Management Accounting And Product Costing System Essay.

Discuss about the Management Accounting, The product casting system is a comprehensive system whereby all the expenses and revenues are recorded under their respective heads. These heads are then classified according to the nature of expenses.

Advantages of Product Costing Systems

In the given scenario we see that Frank the owner of New Age Caravan, is not a huge accounting fan. He considers pricing of the product as only competition and does so by pricing his goods at the level of what his competitors price them.He thinks that accounting is nothing but addition of revenues and deduction of expenses. That too it is necessary just to determine his profits. Frank is aware of the huge advantages of costing system and needs somebody to make him realise that product costing is not as simple as he thinks it to be. (Atkinson, 2012)

In order to convince Frank to appoint an accountant, he should first be made aware of what a product costing system is, types of product costing systems, there advantage and uses, etc. (Blocher, n.d.)

The product casting system is a comprehensive system whereby all the expenses and revenues are recorded under their respective heads. These heads are then classified according to the nature of expenses, if they belong to factory, office or sales department. These are then arranged in a specified format. This helps the people understand the expenses and revenues generated by different departments. It also helps to calculate the profit and helps in valuation of closing stock of finished goods and work in progress. The cost sheet helps to analyse the relevant expenses of the product and thus helps the management in product costing (Boyd, 2013). This will also help him understand the effect of scale of production on costing and help him decide what the most appropriate quantity that should be produced is. Frank needs to understand and analyse his product expenses and add a certain percentage of profit to it in order to price his product correctly. Just pricing the product as same as that of the competitor is not correct.

Also, there are basically two types of costing systems. The one which is most suitable to the business should be adopted for:

• Job order costing: this type of costing system is mostly suitable for organisations which are engage in manufacture of special or unique products. Under this system of costing, all the cots which are related to a particular item or a job is grouped together in order to determine its profitability (Bragg, 2016).
• Process Costing: this is the type of costing under which costs incurred are segregated as per the functions and processes.  This system helps analyse the cash flows from different functions and departments and helps in cutting unnecessary costs. A manufacturing business which specialises in only one king of product uses this type of costing system.

Sometimes when an organisation uses both the kinds of costing systems then it is termed as hybrid costing system. (Brigham and Ehrhardt, n.d.)

Now after the choice of costing system, Frank would be required to choose a cost allocation system. The basic cost allocation systems are:

• Traditional costing: under this system of cost allocation, the management makes a budget overhead expense and divided it on per unit basis of budgeted production. This overhead rate is then applied when the production is done. The amount is recovered is more than actual expense is termed as over recovery, if lower than actual expense is termed as under recovery. (Clifton, 2014)
• Activity Based Costing (ABC):  under this type o cost allocation system costs are allocation amongst various activities as per there actual consumption of the activity. For example, if the production department uses 50 hours of supervisors work then, the cost of 50 hours will only be allocated to production department. This system helps in ascertain the actual and exact amount of expense incurred and services used by departments. (Cokins, 2009)

Therefore, we that product costing is not as easy it seems, but ones it is applied it makes the whole lot of work easier. It uses information, which helps in betterment of the organisation and efficiency of the production. It helps in cost saving and revenue generation. It helps in decision making process along with project development and management.

1. The following statement represents the calculations for cost of goods manufactured and cost of goods sold:

The cost of goods manufactures includes all expenses incurred in connection with the manufacture in the factory. This is in relation to the goods for a certain period. In order to honour the timeliness of the transaction the work in progress which have been not yet completed processing are deducted from this cost, also the opening stock are added. Similar is the case with cost of goods sold. The opening stock of finished goods is added and that of closing stock are deducted while calculating the cost of goods sold. Also, the selling and distribution expenses are added to it.

Types of Costing Systems

Total overheads which were applied in the month of April was $ 156000 whereas the actual expense was incurred for $168500, therefore the expenses were under recovered by $ 12500.

1. As already discussed above, we see that allocation of expense can be made in majorly two ways. Either the use of traditional costing or the use of activity based costing. The under-over recovery of expenses forms part of traditional costing approach. Let us now understand in details the traditional costing method and how to deal with under and over recovery of expenses (Eldenburg and Wolcott, n.d.).

Under the traditional costing system all of the overheads expenses which cannot be directly allocated to the product are distributed on per head basis. All the overhead cost are allocated as per the units produced, machine hours, labour hours, etc, whichever is the most suitable to the manufacturing company.

For example, the company expects a total overhead expense of $100000 to be incurred in the coming year; also the company expects to produce 10000 units. Now the company would find out the allocation rate per unit, in this case the allocation rate results in $10 per unit. Now, when the company continues production, it will charge overhead expenses on each unit at the rate of $ 10. (Hilton, Maher and Selto, 2008)

Moving further, the company now incurs actual expenses. These expenses are just to compare with what has been recognised and what not. When the calculations are then done the actual expenses are compared with the allocated expenses. Any of the following two cases may now arise:

• Actual expenses are greater than allocated expense
• Actual expenses are lower than allocated expense

When the actual amount is greater than allocated this indicates that the company has recovered less amount from the customers as compared to what it has incurred, hence resulting in under recovery. (Holtzman, 2013)

When the actual expense  is lower than allocated this indicates that the company has recovered more amount form the customers as compared to what it has incurred, which results in over recovery of expenses.

Let us continue with the above example. The actual expenses incurred are $95000 and actual units produced are 8500. This means that the company has recovered $ 85000 (8500*10) from its customers whereas it has incurred $95000, this is an under recovery of $10000.

Let us continue with the above example. The actual expenses incurred are $105000 and actual units produced are 15000. This means that the company has recovered $ 150000 (15000*10) from its customers whereas it has incurred $105000, this is an over recovery of $45000.

Let us now understand how we treat these under/over recoveries in our books of account. The under/over recovery of expenses may be due to various reasons (Horngren, 2014). For each reason the treatment is different. Let us discuss few of such reasons:

• Under/over recovery due to fault on the part of management: in situations where the allocation rate has been disputed or wrongfully calculated by the management, then in such cases the under/over recovery are taken to the costing profit and loss.
• Under/over recovery due to seasonal variations: there come certain situations when the allocation rate changes due to seasonal variations. Under such circumstances the whole of under/over recovered amount is carries forward to next year and subsequently adjust. (Horngren, Datar and Rajan, n.d.)
• Under/over recovery due to price changes: the economy keeps changing and there are a lot of factors which affect the price of the product and also the expenses. Under such cases the units which have sold are not affected by such changes. But the ones which are still in stock, for them the price is revalue and adjusted.  The amount is subsequently recovered in the coming year (Kinney and Raiborn, n.d.).
• Other situations: in situations when the under/over recovery is due to reasons other than those specified above, then the amount under/over recovered are transferred to the profit and loss account for the year.

Both under and over recovery have adverse effect on the company (Palaniappan and Hariharan, 2012). Over recovery creates a charge on the selling price of the product which creates a burden on the customers. This harms the company reputation.  In the cases of under recovery the company has to compensate for the less recovered amount, leading to loss of profit. Therefore the company should be alert and choose an efficient manner of cost allocation in order to avoid cases of losses.  Also the company should treat the over/under recovery in correct manner.

1. As already discussed above, we have seen that there are the most two common methods of cost allocation are traditional costing and Activity Based Costing (ABC). We have already discussed about traditional costing in details in the above solution. Now we will see if Frank’s company should adopt Activity Based Costing or not. (White, 2009)

Activity Based Costing is the cost allocation method under which all the costs incurred are divided and allocated in various departments as per the amount of services used by them. This system of costing mostly appropriate for the enterprise which deals in specialised or unique type of products. This enables the cost allocation only to the process which consumes a particular resource or service. The departments which do not use these products or services are not unnecessarily faced with the burden of these costs. This type of costing system helps to know the amount and level of resources used by a particular process or a department in a correct manner. (Polimeni, 2011)

In order to apply the activity based costing in the practical life one first needs to understand the advantages and disadvantages of this system.

Few advantages of the activity based costing have been listed below:

• Helps in improvement of all other processes: In order to implement the activity based accounting, it is important to study all the departments and processes in depth, so that their nature can be understood. This further helps in analysing which process is working efficiently and which is not, hence helping the firm build a bigger picture.
• Identification of unnecessary expenses or waste: under this system all the costs are also analysed in depth if they are really required to be incurred or not. ABC helps in identification of these unnecessary costs and helps in cost cutting. This helps to save money for other processes as well.
• Helps in product pricing: Since activity based costing is a comprehensive manner of cost allocation, it helps is allocating costs to the departments which should be charged with these costs. It helps the management understand per unit cost of production of their product. It helps in pricing policy of the company.
• Can be applied to all of the processes of the management: the process of activity based costing can be applied to whole of the enterprise. It can be applies even in administrative processes and will also help in cost savings of all other departments.

We will now look discuss few of the disadvantages of Activity Based Costing:

• Does not necessarily helps in cost reduction: if the overhead costs represent a very small proportion of the total cost then it is unlikely that the ABC will help in cost reduction. Also, if the overheads are volume related then there is slightly any chance of reduction in cost. (Caplan, n.d.)
• Expensive implementation cost: As discussed if the overhead cost of the firm is very low than it would result to be costly for the firm. The initial implementation of Activity Based Costing is expensive as it requires thorough work and also needs a proper supervising to be done.
• Takes time in implementation: the process of implementation of ABC is also very time consuming. It requires a detailed study of all the processes, departments, staff, etc. (Lucey, 2015)

Therefore we see that the process of Activity Based Costing has both advantages and disadvantages. But the disadvantages relate only to initial implementation mostly. Once the Costing process is applied it helps the firm with the whole of the costing process. Also, it will help the company to analyse the costs and understand the processes. Hence we would recommend Frank to opt for Activity Based costing.

References

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Boyd, K. (2013). Cost accounting for dummies. 1st ed. Hoboken, N.J.: Wiley.

Bragg, S. (2016). Cost accounting fundamentals. 1st ed. Centennial: Accounting Tools.

Brigham, E. and Ehrhardt, M. (n.d.). Financial management. 1st ed.

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Clifton, M. (2014). Target costing. 1st ed. New York: Marcel Dekker.

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Eldenburg, L. and Wolcott, S. (n.d.). Cost management. 1st ed.

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