Principles of Product Costing

Discuss about the Impact On Market Performance And Price.

Product costing is one of the most important aspects of cost accounting and forms an integral part of it. It refers to the amount of expenses involved in the production of any product and mainly comprises of three main parts; direct material, direct labour a direct expenses. It is widely regarded as an important component of any business organisation for taking strategic decisions. As has been indicated by John, in the Journal of Accountancy, that that in today’s ultra-competitive business environment, accurate product costing has become more important critically for any business’s survival.

The usage and application of product costing has now undergone a massive change, since its inception. In the 40s, product estimates usually contained, only the total manufacturing costs. Subsequently in the 50s, variable costs and fixed costs were also introduced. In today’s ultra-competitive environment, most of the manufacturing operations have become automated.  All this has been done with the intention of saving time and money, which are regarded as important tools for sustenance in the manufacturing business. Now, production remains depended on automated technological production processes. Any change in the cost of manufacturing has a direct impact on the profit earning capability of the companies. As a result of which, the importance of product costing cannot be downplayed. Moreover, today businesses have become more customers centric. More focus is being provided to the requirements of the customers and any slight change in their specifications and demands would result in the alterations of the products and costs. With this in mind, a detailed presentation of the prominent principles of product costing, the practices followed by the manufacturing companies in Australia and New Zealand have been provided. Any difference or gaps between the practices and the principles followed have been reviewed critically.

Product costing is a specific kind of methodology associated with the subject of managerial accounting. Product costing is made and prepared with the purpose of accurately determining and ascertaining the cost of a particular unit of production. In other words, it is a process of identifying and recognising various important cost components which can be addressed specifically in order to precisely ascertain the different kinds of cost of any product by purchasing, designing, engineering and packaging the product. The various important aspects or rather parts of product costing are as follows, which are direct materials, direct labour as well as direct expenses including factory overhead. For the efficient ascertainment of costs, a series of principles are followed. Each item of product costing represents a case and effect relationship, In case of product costing, for all the direct materials, labour, expenses or the factory overhead, charging of cost occurs in the books of accounts, only when they are actually incurred. One of other principles of product costing states the fact that in case of product costing, the convention of prudence is not followed here. If there any factual information, only they are depicted. In case of any kind of contingencies, they are to be shown separately and distinctly.  With the intention of avoiding any unnecessary errors, in case of product costing, the principles of double entry should be duly followed. In association with this, any kind of past costs associated with any particular product should not become a part of any kind future costs.

Product Costing Practices in Australia and New Zealand

Various countries have different costing practices and calculation of product costs and other costing practices are no different. In this essay, focus is being thrown in the product costing systems employed in New Zealand and Australia.

In Australia as well as in New Zealand, the manufacturing companies have seen a lot of dramatic changes in the usage and implementation of the costing practices from the erstwhile costing practices which generally involved, only the total costs which were closely associated with a particular product (Ingenbleek, Frambach and Verhallen, 2013). Back in the earlier periods, only total costs which were involved in a particular product were treated as a part of the product costs. In the traditional product costing systems, mainly the cost was being allocated into three main costs:

• Direct Material: They were directly used in the manufacturing processes, example telephone wires in case of Telstra Corporation.
• Direct labour: They are directly involved in the production process and practically execute the production process, example labour involved in the conversion of raw milk for Fonterra, which is New Zealand’s largest milk producing company.
• Direct expenses: This involves payment of those expenses, which were incurred in the production of goods and services, example freight and insurance paid for the procurement of the raw materials.

When, the case of Fonterra is taken, which is a New Zealand milk producing company, it could be seen that the company calculates the product cost by taking into account both the direct as well as the non-direct costs such as supply chain costs, collection costs of the necessary containers and others such things. In the case of most of the New Zealand companies, the following product cost flow is followed:

With the help of the following diagram, the actual procedure of ascertaining the product costs has been stated. It is mostly followed by companies operating in New Zealand, Hong Kong and some other Asian countries.

In the present case scenario, not only the direct costs but also those kinds of costs, which are ancillary to the production of the main products are also included. This holds true especially for the Australian as well as many other Western countries such as UK and the USA. In addition to this, the companies now have started adopting new measures of measuring their costs. Due to this, the prominence of ABC costing procedure has soared high and it is being implemented in almost every organisation present in these countries (Elhamma and Zhang, 2013). Presence of a strong organisational structure, cooperative top management and support of the management has led to the widespread implementation and success of the ABC costing process (Drury, 2013). Most of the technology relied companies like Telstra or even core mining companies like Rio Tinto and BHP have understood the significance of ABC. AS a result of which, they have strongly advocated for this costing procedure (Schmidt and Nakajima, 2013). In ABC costing, activities have been recognised and segregated into one group on the basis of their importance and activities. The complete pictorial presentation of the entire process of ABC costing has been provided below:

Comparison of Traditional Costing and Activity-Based Costing

 The usage of various kinds of cost drivers in influencing the decisions of allocating the cost to different indirect cost related activities is the hallmark of the method of Activity Based Costing.

The major causes of difference in the application of the different kinds of product costing procedures is due to several kind of intricate and inter-related reasons. The prevalence of the product costing, based on the traditional method of costing is mostly prevalent in the country of New Zealand and Hong Kong and many other Asian countries. Here the costs are calculated by the traditional procedure of allocating the cost of the product of any product in terms of direct labour, direct expense, direct material and factory overhead. Whereas in the case of the western countries of UK, USA and Australia, the prominence of the famous ABC method of costing is much more prevalent, when compared to the traditional method of product costing.

Traditional costing systems apply direct as well as indirect costs to different products which is based on a predetermined overhead rate. Unlike ABC, traditional costing systems treat overhead costs as a sole pool of indirect costs. Traditional costing is optimum when indirect costs are truncated when compared to direct costs. On the other hand, Activity based costing systems are far more accurate and precise than their traditional counterparts. It is because they provide a more exact breakdown of indirect costs. However, the ABC costing systems suffer from greater problems (‘Australian Accounting Standards Board (AASB) – Home’, 2018). In the practical business scenario, they are far more complex and more costly to implement. As a result of which, the leap from traditional costing to activity based costing has been difficult, and still many countries still continue to cling to the traditional methods.

Some important aspect of product costing was revealed with the presentation of the principles and the current practices of product costing. When the principles and the practices are being compared against each other, various some stark differences in terms of cost allocation procedure had been seen in the case of traditional costs and the new method of ABC costing. This is pretty evident due to the presence of some external cost drivers which heavily influence the costing procedures and the allocation procedures in the case of the ABC costing method. This is just a tiny example of the different kinds of differences which exists between the two systems.  The major reasons for such kind of diverse differences, is the presence of the various kinds of factors, some of the prominent ones have been mentioned below:

• The presence and the prevalent practices of the existing legal systems in the different countries play an important role in influencing the cost and other accounting practices of the different countries.
• Maintaining provisions for different kinds of financing is also a significant factor in this regard.
• The link between the subjects, functions, procedures and practices of accountancy and tax laws are another significant factor which plays a crucial rule in the costing and accounting practices between the various countries all over the world.

Presence of the different kinds of cultural differences and other external differences also exercise a significant amount on the accounting practices of various countries

Conclusion:

The concerned essay successfully delves into the foray of product costing. The importance of product costing, its involvement in the company’s overall scheme of things, is a brief testimony to the importance it possess. It has a direct and relevant importance on the profitability of any company. In this essay, some important principles of product costing and the existing practices of ABC costing had been discussed and analysed. It could be seen, that the ABC costing is a major up gradation over the previous costing structure, which used to put major emphasis on the major direct costs only. This goes on to prove, the importance of product costing and the relevance of ABC in today’s economic environment.

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