Question

John Carter also prepared the quarterly and annual 2017 income statements based on normal costing and based on standard costing. Write a memo to management describing how these two costing systems differ. Discuss which of the two approaches would be more helpful in controlling operations during the year.

Answer 1

Normal costing is used to value manufactured products with the actual materials costs, the actual direct labor costs, and manufacturing overhead based on a predetermined manufacturing overhead rate. These three costs are referred to as product costs and are used for the cost of goods sold and for inventory valuation. If there is a difference between 1) the overhead costs assigned or applied to products, and 2) the overhead costs actually incurred, the difference is referred to as a variance. If the amount of the variance is not significant, it will usually be assigned to the cost of goods sold. If the variance is significant, it should be prorated to the cost of goods sold and to the work in process and finished goods inventories.

Standard costing values its manufactured products with a predetermined materials cost, a predetermined direct labor cost, and a predetermined manufacturing overhead cost. These standard costs will be used for valuing the manufacturer's cost of goods sold and inventories. If the actual costs vary only slightly from the standard costs, the resulting variances will be assigned to the cost of goods sold. If the variances are significant, they should be prorated to the cost of goods sold and to the inventories.