Purpose of Product Costing System

Describe about the Introduction to Management Accounting for Products Cost.

Product costs refer to the expenses borne while manufacturing a product and the cost of raw materials of the product that is manufactured. It also includes the cost of transportation incurred while transporting the good to the point of sales. Product costs include cost of labor, cost of material, supervision and maintenance expenses and can be regarded as historical by nature until the date of sale (Needles & Crosson, 2013; Kiney & Raiborn, 2012). Product costing assists in controlling the various costs that are involved in the process of manufacturing by providing a detailed view of the expenses. It offers flexibility in the process of manufacturing by stating about the previous and the new costs incurred. The knowledge about the costs of product engineering and manufacturing budgets along with gross margin can also be sorted by means of product costing. With consideration to its effectiveness and virtues, this system of costing is commonly used in the management of supply chain processes (Oracle, 2003).

There are two types of product costing systems, vis a vis, process costing and job order costing. It is necessary to sort out the costs involved in the process of production, when conducting a continuous production of goods, as it assists in identifying the costs involved in each batch of production. In the process costing method, a process cost report is used to learn about the expenses involved in each of the process of production. In case the goods manufactured are heterogeneous by nature, the job order costing method is deemed as more suitable. In this process, the manufacturing cost of each unit of production is calculated to assist in pricing of the goods. It also helps in profit maximization by determining the appropriate product mix and the method of maximizing production. Job order costing is followed by companies when manufacturing customized products in a relatively smaller quantities. In this process, calculation of the direct labor, direct material and overhead of each batch is calculated. At present, the use of a job order costing method can be witnessed with regards to the costs of production and align it with the revenues. Overall, the standard costing system further makes the process costing system more efficient by stating the estimated costs of production. This helps in understanding whether the actual costs are crossing the estimated costs (Shim & Siegel, 2009).

Types of Product Costing Systems

In accordance, there are two facets of assigning the product costing system, which are cost accumulation systems and valuation methods. The cost accumulation system emphasises measurement of costs, identification of costs and product cost assignments. There are three types of techniques of cost valuation combined with the mechanism, which are normal, actual and standard valuation techniques (Kiney & Raiborn, 2012; Needles & Crosson, 2013). Product costing is very useful for the managers, as it helps them to understand whether a particular product is contributing to the profits or is responsible for the losses incurred by the company. It also assists in residesigning the loss making product so that it can contribute to profit generation, which implies greater control of the management on the profit earnings of the company. The process of product costing helps in cost-benefit analysis and developing a superior management information system (MIS) in an organisation. It must be noted in this regard that product costing helps to set an appropriate price of the product on the basis of its recorded costs of a product and promotes planning in businesses and decisions regarding investment (US Aid, 2007). Product costing is important for any company disregard of the competitive strategies adopted. It helps a company to develop as cost leaders with augmented efficiency in the manufacturing process. The manufacturing environment of the business entities are also changing rapidly, further augmenting the need for the product costing system to be aligned with the dynamic environment, as the system helps in taking decisions to allocate overhead costs (Blocher, Chen, Cokins & Lin, 2006).

 It is necessary to improve the product costing system followed in the company and requires recommendation of the higher management. The rapid changes in the external environment of the business have made it necessary to shift the focus from traditional system of product costing to activity based costing system (Hilton, Ramesh & Jayadev, 2007). The product costing system also helps in tracing the performance of the various dimensions of the business, by sorting the different variables involved in the production of the various subassemblies and the components (Shim & Siegel, 2009).

The AASB 102 guidelines emphasises the manner of recording the costs of production associated with inventory. The guidelines suggest the exclusion of certain types of production costs from the financial statements. It includes the production costs that are abnormal in nature. As a part of production, the cost of conversion is included in the calculation of cost of inventories, with the separate allocation of the overheads. The various heads of conversion cost includes cost of direct materials, direct labor, variable and fixed overheads. Certain rules regarding allocation of overheads were also taken into consideration accordingly. The allocation of fixed production overheads was thus based on the average level of production of a business entity, while the allocation of the variable overheads was based on the daily production level (Chartered Accountants Australia and New Zealand, 2016; Commonwealth of Australia, 2009).

Facets of Assigning the Product Costing System

Table 1: Cost of Goods Manufactured

It can be observed that the cost of goods manufactured by Seafarer kayaks amounts to $85,700. The kayak company manufactures various types of paddles, accessories, kayaks and velomobiles, with exciting features to serve the customers and ensure their highest degree of satisfaction (Nimbus, 2011).

Table 2: Cost of Goods Sold

 The cost of goods sold for seafarer kayaks is $84,600, which is lower than the cost of goods manufactured. This implies that the company is unable to sell all the products manufactured. Contextually, the amount of unsold stock reflects the inability of Seafarer kayaks to market its products properly or take appropriate inventory decisions. Seafarer kayaks must therefore conduct appropriate production planning and control mechanisms, and set the price in a manner that will promote the sale of its products in the competitive market.

The study of the general format of cost of goods manufactured further reveals that factory utility and indirect materials are missing. It is principally because many records of the accounts are not available at present (Walther & Skousen, 2009). It must be noted in this context that the use of standard costing focuses on the allocation of expected costs rather than the actual costs (Massachusetts Institute of Technology, 2016).

The indirect materials vary with the production of goods and are considered as variable overheads. It consists of welding rods, oil required in machines, electricity, welding rods, nuts, bolts (ICWAI, 2012; Regis University, n.d., IFRS, n.d.). Notably, the indirect costs of materials were not considered in the previous accountant, as the record of the expenses is stored at a confidential place.

It is evident from the T-accounts that there is a credit balance of raw materials at the end of the year amounting to $1,000. WIP also have a credit balance of $500, while the stock of finished goods have a debit balance of $1,000, which suggests that goods amounting to the stated amount was manufactured during the accounting period.

The manufacturing overhead have a credit balance of $18,950, implying that the amount of actual overhead is more than the amount of applied overhead. The difference in the balance can be regarded as overhead variance or under applied overhead. Considering the case of accounts payable, it can also be assumed that there is an increase in the head by $2,250 in the end of the year. This is unfavourable as it implies rise in current liabilities. The cost of goods sold was also recorded at $84,600 that represents the production cost of the good that have actually been sold into the market by Seafarer Kayaks.

Importance of Product Costing

The applied overhead can be calculated by multiplying the pre-determined rate by the actual level of activity. In this case, the pre-determined rate is $63 and the actual labor hours is $850. This gives the value of the applied overhead to be $53,550, as represented hereunder.

The mathematical formula for calculating applied overhead is as follows:

Applied Overhead= Predetermined overhead rate x actual activity level

Table 3: Applied Overhead

Table 4: Actual Overhead

The total actual overhead for the accounting period comprises of all the non-direct activities concerned with manufacturing of a product. The various types of overhead that are applicable to Seafarer Kayaks, include administrative overhead, selling and administrative expenses and factory overhead. In total, there are 11 types of heads of overhead costs that have been actually incurred in the accounting year by Seafarer Kayaks. The total amount of overhead thus stands to be $72,500.

Table 5: Under Applied Overhead

The applied overhead is observably less than the actual overhead that indicates towards the existence of an under applied manufacturing overhead by $18,950. This amount can also be stated as the overhead variance.

The imbalances observed between the actual and applied overhead in this case is $18,950 that falls under the applied overhead costs due to higher actual overhead than applied overhead. In this case, the journal entries will transfer the under applied overheads to cost of goods sold, which is as follows:

Cost of Goods Sold A/c…………………………………………Dr.  $18,950

To manufacturing overhead A/c ……………………………………$18,950

Source: (Accounting for Management, 2015)

Generally, the difference between the applied overhead and the actual overhead is represented by means of over or under applied overheads. In case the actual overhead is more than the applied overhead, the difference is referred as under applied overhead. In case the applied overhead is more than the actual overhead, it can be noted that applied overhead exists. Considering the case of Seafarer Kayaks, it can accordingly be asserted that there is an under applied overhead amounting to $18,950 (Accounting for Management, 2015).

Seafarer Kayaks must consider the situation of under applied overhead with due significance. In this case, the overhead variance can be observed as positive in nature. This implies that the company is not using the indirect materials in an efficient manner, with possible alterations in the cost of the indirect factors of production. The presence of variance gives a clue about the effectiveness of the present cost controls mechanisms. Thereafter, the manger can take appropriate steps to make the cost control mechanisms more effective. To deal with the issue of under applied overhead, the company must sort out if the volume output produced was appropriate. The top-level managers must also focus on sorting that the variance in the overhead is due to the faults of the marketing departments or break down in the machines.

Production Cost in AASB 102

The journal to eliminate the imbalance is as follows:

Cost of Goods Sold A/c…………………………………………Dr.  $18,950

To manufacturing overhead A/c ……………………………………$18,950

Source: (Accounting For Management, 2015)

Standard costing begins with estimating the costs that can be incurred while performing the business operations. These estimated costs are known as standard costs, because it is linked with the overall efficiency of the operations. Notably, the differences between standard and actual costs are referred as variance (Rao & Bargerstock, 2011).

Advantages of standard costing system are that it assists in recording each transaction in details. This enables to know about the different processes that takes place in different phases of production (Rao & Bargerstock, 2011). The formation of the budgets, in case of standard costing is done on a pre-determined basis. This helps in understanding whether the various materials of production are used efficiently by the organisation. It will help the managers to keep a track of the problems accordingly (John Siambanopoulos, 2015). The difference observed between the actual and predetermined budgets can be used to find the personnel responsible for the variance. Another advantage of standard costing is that it helps in estimating the cost of producing new products. It can also be used for calculating the value of stocks.   

Standard costing will help Seafarer Kayaks in many ways. The company will be able to sort out the predetermined costs of it inputs that will help to understand whether the actual costs are at par with the predetermined costs. The production manager can hence, adopt the necessary steps that are needed to control the rising costs of production. The analysis also reveals the fact that cost of goods sold is lower than the cost of goods manufactured, which refers that there are unsold stock of kayaks. To reduce the unnecessary costs of unsold stocks, a proper inventory planning mechanism can be adopted by the managers, with the use of the standard costing mechanism.

References

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