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Why use normal costing instead of actual costing?

Author:
Harold Averkamp, CPA, MBA

Definition of Normal Costing

For a manufacturer, normal costing means assigning the following costs to the actual goods produced each month:

  • Actual direct materials
  • Actual direct labor
  • Applying manufacturing overhead by using predetermined annual overhead rates times actual goods produced

Definition of Actual Costing

For a manufacturer, actual costing means assigning the following costs to the actual goods produced each month:

  • Actual direct materials
  • Actual direct labor
  • Actual manufacturing overhead incurred during each month is applied to the goods produced in that month

Examples of Normal Costing and Actual Costing

Assume that a manufacturer experiences an additional $200,000 in manufacturing overhead costs (air conditioning and other) in each of the months of June, July, and August. The overhead costs in each of the other 9 months is $1,000,000. Therefore, on an annual basis the manufacturing overhead is $12,600,000.

Assume that the overhead costs are assigned/allocated/applied to products using machine hours (MHs). MHs are 50,000 each month, except for December and January when each month has 30,000 MHs. Therefore, for the year there are expected to be 560,000 MHs.

Using normal costing, the company applies the manufacturing overhead to products at a rate of $22.50 per MH ($12,600,000/560,000 MH) throughout the year.

Using actual costing, the company will apply the manufacturing overhead to products at the following rates:

  • January and December: $33.33 per MH ($1,000,000/30,000 MH)
  • February-May and September-November: $20.00 per MH ($1,000,000/50,000 MH)
  • June through August: $24.00 per MH ($1,200,000/50,000 MH)

As shown above, normal costing results in an overhead rate that is uniform and realistic for all units manufactured during an accounting year.

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About the Author

Harold Averkamp

For the past 52 years, Harold Averkamp (CPA, MBA) has
worked as an accounting supervisor, manager, consultant, university instructor, and innovator in teaching accounting online. He is the sole author of all the materials on AccountingCoach.com.

Learn More About Harold

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