Actual Costing

Learning Objective 5 Distinguish actual costing from normal costing

• actual costing uses actual indirect-cost rates
• normal costing uses budgeted indirect-cost rates

How would the cost of Job WPP 298 change if Robinson used actual costing rather than normal costing? Both actual costing and normal costing trace direct costs to jobs in the same way because source documents identify the actual quantities and actual rates of direct materials and direct manufacturing labor for a job as the work is being done. The only difference between normal costing and actual costing is that normal costing uses budgeted indirect-cost rates calculated at the beginning of the year, whereas actual costing uses actual indirect-cost rates calculated at the end of the year. Exhibit 4-5 distinguishes actual costing from normal costing.

The following actual data for 2020 are for Robinson’s manufacturing operations:

Steps 1 and 2 are the same in both normal and actual costing: Step 1 identifies WPP 298 as the cost object; Step 2 calculates actual direct materials costs of $4,606 and actual direct manufacturing labor costs of $1,579. Recall from Step 3 that Robinson uses a single cost-allocation base, direct manufacturing labor-hours, to allocate all manufacturing overhead costs to jobs. The actual quantity of direct manufacturing labor-hours for 2020 is 27,000 hours. In Step 4, Robinson groups all actual indirect manufacturing costs of $1,215,000 into a single manufacturing overhead cost pool. In Step 5, the actual indirect-cost rate is calculated by dividing actual total indirect costs in the pool (determined in Step 4) by the actual total quantity of the cost-allocation base (determined in Step 3). Robinson calculates the actual manufacturing overhead rate in 2020 for its single manufacturing overhead cost pool as follows:

In Step 6, under an actual-costing system,

In Step 7, the cost of the job under actual costing is $10,145, calculated as follows:

The calculated manufacturing cost of the WPP 298 job is higher by $440 under actual costing than under normal costing ($10,145 vs. $9,705) because the actual indirect-cost rate is $45 per hour, whereas the budgeted indirect-cost rate is $40 per hour. That is, $(\$\mathrm{45\; }- \$40) \times \mathrm{88\; }$ actual direct manufacturing $\text{labor}‐\text{hours} = \$\mathrm{440\; }$.

As we discussed previously, the manufacturing costs of a job are available much earlier in a normal-costing system than in an actual costing system. Consequently, Robinson’s manufacturing and sales managers can evaluate the profitability and the adequacy of the pricing of the different jobs, and the efficiency with which the jobs are done, as soon as they are completed, while the experience is still fresh in everyone’s mind. Another advantage of normal costing is that it provides managers with cost information at a point when there is still time to take corrective actions, such as improving the company’s labor efficiency or reducing the company’s overhead costs.

Costs allocated using normal costing will not, in general, equal costs allocated using actual costing based on actual indirect cost rates calculated at the end of the year. For financial accounting purposes, if the differences between normal and actual costing are significant, adjustments will need to be made so that the cost of goods sold and the costs in various inventory accounts are based on actual rather than normal costing. Companies have to prepare financial statements based on what actually happened rather than on what was expected to happen at the beginning of the year. We describe these adjustments later in the chapter.

The next section describes in detail how a normal job-costing system is used within the financial accounting framework in order to achieve the costing objectives of financial accounting. Instructors and students who do not wish to explore these details can go directly to the section “Budgeted Indirect Costs and End-of-Accounting-Year Adjustments.”