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Question:

Explain Determination of Production Cost.

 

Answer:

Determination of Production Cost

The production cost is the expenses incurred by the business while manufacturing a product or producing a service. The cost of production includes Material Costs, Labor Costs, Factory costs etc (Horngren). Here in the given case study to determine the production costs certain assumptions are made because the information provided lacks completeness.

Assumptions

The Assumptions that are made for the case study is given below:

The material costs of a Duplo block is $2000.00 but it is given that for each subsequent increase in quantity cost will decrease by $25.00. So there are 10 possible material costs depending upon the quantity purchased.

It is assumed that for each unit of ichibutsu it will require one labor.

It is assumed that for producing one unit one oven is required so the equipment costs per unit is $4000.00.

Factory overhead costs are the indirect costs incurred by the business (Marshall). Factory overhead costs depend on the table rented and each table costs $10000.00. It is assumed that each unit of ichibutsu will require one table.

The total production cost per unit is calculated on 10 possibilities depending on the number of units material purchased. As the minimum batch of production is of 6 units, so at least 6 units of material will be purchased at a time. It is clear from the statement that as unit of material purchased increases, the cost per unit of material is decreased so all other costs remaining the same. Cost of production decreases with increase in number of material purchased.

Determination of Work in Progress and Finished Goods

The Work in Progress means the total amount of material and labor used for unfinished product in process (DRURY). The Finished goods may be defined as the goods that are completely manufactured and are ready for sale (Hilton). In the case study details regarding WIP and FG are not provided so it is necessary to make some logical assumptions.  For the purpose of this study it is assumed that at all times company will maintain double the quantity purchased in FG so that sales are not affected. The WIP is always maintained at quantity purchased but it cannot be less than 6. This assumption is important for determining holding costs.

Revenue

Revenue is the amount of money that the company can earn by selling its products or services (Kaplan). In the given case company can earn revenue of $6000.00 per unit by selling product on time and in case of delay it can earn revenue of $4500.00 per unit. It is assumed that always enough Finished Goods will be maintained so that sales can be made on time. Therefore sale price will be $6000.00. 

Statement showing Calculation

Statement showing calculation of profit per unit

Units Purchased

6

7

8

9

10

WIP Unit

6

7

8

9

10

FG unit

12

14

16

18

20

Material Costs

$1,875.00

$1,850.00

$1,825.00

$1,800.00

$1,775.00

Labor Costs

$1,250.00

$1,250.00

$1,250.00

$1,250.00

$1,250.00

Equipment Costs

$666.67

$571.43

$500.00

$444.44

$400.00

Factory Overhead

$1,666.67

$1,428.57

$1,250.00

$1,111.11

$1,000.00

Total Production Cost

$5,458.33

$5,100.00

$4,825.00

$4,605.56

$4,425.00

Holding Costs

432.00

622.08

895.80

1539.95

2517.52

Total Costs

$5,890.33

$5,722.08

$5,720.80

$6,145.50

$6,942.52

Profit/Loss

$109.67

$277.92

$279.20

-$145.50

-$942.52

Revenue

$6,000.00

$6,000.00

$6,000.00

$6,000.00

$6,000.00

The profit is the reward for undertaking risk (Guenther). The profit earned is calculated by adding all costs then deducting it from revenue.

Conclusion    

On analyzing the above statement it can be concluded that profit is maximum of $279.20 per unit when 8 units are purchased and produced.  Therefore it is advised that eight units should be purchased.

 

Recommendations

The cost system of the company shows that material and labor forms the major part of costs. In material a discount of $25.00 is provided for increase in each successive unit. It is recommended that quantum of discount should also increase with increase in purchase of each successive units. Then the company will be able to enjoy more discounts thus increasing profits. The labor costs are a huge component of costs and measures should be undertaken to reduce the same. The Holding costs of inventory are the variable component of costs it increases with increase in inventory. Therefore to control this costs it is important to develop a plan for inventory management. 

 

References

DRURY, COLIN M. Management and cost accounting. Springer, 2013.

Guenther, Edeltraud, et al. "Material Flow Cost Accounting–looking back and ahead." Journal of Cleaner Production 108 (2015): 1249-1254.

Hilton, Ronald W. Managerial accounting. New York: McGraw-Hill, 1991.

Horngren, Charles T. Cost accounting: A managerial emphasis, 13/e. Pearson Education India, 2009.

Kaplan, Robert S., and Anthony A. Atkinson. Advanced management accounting. PHI Learning, 2015.

Marshall, David H., Wayne W. McManus, and Daniel F. Viele. Accounting. McGraw-Hill Irwin,, 2011. 

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