The actual cost implies the total amount spent in acquiring an asset. That includes several essential factors such as labor costs, delivery charges, and any such direct expenses.
Actual costing contains the actual cost of products and overhead charges to estimate the cost of production.
This method is highly recommended when each production process is analyzed to determine the production costs at each phase.
Actual cost formula
The formula for calculating actual cost is as follows
Actual Cost = Direct Costs + Indirect Costs + Fixed Costs + Variable Costs + Sunken Costs
Below is the meaning of factors used in the formula.
- Direct costs: This is the precise cost that is directly related to your processes, such as fixed costs and variable costs
- Indirect costs: These costs are additional or extra costs to support your process, like administrative charges
- Fixed costs: This is the cost that remains constant throughout the process, like rent of the building or rent of an equipment
- Variable costs: This is the cost that varies during the process. For example, labor charge.
- Sunken costs: This is the cost that occurs due to the error during the process
If you are manufacturing products, the calculation of actual cost is as follows.
- Number of units of material used X Per unit cost = Actual material cost
- Labor hours used in production X Wage paid per hour = Actual labor cost
- Addition of all overhead expenses (electricity, rent, insurance ) = Actual overhead cost
- (A+B+C) / Number of units produced = Actual production cost per unit
Actual cost example
For example, a manufacturing company estimated $1500 for product repair. But the actual cost was $2000. So the company had a cost variance of $500.
Cost variance is the difference between planned or estimated costs and actual costs.
Here the actual cost is more than the estimated cost. Hence the cost variance is considered as an unfavorable variance.
- Helps to calculate fixed costs for different stages of production.
- It is widely used in manufacturing sectors where more raw materials are utilized. It also enhances the inventory system and makes procurement easy.
- It assists in making several outsourcing decisions and also helps in setting up the correct prices for the products.
- It helps streamline procurement as it depicts the cost of all alternative sources of supply and helps choose the most feasible option.
Actual cost uses realistic numbers to ascertain the prices and helps decision-making an easy task. However, the disadvantage lies in the fact that the overhead expenses can never be exact.
Even the labor charges are a varying factor, making it challenging to use this technique compared to normal costing.
Also, this is useful in industries where the raw materials and other related factors are consistent with significantly fewer changes. It is ideal for standardized products.
Also, the process is time-consuming, with a need for several technical skills.
Normal costs or regular costs
Normal costs are the cost that is pre-planned. That means you calculate the cost of the product before production based on the previous data.
What are the differences between Actual costing(AC) and Normal costing (NC)?
- In normal costing, the cost is calculated before the production process, and in actual costing, the cost is calculated after the production process.
- NC includes direct costs and indirect costs, AC consists of costs of the production process in real-time. That means AC includes the costs like any variations in labor charge and raw material price.
- In NC, costs update once in a while, but in AC, costs of the product updates for each batch after calculating the actual expenses.
- NC assumes the cost of the production, But AC takes the actual expenses of each batch.
What is the total fixed cost?
Total fixed cost is the sum of all non-variable costs of a company like rent of office area per month, rent of machines per month, utility costs, etc.
Get more definitions about Actual cost and other ERP-related terms here.