Written by True Tamplin, BSc, CEPF®
Updated on September 17, 2021
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.
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.
The actual costing system is also referred to as an allocation costing system. It is not a product cost computer software program like the standard and normal costing systems.
A normal or absorption-costing system does not allocate manufacturing overhead costs; rather, these costs are added to the cost of goods sold as incurred. As a result, during periods in which manufacturing overhead costs exceed production volume, there is an accumulation of manufacturing overhead in the work-in-process and finished goods inventory accounts.
Under normal costing, only variable production costs - direct material and direct labor - are included in the cost of goods sold. The fixed manufacturing overhead costs assigned to production units remain as inventory until they are absorbed into unit product costs. If overheads exceed production, then rather than raising finished-goods inventories, a company will incur losses on its work-in-process (wip) inventories and product costs.
In actual costing, total manufacturing cost for a period is divided into two parts: variable cost and fixed cost. Variable costs are direct material, direct labor, and factory overhead allocated to production during a given time period. Fixed costs include Depreciation of the existing Fixed Assets, fixed costs that are not identified with any specific department or time period, and other fixed costs.
Absorption costing is the process of including all manufacturing overhead cost in factory overhead at the end of a given accounting period. The under- or overapplied overhead will be transferred to inventory accounts.
True Tamplin is a published author, public speaker, CEO of UpDigital, and founder of Finance Strategists.
True is a Certified Educator in Personal Finance (CEPF®), a member of the Society for Advancing Business Editing and Writing, contributes to his financial education site, Finance Strategists, and has spoken to various financial communities such as the CFA Institute, as well as university students like his Alma mater, Biola University, where he received a bachelor of science in business and data analytics.
To learn more about True, visit his personal website, view his author profile on Amazon, his interview on CBS, or check out his speaker profile on the CFA Institute website.