As we indicated, because it’s hard to calculate accurate actual indirect-cost rates on a weekly or monthly basis, managers cannot calculate the actual costs of jobs as they are completed. Nonetheless, managers have a need for a close approximation of the costs of various jobs as they are being completed during the year, not just at the end of the fiscal year. Managers want to know a job’s timely manufacturing costs (and other costs, such as marketing costs) to price jobs, monitor and manage costs, evaluate the success of jobs, learn about what did and did not work, bid on new jobs, and prepare interim financial statements. In order to facilitate immediate job cost approximations, a predetermined or budgeted indirect-cost rate is calculated for each cost pool at the beginning of a fiscal year and used to allocate overhead costs to jobs as they are being completed. For the numerator and denominator reasons described above, the budgeted indirect-cost rate for each cost pool is computed as
Using budgeted indirect-cost rates gives rise to normal costing.
Normal costing is a costing system that (1) traces direct costs to a cost object by using the actual direct-cost rates times the actual quantities of the direct-cost inputs and (2) allocates indirect costs based on the budgeted indirect-cost rates times the actual quantities of the cost-allocation bases.