Actual cost implies the total amount spent in acquiring an asset. This includes several important 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 process of production is analyzed to determine the production costs at each phase.
Calculation of actual cost
The formula for calculating actual cost is as follows
Actual Cost = Direct Costs + Indirect Costs + Fixed Costs + Variable Costs + Sunken Costs
If you are manufacturing products, the actual cost will be calculated 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
Cost variance is the difference between planned or estimated costs and actual costs
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.
Here the actual cost is more than the estimated cost. Hence the cost variance is considered as an unfavorable variance.
Benefits of actual costing
- Helps to calculate fixed costs for different stages of production.
- It is widely used in manufacturing sectors where more number of raw materials are utilized. It also enhances the inventory system and makes procurement easy.
- It assists in taking several outsourcing decisions and also helps in setting up the right prices for the products.
- It helps in streamlining procurement as it depicts the cost of all alternative sources of supply and helps in choosing the most feasible option.
Actual cost uses realistic numbers to ascertain the prices and helps decision making an easy task. Though the disadvantage lies in the fact that the overhead expenses can never be exact.
Even the labor charges are a varying factor which makes it challenging to use this technique in comparison to normal costing. Also, this is useful in industries where the raw materials and other related factors are consistent with very fewer changes. It is ideal for standardized products. Also, the process is time-consuming with a need for several technical skills.
Get more definitions about Actual cost and other ERP related terms here.