Posted in Finance, Accounting and Economics Terms, Total Reads: 304
Definition: Actual Cost System
Actual cost system is a costing methodology where the actual costs incurred are used to arrive on the total cost of the production or the cost of the final product. The cost considered being the actual cost of the raw materials, labour costs, and overhead expenses for the period or by splitting it on the basis of units produced or man hours spent. It is one of the simplest costing methods to be used by companies since it works on the actual cost basis and does not require any pre planning or take into account any pre-defined standards or budgetary allocations.
The actual cost system can result in greater fluctuations since it works on a short term basis of allocation of overhead or indirect costs which can result in huge cost variation.
This method is effective for a production plant with relatively stable month on month production volumes since allocating indirect costs will be an easier task. On the other hand, in a plant with varying volumes since this method results in greater fluctuations.
For Example: For a plant manufacturing pencils, we will take into account the actual material used to makes pencils for a production run. Then we will take into account the man hours consumes and take that cost into account. Then we will consider the overhead cost of that particular production run. Summation of all this will give us the actual cost of that production run. We will have to divide the actual cost by the number of units produced in that production run to give us actual cost per unit.