasts that come from expectations of specific expenses, such as repairs, mandatory improvements or replacements in relation to manufacturing.
As can be seen, each type of predetermined cost serves a different purpose. While the standard has a more economic forecasting function in a normal scenario, on the other hand, the estimated costs serve to shed some light on those costs that may arise whether in a normal year or not.
Example of predetermined costs
Given a business starting its first year in business, how can the use of predetermined costs help the business start?
First of all, a company that is just beginning its activity must first of all establish a price. That price must be set based on, at a minimum, trying to cover expenses during the period. Therefore, the number of sales to be made must also be estimated to calculate the total income in the period.
Then, only with the price, expenses, sales and income factors, a multitude of subvariables emerge that must also be estimated. An example of this may be the number of workers or the resources that will be needed during the year or, failing that, in the short term if the rotation cycle is high.
Ultimately this is a brief example of how predetermined costs can help a business operate relatively immediately without the need for actual or historical costs.Zero-based budgeting