Normal costing is used to derive the cost of a product. It includes the following components:
- Actual cost of materials
- Actual cost of labor
- A standard overhead rate that is applied using the product's actual usage of whatever allocation base is being used (such as direct labor hours or machine time)
If there is a difference between the standard overhead cost and the actual overhead cost, then you can either charge the difference to the cost of goods sold (for smaller variances) or prorate the difference between the cost of goods sold and inventory.
Normal costing is designed to yield product costs that do not contain the sudden cost spikes that can occur when you use actual overhead costs; instead, it uses a smoother long-term estimated overhead rate.
Normal costing varies from standard costing, in that standard costing uses entirely predetermined costs for all aspects of a product, while normal costing uses actual costs for the materials and labor components.