Actual vs Normal vs Standard

Actual Costing – costing method wherein the cost elements (Direct Materials, Direct Labor, and Manufacturing Overhead costs) are recorded using their ACTUAL amounts. (Can’t be more obvious than that, can it?)

Normal Costing – costing method that recognizes the inconvenience of waiting for the bills to record the overhead costs. As such, only Direct Materials and Direct Labor are recorded using their actual amounts, whereas the Manufacturing Overhead is recorded using a pre-determined rate. (see lecture on Activity-based costing)

Standard Costing – costing method that uses pre-determined rates per unit costs (for each cost element). They call it standard rates. The Direct Materials, Direct Labor, and Manufacturing Overhead are recoded using standard rates.

Standard costs are computed using either IDEAL standards or NORMAL standards.

IDEAL STANDARDS – this connotes perfection. You are assuming that the production would go so well, no problems would arise, and everything is perfect. You don’t consider unexpected situations to happen and you also assume that your people don’t get tired, or that your equipment won’t need repairs. So yeah, this is not usually used. It’s simply unrealistic.

NORMAL STANDARDS – this is the norm. You accept that some problems may arise in the production. You consider the fact that your employees do get tired, and that your equipment need repairs, etc.

What are these standards for?

You choose which assumption to take in computing the production for the year.

Say, under perfect conditions (IDEAL STANDARDS) the company can produce 100,0000 units next year.

But considering all the usual cases/interruptions we experience (NORMAL STANDARDS) we can say the company can produce 85,000 units next year.

In a given problem, you have to take note of the standard they used. If nothing is stated, you go for NORMAL STANDARDS.

Still following? Cool.

Next is Standard vs Budget.

Both standard costs and budgets are usually based on historical information available, adjusted for factors that affect each cost element (like inflation, exchange rates, etc.)

STANDARD costs are PER UNIT costs, whereas BUDGETS are TOTAL costs.

In both instances, yes, we really compute for budgeted total costs. Your budget stops there.

Your standard costs are then computed through dividing your total costs (broken down into various expenses or cost elements) by the expected production at normal capacity (or ideal, whichever the company decides to use).

If you’re still confused between the two, here it is:

Simple example:

A company prepared a budget for the year as follows:

To produce 100,000 units, Direct Materials P350,000; Direct Labor P400,000; and Overhead, P250,000. The total budgeted costs is P1,000,000.

The standard costs would be as follows:

Direct materials = P350,000/100,000 = P3.50

Direct labor = P400,000/100,000 = P4.00

Overhead = P200,000/100,000 = P2.00

Much clearer now? Good.

Let’s move on. How do we use a budget or standard costs?

This is going off-topic, but just to introduce the types of budgets. We have two: (1) Static budget and (2) Flexible budget.

A static budget is just one set of costing for expected production.

A flexible budget provides for different sets of costing for the expected production, production under unfavorable conditions, and production under favorable/better conditions.

We’ll discuss this more when we get to the variances computations. (Probably in the Exercise Problems)

And so, let’s start with the variances.

Hit Complete and see next section. :)