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Directly Incurred In Manufacturing Product

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Question:

Discuss About The Directly Incurred In Manufacturing Product?

 

Answer:

Introducation

a) Flexible budget is a budget where the budgeted costs differ for different levels of activity. The expenses of a business are classified into variable, semi variable and fixed costs with utmost accuracy as the importance of the budget depends upon the accuracy to which the costs have been properly classified. Flexible budget helps in identifying the deviation of the actual costs of the actual quantity from the budgeted costs of the actual quantity(Hilton & Paltt, 2016) .This is very important for cost control as the reason of the deviation of actual performance from the planned performance can be known. For example, management has prepared a budget for production of 2000 units of product A as follows:
 

 

Standard Budget

Flexible budget

Actual

 

2000

1500

1500

Variable costs ($10 per unit)

$20,000

$15,000

$17,000

Fixed cost

$50,000

$50,000

$50,000

From the above we see that the actual deviation of variable costs has been an excess of $2000 over budgeted. If we were to go by standard budget, the deviation would be favourable $3,000 which is unrealistic.

Flexible budgets overcome the shortcoming of the static budgets in performance evaluation. Under static budget, the actual results are compared to the budgeted ones irrespective of the level of sales. So if the sales volume increase, the corresponding variable costs are bound to increase, however, static budget does not consider this. Flexible budgets increase the budgeted costs with an increase in the volume of sales and thus provide for a more realistic performance evaluation thus eliminating the scope of volume variances.

b) Before a cash budget is prepared, the budgets that need to be prepared include Sales budget, Materials budget, and Selling and expenses budget. The likely timing of the cash flows and their impact on the cash budget is discussed below:

i) Sales budget – this is the first budget and depending on the sales forecasted, other budgets follow. The sales budget will increase the cash flows as the revenues will result in receipts. The timings of the cash flow depend on the collection policy of the company. If sales are made for cash, the cash flow will increase in the month of sale. For credit sales, the cash flow will increase in the month the cash is collected for the credit sales.

ii) Materials budget – depending on the production budget, the materials required to produce the required quantity is determined by the materials budget. The materials are purchased to be used in production and hence will result in outflow/disbursements in the cash budget. The cash outflow depends on the credit the company gets from its suppliers. For cash purchases, the month in which the material is purchased is effected and for credit purchases, the month in which the payment is being made is affected.

iii) Selling expenses budget – this budget results in cash outflow and hence will increase the cash disbursements in cash budget. The cash is normally paid when such expenses are incurred.

c) Operating cycle is the time required to acquire the inventory, sell it and receive cash from the customers for the inventory sold. A cash cycle is the time taken to release cash tied up in production and sales processes. Operating cycle and cash cycle can be used interchangeably however; operating cycle measures the operating efficiencies whereas cash cycle measures the effectiveness of cash flow management. Operating cycle is a sum of the day’s inventory outstanding and day’s sales outstanding whereas the cash cycle is the sum of day’s inventory outstanding and day’s sales outstanding less the days payables outstanding. A shorter operating and cash cycle means effective working capital management as the inventory is converted into sales and the sales are paid for in a shorter time period. Also the time taken to pay the suppliers is more than the time taken to receive payment. The various ratios that can be used in measuring the working capital efficiency include inventory turnover, receivables turnover and payables turnover. Inventory turnover is the number of times the company is able to turn its inventory into sales in a year. Higher the ratio, the better it is. Receivables turnover is the number of times a company can convert its receivables into cash during the year. A higher ratio means the receivables are fast moving and debtors are paying on time. Higher the ratio, the better it is. Payables turnover is the number of times the company is paying its average accounts payables in a year. Higher the ratio the better it is because this means the company is able to pay its bills on time and the ratio can be used to negotiate favourable credit terms for the company.

d) No, we do not agree that government organisations do not need accounting; rather it is important for these organisations to have transparency and uniformity in the financial data being reported. Accounting refers to recording all financial transactions and thereby interpreting, reporting and summarizing this data. The source of funding for these organisations is grants or taxes both of which are public money. The government uses this money to provide valuable goods and services to the public like roads, infrastructure, and other public amenities. The source and use of such funds should be properly recorded in the books of accounts to be reported to the public as the public would want to know where their money is being spent. The financial data can also be used by the government agencies for preparing annual budgets. Accounting helps to keep a check on the expenditures so that the expenditures remain within the limit of the budget as approved by the government also to ensure that the expenditures are made as per the rules, regulations and the legal provisions of the government. The accounting data can be used to prepare financial statements and various reports of use to the government and the public. The government organisations should use Generally Accepted Accounting Principles for accounting purposes.

e) A costing system is used by a company to accurately estimate the costs of the products in order to determine the selling price of the products. The system uses various cost control measures, reports, processes and forms to report on the revenues and a cost incurred for the product and therefore measures the profitability of the product. A costing system also helps in multiple product profitability analysis, comparison of budgeted and actual results, and accurate estimation of futura) Manufacturing overheads allocation rate for Wonder Products on the basis of machine hours.

 


Manufacturing overhead rate = total manufacturing overheads / total machine hours

= 598080 / 7000

= $85.44

b) Administrative overheads allocation rate for Wonder Products on the basis of direct labour hours.

Administrative overhead rate = total administrative overheads / total direct labour hours

= 695520 / 14000

= $49.68

c) Price to be quoted to Bushy for the wonderful creation is calculated below:

Particulars

Amount

Direct material

$19,000

Manufacturing overhead (400*85.44)

$34,176

Administrative overhead (750*49.68)

$37,260

Total costs

$90,436

Mark up of 40% on total costs

$36,174.4

Price of Wonderful Creation

$126,610.4

d) It is important to carefully allocate overhead expenses to products for accurate pricing. The prices are determined on the basis of costs for products. Overhead expenses are not directly incurred in manufacturing the product rather these may relate to support services costs. Since the product is indirectly using such services, it is necessary to include these costs in the total product cost as it also helps in decision making.

The most common and old method of overhead allocation is traditional costing where the overheads are allocated to the products on the basis of a predetermined rate irrespective of the complexity of the activities undertaken to incur the cost. Hence, this method does not accurately allocate the overhead costs. Another costing method Activity Based Costing solves the problem by allocating overhead costs by dividing overheads into various activities and identifying cost drivers. On the basis of the usage of the various activities, the costs are allocated.

e) The companies use a predetermined rate rather than actual overhead costs in allocating overheads because these overheads are not directly incurred in manufacturing the product. Administrative and manufacturing overheads like salaries, rent, electricity, insurance are not incurred for production but are rather support services. Hence, these costs need to be allocated on a predetermined basis.

 

References

Hilton, R., & Paltt, D. (2016). Managerial Accounting: Creating Value In a Dynamic Business Environment. Australia.

Weygandt, J., Kimmel, P., & Kieso, D. (n.d.). Managerial Accounting: Tools for Business Decision Making, 7th Edition. Australia: Wiley.

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