Actual costing is the recording of product costs based on the following factors:
- Actual cost of materials
- Actual cost of labor
- Actual overhead costs incurred, allocated using the actual quantity of the allocation base experienced during the reporting period
Thus, the key point in an actual costing system is that it only uses actual costs incurred and allocation bases experienced; it does not incorporate any budgeted amounts or standards. This is the simplest costing method available, requiring no pre-planning of standard costs. However, it can take longer to formulate a valuation for ending inventory and the cost of goods sold, since all actual costs must be compiled and allocated.
A similar costing system is normal costing, where the key difference is the use of a budgeted amount of overhead. Actual costing will result in a greater fluctuation in overhead allocations, since it is based on short-term costs that can unexpectedly spike or dip in size. Normal costing results in less fluctuation in overhead allocations, since it is based on long-term expectations for overhead costs.
A company having relatively stable production volumes from month to month will have few problems with actual costing. However, one that experiences continual variation in its production volumes, and especially one that regularly faces questions from its investors may be better off using normal costing, since that method offers greater stability in reported costs.