Question

a)Distinguish between actual and normal costing. Why might a company use normal rather than actual costing?

Answer 1

Solution:- Difference between Actual Costing Vs Normal Costing

Actual costing is the recording of product costs based on the following factors:

a Actual cost of materials

b Actual cost of labor

c Actual overhead costs incurred, allocated using the actual quantity of the allocation base experienced during the reporting period

Thus, the key point in an actual costing system is that it only uses actual costs incurred and allocation bases experienced; it does not incorporate any budgeted amounts or standards. This is the simplest costing method available, requiring no pre-planning of standard costs. However, it can take longer to formulate a valuation for ending inventory and the cost of goods sold, since all actual costs must be compiled and allocated.

Normal costing is used to derive the cost of a product. It includes the following components:

a Actual cost of materials

b Actual cost of labor

c A standard overhead rate that is applied using the product's actual usage of whateverallocation base is being used (such as direct labor hours or machine time)

If there is a difference between the standard overhead cost and the actual overhead cost, you can either charge the difference to the cost of goods sold (for smaller variances) or prorate the difference between the cost of goods sold and inventory.

Normal costing is designed to yield product costs that do not contain the sudden cost spikes that can occur when you use actual overhead costs; instead, it uses a smoother long-term estimated overhead rate.

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.

The accuracy level of normal costs is between actual costs and standard costs.

Company might use normal Costing because actual costing will result in a greater fluctuation in overheads allocation, since it is based on short term costs. Howevr Normal costing results in less fluctuation, since it is based on long term expectation for overhead costs. 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.