What Is Extended Normal Costing?
Extended normal costing is a business budgeting method that is used to estimate and track production costs over the course of a year.
Budgeted costs of production are predetermined by the business' management, usually at the beginning of the year. When extended normal costing is used, the budgeted costs rather than the actual costs of production are input as they are incurred.
- Normal costing records actual expenditures as they occur in the course of production.
- Extended normal costing records a pre-determined figure for overhead costs.
- Extended normal costing is useful in a business that experiences constant fluctuations in overhead costs.
Specifically, the budgeted cost of production is multiplied by the actual quantity of the products or services that were purchased for use in production.
Understanding Extended Normal Costing
Actual costing uses the real expenditures that were incurred in the production of a product or service. Extended normal costing uses the actual costs of direct materials and direct labor but relies on a budgeted figure for overhead costs.
That is, extended normal costing figures are predetermined and do not need to be calculated to develop a total cost estimate.
The extended normal costing method allows a business to ignore predictable fluctuations in overhead costs.
The disadvantage of extended normal costing is that the cost figures may be inaccurate since they are determined in advance of actual production and real costs may change over time. However, in cases where it is very difficult to track all the costs going into a product, extended normal costing may be the most effective way to assign production costs.
Extended normal costing is commonly used in industries where input costs are difficult to determine, such as the service sector. These are sectors that typically have variable overhead costs. Such costs may include indirect materials prices, indirect labor costs, utilities, and depreciation expenses.
Example of Extended Normal Costing
At the beginning of the year, the management team of Charming Chairs, a furniture manufacturer, must estimate the cost of producing a single Charming Chairs chair.
They decide to budget costs of $100 for direct labor, $40 for direct materials, and $10 in overhead per chair produced. Thus, the extended normal cost of producing one chair is:
$150 = ($100 + $40 + $10)
During the course of the year, actual costs will fluctuate. For example, overhead costs at the factory will increase in winter. The price of some materials may be less or more than budgeted over the course of the year.
Nevertheless, if their extended normal costing method is based on realistic numbers, the average production cost over the year as a whole will work out to about $150.
If the difference between budgeted costs and actual costs proves to be significant, the business may be forced to reevaluate its pricing. For example, if production costs greatly exceeded estimates, it may have to increase its price per chair on its current inventory in order to make up the shortfall.