Normal cost, also known as standard cost, is a management accounting term relating to the estimated or predetermined cost of producing a good or service. Many companies use normal cost figures in their management accounting processes. This figure typically represents how much a company would pay to produce goods or services under normal operating conditions. Companies can also use this figure as part of their budgeting or performance analysis functions.
Manufacturing and production companies are the primary users of cost accounting. Cost accounting is the specific management accounting function, meaning that companies allocate business costs to goods and services. The normal cost is usually made up of three particular items: raw materials, labor and manufacturing overhead. Raw materials are the economic resources companies use to manufacture consumer goods. Labor represents the individuals who transform raw materials into consumer goods. Manufacturing overhead includes a variety of costs directly attributable to goods or services. Equipment depreciation, building rent, utilities to run manufacturing facilities and wages for production supervisor are a few examples of manufacturing overhead.
The normal cost is often the goal or objective manufacturing and production companies wish to achieve when producing goods or services. This figure is usually compiled from extensive historical data relating to a company’s production process. Management accounting usually keeps copious records relating to how much companies spend when producing goods or services. Business owners can use this information to discover trends in their company’s production facilities. The development of a normal cost can also help companies create a production variance analysis. This helps business owners determine why the company spent more or less money when producing goods or services under current economic conditions.
Manufacturing and production companies rarely achieve their normal cost goals. Several different factors may cause these companies to miss their production cost goals. High cost economic resources, decreases in production output and supply of labor can create difficult cost management situations. Business owners and managers often conduct an in-depth analysis to determine which specific factors had the most impact on the company’s production process.
Companies can also create production budgets based on their production process’ normal cost. These budgets form a financial road map business owners and managers use to estimate future financial expenditures. Management accountants can also maintain several years’ worth of production budgets to form a trend analysis for budgeting purposes. This allows owners to refine and assess their production budget process and create the most efficient production operations for their company.