Key Differences Between Actual Costing and Normal Costing

Updated September 30, 2022

If you're calculating the costs associated with operating a business, there are several methods you can use. Two of these methods are actual costing and normal costing. Understanding the differences between these methods may help you continue to develop your knowledge of standard accounting practices and procedures. In this article, we discuss what actual costing and normal costing are, describe the key differences between them and give an example of each.

What is actual costing?

Actual costing is a calculation of all accurate costs associated with a project including materials, labor and overhead costs. Labor costs include money spent on salaries and wages and other contract workers' salaries or wages. Materials costs include money spent on raw materials. In actual costing, you calculate accurate overhead costs based on actual data from previous months or years.

What is normal costing?

Normal costing is a standard cost system that accounts for materials, labor, and overhead when determining the cost of producing products. Normal costing accounts for actual material and labor costs while gathering data about overhead costs by multiplying the overhead rate for each product by the total number of products your team produces in a specific time period. Normalizing costs allows you to compare total production expense with total revenue. This allows for easy comparison of current operations with historical production expenses and can help in the creation of future projections.

Key differences between actual costing vs. normal costing

Here is a description of some key differences between these two costing methods:

Accuracy

Under actual costing, rates are based on costs incurred, while in normal costing, rates are based on the anticipated total efficiency of production. For example, the actual number of units produced at each rate might be lower than your team expected, resulting in inefficient use of resources and higher costs per unit. This makes the calculation of actual costs higher than normal costs.

Time frame

Under actual costing, you track costs in real-time, as calculations of actual costing occur after your team incurs the costs. You can conduct normal costing calculations at any time, as you can base future predictions of costs by using calculations on previous production data. For example, you can use the normal costing method to predict how much it may cost to produce enough products to meet consumer demand over the next three years.

Budgeting

If you base budgets on normal costs, then any demand increases may result in over-budget spending. This is because budgets are based on standard manufacturing rates, but actual production rates may be higher than anticipated due to the increase in demand. This may increase the total overhead costs for that period, though revenue is also likely to be higher.

You can also base budgets on previous actual costs, though changes in demand or material and labor costs may result in over or under-budget spending.

Goal-setting

Normal costing allows team members to accurately set goals and meet specific targets for production rates and costs, as they have a per-unit overhead price that they can aim to meet. As you conduct actual costing calculations after producing products, it is more difficult to use in goal-setting. You can still use actual costing to aim for specific amounts of total costs through a given time period.

Example of using actual costing

Here is an example of a fictional company using actual costing:

Archibald Technology Manufacturing is a hardware manufacturing company that sells three distinct products, graphics cards, speakers and keyboards. Use of actual costing allows Archibald Technology Manufacturing to track accurate costs by department for each of its products and plant-wide. This allows Archibald Technology Manufacturing to continually review its financial efficiency by comparing total production expenses with total revenue, an important aspect of managing any business. To calculate the actual costs of producing the three products, Archibald tracks the materials, labor and overhead costs for the previous year.

The materials costs for each product are as follows:

Graphics cards: $10,000

Speakers: $5,000

Keyboards: $2,500

The labor costs for each product are as follows:

Graphics cards: $20,000

Speakers: $20,000

Keyboards: $10,000

The overhead costs for the actual number of products produced are as follows:

Graphics cards: $4,000

Speakers: $5,000

Keyboards: $2,000

The total for each category is:

Materials costs: $17,500

Labor costs: $50,000

Overhead costs: $11,000

The grand total for actual costs is $78,500

Example of using normal costing

Here is an example of a fictional company using normal costing:

Matt's Outdoor Furniture Company is a manufactured furniture company that produces three distinct products, chairs and tables and accessories. Using normal costing allows Matt's Outdoor Furniture Company to predict manufacturing costs for each of these products for the next year based on the per-unit overhead costs of each product from the previous year.

Matt's Outdoor Furniture Company manufactured 2,000 chairs, 3,000 tables and 1,000 accessories during the previous year. The overhead costs per unit are $1.00 to produce a chair, $2.00 for a table and $1.00 per accessory. This means the total overhead costs for this period are as follows:

(2,000 x $1) + (3,000 x $2) + (1,000 x $1) = $9,000

The materials costs for each product are as follows:

Tables: $15,000

Chairs: $5,000

Accessories: $8,000

The labor costs for each product are as follows:

Tables: $12,000

Chairs: $8,000

Accessories: $10,000

To calculate the total normal costs, Matt's Outdoor Furniture adds all the labor and materials costs to the total overhead costs. The grand total is:

($15,000 + $5,000 + $8,000) + ($12,000 + $8,000 + $10,000) + $9,000 = $57,000