Actual Costing

Updated on April 16, 2024
Article byJyotsna Suthar
Reviewed byDheeraj Vaidya, CFA, FRM

Actual Costing Meaning

Actual costing in cost accounting refers to the preparation of the cost structure of products by taking into account the actual costs of the goods and services used in production. Its main purpose is to consider the real-time expenses of materials, labor, and overheads spent in production.

Actual Costing Meaning

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This costing method depicts the true picture of the production team. Plus, it provides an accuracy of the cost sheet elements. In addition, it aids in the decision-making process. Also, it helps in identifying areas that need cost control. However, the process can be lengthy and hectic compared to other methods.

Key Takeaways

  • Actual costing is a cost accounting method that allows manufacturing units to use the actual costs of cost elements and calculate the total cost incurred. 
  • Further, they can attribute the total cost to each unit produced. Here, cost elements include direct materials, labor, and manufacturing overhead. 
  • In the 18th century, economist Adam Smith propagated the importance of natural or actual prices in making price and business decisions. 
  • Lastly, firms would use the method to compare with the standard cost (estimated costs) to find any differences.

Actual Costing Explained

Actual costing is a method of recording and calculating the cost sheet balance by including the real-time prices of goods and services. Here, there are no budgeted or estimated costs used. As a result, there is proper allocation and transparency. This costing method prevails more in production firms. For example, a firm producing clothes will adopt this method rather than standard costing.

Although the origin of this method is hard to trace, the first usage of actual costs travels to the 18th century. The Scottish economist Adam Smith, in the book “Wealth of Nations,” emphasized the importance of natural prices (actual costs). Smith further argued how these costs help in decision-making and price-making during production. As a result, the firms can determine the break-even point where revenue crosses costs. Later, in the 1840s, French economist Jules Dupuit explained the importance of actual costs in marginal cost pricing. Thus, by the end of the century, this cost became a prime aspect of production.

Certain costs are a part of this costing system. It includes direct and indirect, variable, fixed, and sunk costs. Other factors influencing it are production volume, efficiency, labor costs, overhead costs, and external factors. For example, if the volume produced is 20% higher than the previous year, the actual costs will also rise.

The firms must follow certain steps to determine and implement the actual cost. Let us look at them:

  • Identifying the different processes involved in production.
  • Next, calculating the actual cost incurred in producing the goods. It includes costs of raw materials, labor, rent, freight, handling charges, and others. The firms must use the real-time prices listed in the invoices or bills.
  • Assigning the actual costs to the products.
  • Developing the cost sheet and calculating the total cost.
  • Lastly, comparing with the budgeted cost structure to find deviation.

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Formula

Let us look at the formula for a better understanding of the concept:

Actual cost = Direct Materials Cost + Direct Labor Cost + Manufacturing Overhead Cost

Where,

Examples

Let us look at some examples to comprehend the concept better:

Example #1 

Actual costing in System Analysis Program Development (SAP) is very popular in the modern corporate world. Businesses use this software application to calculate the total cost using actual expenses. It helps in determining the cost of semi-finished and finished products. Firms calculate the periodic price per unit (or actual price) of direct materials, labor, and overheads. Here, the material data ledger forms a base for actual costing in SAP.

Example #2

Suppose a manufacturing unit has the incurred or actual cost of the following cost elements:

Direct Materials = $25,000

Direct Labor =$35,000

Overhead Costs (includes rent, freight, and depreciation charges) = $4500

Total Actual cost = Direct Materials Cost + Direct Labor Cost + Manufacturing Overhead Cost

= $25000 + $35000 + $4500

= $64,500

Here, the total actual cost for the firm is $64,500. However, if one attributes to each product (1000 units), the actual cost per unit is $64.5.

Advantages And Disadvantages

Let us look at the advantages and disadvantages of this accounting method:

AdvantagesDisadvantages
It provides accuracy and a true picture of the production firm. It is time-consuming compared to other costing procedures.
It serves as a realistic tool in the decision making process.Sometimes, it might be difficult to attribute an actual cost to the product.
Helps in identifying places that are cost-effective.Frequent fluctuations in costs can cause a diversion in the actual cost.
Plus, it aids in creating an optimum budget with cost control. 
Firms can use this actual price as the standard price for future calculations.
It helps in determining the periodic unit price of goods. 

Actual Costing vs Standard Costing

Although actual and standard costing are closely related, they have quite differences. So let us look at them:

BasisActual CostingStandard Costing
Meaning It refers to a costing method using the actual costs and values of materials, labor, and overheads. Standard costing uses the estimated values of the direct costs to determine the total cost. 
Purpose Consider the real-time prices of cost elements and their diversion from estimated costs. To provide the management with the estimated costs to plan the budget for the year. 
Accounting Treatment It is shown as expense (Direct Materials, Direct Labor, and Manufacturing Overheads). It is only used for estimation. Thus, it is not visible in the financial statements. 
Recorded It is recorded at the end of the financial year. Standard costing is used at the start of the year. As a result, a budget for the same is prepared.  
Deviations If the actual costs exceed standard costs, the inventory valuation changes. Here, it does not change, but inventory valuation is shown as a variance. 
Formula Direct Materials Cost + Direct Labor Cost + Manufacturing Overhead CostDirect Materials Cost + Direct Labor Cost + Variable Overhead + Fixed Overhead 

Actual Costing vs Normal Costing

Although both are involved in the production, they have distinct features. Therefore, let us look at the differences between actual costing and normal costing:

BasisActual Costing Normal Costing
Meaning It refers to a method of considering actual values rather than estimated values. Normal costing uses predetermined or projected overhead costs to determine the total cost. 
ObjectiveTo detect any diversion from the standard costs. To compare the production expense with the revenue earned. 
Cost elementsIt includes only direct materials, direct labor, and manufacturing overhead.Here, normal costing involves both indirect and direct costs. 
Accuracy Higher Lower (as estimated values are involved). 
Time It is time consuming. There is less time needed for calculation. 

Frequently Asked Questions (FAQs)

1. How to run actual costing in SAP?

Following are the steps to run or use the actual costing method in the SAP application. Let us look at them:
– Activate the Actual costing in the Controlling module of the SAP.
– Define and determine the cost variants for the product or process needed.
– Now, run the costing model, and it will calculate the data for each cost element.
– Lastly, analyze the results and compare them with the standard costs set.

2. Why do we use actual costing?

The importance of this costing is visible in the production units of businesses. They use actual costs to detect any periodic variances. Also, it determines if the actual expenses are crossing the budgeted or estimated price range. Firms can set up a cost-control center to tackle it if it happens.

3. What is the actual cost of SAP HANA?

SAP HANA is a cloud-based database that stores the data performed during analytics in its memory. It is an application that works similarly to SAP (System Analysis Program Development). Here, it considers the real-time prices of cost elements and calculates the total actual cost.

This article has been a guide to Actual Costing & Meaning. We compare it with normal and standard costing, explain its formula, examples, advantages & disadvantages. You may also find some useful articles here –

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