What is Actual Cost?
Definition: Actual cost is an accounting term that means the amount of money that was paid to acquire a product or asset. It’s exactly what it sounds like — the actual cost. This cost could be either a historical, past, or present day cost of product. You might be thinking to yourself what other costs are there besides the actual cost of an item.
Actual cost is the actual expenditure made to acquire an asset, which includes the supplier-invoiced expense, plus the costs to deliver, set up, and test the asset. This is the cost of an asset when it is initially recorded in the financial statements as a fixed asset.
The actual cost approach is different from the use of estimates to derive costs that may occur in the future. The two approaches are commonly blended together, so that budgeted costs derived in advance are compared to actual costs to create a variance. The variance can be used to control operations and/or to work on improving the accuracy of predictions.
The actual cost of a project represents the true total and final costs accrued during the process of completing all work during the pre-determined period of time allocated for all schedule activities as well as for all work breakdown structured components. Actual costs are primarily made up of a number of specific items including, but not limited to, cost in direct labor hours, direct costs alone, and also all costs including indirect costs. Actual costs, when possible, should be thoroughly itemized in detail throughout the project as opposed to merely compiled at the end as it is easier to accurately itemize costs when it is done as the expenditures occur. The term actual cost can also be referred to as actual costs of work performed. For more information on the term actual cost, see the definitions for earned value management as well as the definition for earned value technique.
What Does Actual Cost Mean?
Well keep in mind in managerial accounting, you also have budgeted and forecasted costs. Neither of these costs reflects reality or actual costs most of the time. Management might set a budget to buy a new piece of equipment, but this budget does not always happen. Sometimes companies can get discounts from vendors and other times product prices increase.
Costing accounting that uses actual cost, direct-cost rates and actual qualities used in production to determine the cost of specific products is called Actual Costing.
With actual costing system, usually direct costs to a cost object or something that has a measurable cost is traced. This allows managers to go back to the source of the costs (cost objects) like labor and materials. Through analyzing how many hours of manufacturing time a product requires, managers can calculate the actual costs of producing that product.
Actual cost also applies to manufacturing products as well. The actual cost of manufacturing a product is the total expenditures required to build or manufacture the product. Think of actual cost as the end result of a manufacturing process.
First, a company starts planning the production and forecasts what the expenses will be. Second, the company budgets what it will be able to afford and adjusted to the production levels to meet the budget. If everything goes according to plan, the actual costs will equal the budgeted costs. In the real world, things can go wrong and budgets are not always met. The end result is the actual cost. It could be plus or minus the budgeted or forecasted cost.
What Is the Actual Cost Formula?
Actual cost can be calculated with the following formula:
Actual Cost = Direct Costs + Indirect Costs + Fixed Costs + Variable Costs + Sunken Costs
As you can see above, the actual cost formula factors in several types of project costs:
- Direct Costs: Obvious costs directly related to your projects like fixed costs and variable costs.
- Indirect Costs: Additional cost that supports your project but is not easily measured like administrative services.
- Fixed Costs: Costs that remain consistently the same throughout the project, such as cost to rent equipment.
- Variable Costs: Changing costs during the course of the project. An example the hours of anticipated labor for a project might be greater than the actual time it took for labor to be complete.
- Sunken Costs: These are costs that have incurred due to an error or change of scope that must be included in the total cost of the project.
Actual Cost, Manufacturing, and Planning Expenses
Actual cost doesn’t only apply to purchasing assets. It can also be used for the cost of manufacturing assets.
When you’re planning to manufacture a product, you won’t know the actual cost until the product has been created. This is because the actual cost of manufacturing reflects all the expenditures needed to create the product, including the cost of raw materials and the price of the manufacturing machinery. There are several steps you will need to complete when you’re planning the expense of manufacturing a product. First, you will need to develop a production plan and calculate an estimate of your expenses.
Next, you will need to examine these projected expenses to determine if they will fit into your company’s budget. If not, you will need to adjust your production plan to lower your expenses so that they match the budget.
Hopefully, the actual costs of manufacturing will fit into your company’s budget. Unfortunately, this is rarely the case, and it can be hard to meet your projected budget. The total you have paid to manufacture your product is the actual cost, and this cost may either be higher or lower than your forecasted or budgeted cost.
What Is a Cost Variance?
Cost variance is the difference between the actual cost and the budgeted or planned costs.
For example, if a company had repairs done for $1150 but the budget amount was $800, the company had a cost variance of $350.
Since the actual cost is more than the budgeted amount, the cost variance is considered to be unfavorable. When the actual cost is less than the budgeted cost, the variance is considered favorable.