The calculation of the standard overhead rate for use in the normal costing system is as follows. 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 self assessment income and expense tracker spreadsheet year. It is not a product cost computer software program like the standard and normal costing systems. 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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Finance Strategists is a leading financial education organization that connects people with financial professionals, priding itself on providing accurate and reliable financial information to millions of readers each year. It is acceptable under the generally accepted accounting principles and international financial reporting standards accounting frameworks to use normal costing to derive the cost of a product for financial reporting purposes. These standard costs are used to calculate the manufacturer’s cost of goods sold and inventories. Additionally the table below summarizes the differences between the normal costing system and the standard cost system.

1. Normal costing varies from standard costing, in that standard costing uses entirely predetermined costs for all aspects of a product, while normal costing uses actual costs for the materials and labor components.
2. They are the actual cost of materials, the actual cost of labor, and the actual overhead costs incurred.
3. If the variances are significant, they should be prorated to the cost of goods sold and to various inventories based on their amounts of the standard costs.
4. All of our content is based on objective analysis, and the opinions are our own.

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. A similar costing system is normal costing, where the key difference is the use of a budgeted amount of overhead. Actual costing will result in a greater fluctuation in overhead allocations, since it is based on short-term costs that can unexpectedly spike or dip in size. Normal costing results in less fluctuation in overhead allocations, since it is based on long-term expectations for overhead costs. As we have seen above, the normal costing system uses both actual and standard costs and therefore in terms of accuracy, sits somewhere between the actual and standard cost systems.

Examples of Normal Costing and Actual Costing

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. A company having relatively stable production volumes from month to month will have few problems with actual costing. However, one that experiences continual variation in its production volumes, and especially one that regularly faces questions from its investors may be better off using normal costing, since that method offers greater stability in reported costs. If the actual costs vary only slightly from the standard costs, the resulting variances will be assigned to the cost of goods sold. If the variances are significant, they should be prorated to the cost of goods sold and to various inventories based on their amounts of the standard costs.

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Normal Costing System and Product Costs

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He has worked as an accountant and consultant for more than 25 years and has built financial models for all types of industries. He has been the CFO or controller of both small and medium sized companies and has run small businesses of his own. He has been a manager and an auditor with Deloitte, a big 4 accountancy firm, and holds a degree from Loughborough University.

Under the system the direct costs are based on actual costs and the overheads are based on actual quantities at a standard rate. By using the standard rate, which is effectively fixed, the product cost is not subject to sudden variations throughout the accounting period. This allows the business to base decisions such as product pricing, on stable product costs. Both normal costing and actual costing systems use actual prices and quantities to calculate direct costs. The difference between the two systems is that the normal costing system uses standard overhead absorption rates based on the overhead budget, instead of actual overhead rates. Production costs consist of both direct costs such as production labor and materials, and indirect costs such as manufacturing overhead allocated to production and absorbed in the total cost of the product.

The table below summarizes the differences between the normal costing system and an actual cost system. Our team of reviewers are established professionals with decades of experience in areas of personal finance and hold many advanced degrees and certifications. At Finance Strategists, we partner with financial experts to ensure the accuracy of our financial content. Our writing and editorial staff are a team of experts holding advanced financial designations and have written for most major financial media publications.

Normal Costing vs. Standard Costing

For a more accurate view of the direction in which product costs are headed, it is better to use actual costs, since they match the current amount of actual overhead costs. Standard costs are the least usable from a management perspective, since the costs used may not equate to actual costs. If there is a difference between the total amount of overhead costs applied to the products and the total amount of actual overhead costs incurred, the difference is referred to as a variance. If the amount of the variance is not significant, it will usually be assigned to the cost of goods sold. If the variance is significant, it should be prorated to the cost of goods sold, the work-in-process inventory, and the finished goods inventory based on their amounts of applied overhead.

It includes the actual cost of materials, the actual cost of labor, and a standard overhead rate that is applied using the product’s actual usage of whatever allocation base is being used (such as direct labor hours or machine time). An actual costing system is a product costing system that adds actual direct material, actual direct labor, and actual manufacturing overhead costs to the work-in-process inventory. Normal costing refers to a product costing system that adds actual direct material, actual direct labor, and applied manufacturing overhead costs to the work-in-process inventory. They are the actual cost of materials, the actual cost of labor, and the actual overhead costs incurred. Overhead costs are allocated using the actual quantity of the allocation base experienced during the reporting period.