Definition: Normal costing is cost allocation method that assigns costs to products based on the materials, labor, and overhead used to produce them. In other words, it’s a way to find the price of an item that is being produced using three different cost factors (which make up the product cost).
What Does Normal Costing Mean?
What is the definition of normal costing? The product costs that make up normal costing are actual materials, actual direct costs and manufacturing overhead. The materials and direct costs are the true costs that are associated with producing the item such as raw materials (the materials that make up the product) and labor.
In this costing appraoch, manufacturing overhead is an estimated rate decided by management or accountants. Manufacturing overhead includes the expenses that are related to producing the item but cannot directly be applied to the items. Examples of manufacturing overhead include facility rent or mortgage, electricity in the facility and depreciation on the machines that are used to produce the items.
Let’s look at an example.
Terry is the CEO of a furniture manufacturing company. Terry needs to find the normal cost of one of their most popular item, a coffee table. In the last production, the company produced 10,000 coffee tables. The actual materials used totaled to be $50.00 per table and direct costs were $20.00 per table. The manufacturing overhead determined per table is $10.00. So Terry determines it costs the company $80.00 to produce one coffee table.
Terry can use this information in many different ways. One, is to value his inventory. Any company that has inventory has to assess its value for accounting purposes. This costing method is a popular way of valuating inventory because it associates 2 actual costs (materials and direct costs) and only one estimated rate to the product. Terry can also use the normal cost per unit to determine a markup for sales. If Terry makes each coffee table for $80.00 and wants to markup all items at a 100% rate, he would sell the coffee table for $160.00.
Define Normal Costing: Normal costing means a way to determine to cost of a manufactured item using the product costs.