ACC200-Importance Of Accurate Product Costing

1.Accurate product costing

Estimating the cost accurately as it helps is making right commitment for business in terms of dollar. The process of costing the product accurately requires experience, judgement, decision making and research. However, none of these approaches alone will lead to best cost estimation. Putting together all these approaches the analysts and managers practice the combined procedure for estimating the costs with certain level of accuracy. This in turn, can be used for making the financial decisions that will have an impact on the direction of the entity heading towards future (Drury 2013). Accurate product costing is important for the below mentioned reasons –

• Accuracy is crucial – better accuracy for the cost estimate leads to better decision making and planning in estimating and predicting the future changes. Further, it is more crucial when the business decisions are required to be made on guesses and the bad decisions have serious impact on profit or loss of the entity. Good estimation of cost keeps the operating margin at acceptable level which in turn helps to avid the unnecessary expenditures.
• Issues associated with inaccuracy – wrong estimation or bad estimation hamper the business in 2 ways. Underestimation of the expenses related to any project may lead to the situation of financial emergency in the midway of the project that may put the completion at risk. Further, insufficient support from the labours or insufficient resources may shut down the project or can make it more expensive or may take considerable time in completion (Fullerton, Kennedy and Widener 2014).
• Keeping on the schedule – accuracy in cost estimation forces the business project to complete on time, particularly the client projects once it gets confirmed. Business requires staying within the budget if it does not lose any money. This will have ripple impact on all the activities to complete the project below or within the budget amount to meet all the goals of the client including the delivery and schedule.
• Good decision-making – god business decisions can be formed when the data on which the decisions are based are accurate. Importance of the accurate cost estimation is crucial when the decisions can change the results. Further, investments of the funds in cost-cutting projects or new projects depend on the correct cost estimation. Thereafter the assumptions are build into contracts, commitments, procurements, budgets and the accounting accruals. Hence, if the data are wrong, further changes in emergency will have to be made at last second of compensation. Avoidance of likewise situation requires accurate estimation at 1^st time (Gertler and Karadi 2015). 

On the other hand, there are various issues associated with the traditional approach of costing used by Beztec are as follows –

• Under the traditional costing approach it is assumed that the overhead costs are associated with the production volume. In fact, in many years ago this approach was valid when the production system were machine intensive or labour intensive and mass production were to take place for the common standard items. As generally the direct cost is high and indirect costs are low, any accuracy in charging of the overhead costs over the products is not significant (Dong, Liu and Lin 2014). However, in modern production system the traditional method of costing is not appropriate due to the complexities involved in the production system. The reason behind this is that the good are generally produced in small batches that lead to high level of overhead expenses. Thus, the traditional costing is not appropriate in modern system of costing.
• Overhead recovery rate like the machine hour rate, labour hour rate are used to absorb the overhead or indirect cost. It can be used for valuation of the closing stock and and making reports for the management. However, it is not useful for taking any crucial decisions that will have the impact on the company’s long-term objectives (Hilton and Platt 2013).
• Traditional approach wants the costs to be segregated into variable costs and fixed cost that is not actually realistic. Further, segregation of cost into fixed and variable will result into inaccurate costing of the product if the business makes improvements.

2.Computation of cost driver rate as per activity based costing

It is identified from the above computation that the total cost driver rate for Lexon model will be $ 39,10,620 and activity cost driver per unit is $ 162.94. On the other hand, total cost driver rate for Protox model will be $ 20,29,380 and activity cost driver per unit is $ 338.23. 

3.Cost for each model as per activity based costing

Looking into the above table it can be found out that the cost of Lexon model as per ABC model is $ 861.44 per unit and cost of Protox model is $ 1,374.98 per unit.

4.Profitability analysis through computation of gross profit

Looking into the above table it can be identified that the gross profit per unit for Lexon is $ 420.06 and gross profit margin is 42.43%. On the other hand, gross profit per unit for Protox is $ 420.06 and gross profit margin is only 11.80%.

5.Beztec Limited is engaged in producing 2 printer models named as Protox and Lexon. However, the Lexon model is produced by the company since 2014 whereas the Protox model is newer and introduced in 2016. The selling price for Lexon is $ 990 and for Protox is $ 1,254. From the presented income statement of the company is is identified that the operating income per unit for Lexon is $ 71.50 and for Protox is $ 107.25. Based on the result the company is thinking of concentrating more on the Protox model and discontinuing production of Lexon model (Kumar and Reinartz 2018). However, after computing the overhead cost as per ABC approach the management accountant of the company is advocating using the ABC approach as it will give better computation and allocation of overhead. Further, the ABC approach as can be seen from the above calculation is indicating that if gross margin for Lexon model is significantly high as compared to Protox model. Therefore, it can challenge the management’s decisions regarding concentrating more on the Protox model and discontinuing production of Lexon model. However, the CEO of the company Steven Key is feared that if the headquarter sees the analysis they may decide to phase out Protox instead of Lexon (Ren et al. 2016). This entire costing stuff will be a major issue for the company as per the traditional costing Lexon model was not profitable and now as per ABC approach Protox model is not profitable. 

If based on the suggestion of Kay, the CEO costs of production for Protox and Lexon are altered by Smith, it will lead to violation of the integrity principle under APES 110 regarding code of ethics. As per the requirement of APES 110, integrity principle requires the member to be straightforward and honest while performing his activities (Apesb.org.au 2018). Further, it requires that the member shall not involve himself in any kind of activities that include misstatement, fraud or error. Further, the member shall not be involved in the information that –

• Includes the information or any statement that are presented irresponsibly
• Involve materially misstated or misleading statements
• Omit the information that is required to be included as the omission will make the statement misleading (Simkin, Norman and Rose 2014).

6.Overheads are the indirect cost carried out for business operation including the utility expenses and supply expenses. As the overhead expenses cannot be traced directly, for some of the departments it requires to be pre-determined. Overhead can be allocated by any reasonable approach but is shall be applied consistently over the reporting period. Common approach of overhead allocation is using the direct labour hours or the machine hours used for the production of the product (Weygandt, Kimmel and Kieso 2015). Under allocation is the instance where the planned output is not achieved due to insufficient allocation for covering up the reasonable wastes. On the contrary, over allocation is the instance where unnecessary inputs are allocated as wastage will be at lower level. Though the company may use the predetermined rates there may be variance in the actual overhead and projected predetermined overheads. Actual costs have its impact on the short term changes. For instance, while providing any service or selling any goods to any customer it is required to raise the bill immediately. However, at the time of completing the production it may found that the rates are not same as determined. If the actual cost is less as compared to the projection it will result into over allocation of overhead (Warren, Reeve and Duchac 2013). On the other hand, when the actual cost is more as compared to the projection it will result into under allocation of overhead. 

Disposition of the over allocated or under allocated overheads are depended upon the significance of amount involved. If the involved amount is immaterial the amount is closed under COGS.  On the contrary, when the amount involved is high the amount shall be assigned to the accounts that includes the applied overhead like finished goods inventory, WIP inventory and COGS. Significant amount indicates that balance in the associated accounts vary from the projection. Allocation restates account balance for confirming the actual cost more closely as required by GAAP. Practically, over applied or under applied overhead shall be assigned on the basis of applied overhead that is included under each account and not on the total balance of accounts. 3 ways of disposing the over or under application of overhead are as follows –

1. Transfer the total amount to COGS – under this method total amount is transferred to COGS. The journal entry passed for accounting the transfer is –

COGS A/c Dr XXX

Finished goods Dr XXX

Manufacturing overhead XXX

2. Allocating the total amount to finished goods, COGS and WIP – as per this method the amount is assigned to finished goods, COGS and WIP. The journal entry passed for accounting the transfer is –

WIP A/c Dr XXX

COGS A/c Dr XXX

Finished goods Dr XXX

Manufacturing overhead XXX

3. Making the adjustments with the allocation rate – 3^rdmethods used for allocating the amount of under application or over application of overhead amount is adjusting the amount based on the allocation rate (Chikoto and Neely 2014). The amount of under application or over application of overhead is re-allocated to the jobs after completion.

All the above mentioned all the 3 methods are considered as theoretically. The method used for disposing the amount of under application or over application of overhead is dependent upon which one will be most appropriate for the entity taking into consideration the amount involved. 

Apesb.org.au. 2018. [online] Available at: https://www.apesb.org.au/uploads/standards/apesb_standards/standard1.pdf [Accessed 9 Sep. 2018].

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