Costing System And Make Or Buy Decision

Types of Costing System

1.Explain why you have chosen this method over an alternative and explain which works best for a department within this project Job Costing ,Contract Costing and Absorption & Marginal Costing?

2.Within your costing analysis, measure and evaluate the financial impact of manufacturing these new product lines within the company as opposed to purchasing them externally?

3.Using your costings above, evaluate how achievable this project is against the original time scales. Support your findings with the budgeted costs compared to the actual costs?

4.Produce an operational plan for this project, it must highlight the required resources, time scales and costs?

1. The Management of a business uses the costing system for monitoring the cost that a business incurs for a particular project or product.  The costing system includes process, controls and reports that are designed to report to the management about the cost incurred, revenue earned and overall profitability of the project (Kaplan and Atkinson 2015). The reporting can be of any area of the business that includes departments, facilities, sales region, product and services. Therefore, it can be said that the costing system is useful to management for variety of reasons that are listed below:

• It helps the management to fine tune operations so that they can increase the profitability of the business.
• It helps management to control cost by comparing the actual cost with the budgeted cost.
• In case of downturn, it helps the management to make decision regarding the areas for curtailing of cost.
• It helps the management develop the tactical and strategic plan for operations in the future.

In this case, an appropriate costing system will help to determine the total cost of the project. The board for making decision regarding the acceptability of the project will eventually use this information provided by the costing system (Seuring and Goldbach 2013).

There are different types of costing system that are used depending on the suitability of different types of business. The three most popular types of costing system that discussed below are job costing, process costing, marginal costing and absorption costing. This are discussed below:

Job order costing: 

The cost accounting system in which the manufacturing cost for each job is accumulated separately is known as the job order costing. It is suitable for business that are engaged in the production of unique and special products (Potts and Ankrah 2014). The business in which the job order costing is more applicable are event Management Company etc.

Process costing:

The cost accounting system in which the cost are accumulated separately for each process is known as the process costing. This costing system is suitable for products that are produced by the involvement of different process and departments (Fawcett et al. 2014).  

Marginal costing:

The marginal costing is a costing system in which the costs are divided in fixed and variable costs. The marginal costing is an important decision making tool for management. The marginal costing reflects the effect of contribution and net profit by increasing sales of one additional product. This system of costing helps the management to make decision regarding expansion or discontinuation of a product line (Shu et al. 2014).  

Job Order Costing

Absorption costing:

The costing system in which all the manufacturing cost are absorbed in the units produced is known as the absorption costing. In this system all the cost are treated as the product cost irrespective of the nature of cost whether it is fixed or variable. In this costing system, the cost of a unit produced is calculated by adding material, labor and overhead costs. The absorption costing is also known as full costing. The absorption costing is compared with the marginal costing. The absorption is useful because it is used for external reporting (Phillips 2013).

In this case, it can be seen that the company is planning to launch a new product that it is intending to sale. On analyzing, the outline of the project given in the case study it can be seen that the company should apply the absorption coting method. The main reason for this decision are that in the case study the main purpose is to determine whether the product should be produced or purchased. The management can make this decision by calculating the total cost per unit and comparing it to the purchasing price of the product. Therefore, it can be concluded that the absorption costing system should be applied.

2. The decision that management has to make whether to make the product internally or purchase it from external supplier is known as the buy or make decision. The make or buy is a strategic choice that a business has to make if the business is developing a product or adding capacity. This is termed as a strategic choice because it has long-term implication for the business. The variables that are considered in making the long-term decision are the current and the future environment. The issues such a government regulations, competition from the peers and trend of the market all influences the strategic decision of buy or make.  The main factor that influences the buy or make decision is the cost of product. The simple decision rule is that if the production cost per unit is more than the purchasing then it should be purchased otherwise it should be produced. If the production cost is less than purchasing the product then other factors that should be considered in making the decision in favor of in-house production are:

• It should be considered whether there is sufficient expertise for making the product in house.
• The production capacity should be compared with the volume of units needed to meet the demand in order to make the decision of buy or produce.
• The manufacturing capacity should be evaluated properly before making the decision.

In order to analyze, the financial effect of the decision to manufacture the product. The total cost for producing per unit is calculated and it is compared with the cost for buying the product. The calculation is given below:

Statement Showing calculation of Production Per annum
Number of Weeks operate Per annum	48
Number of days per week of operation	5
Production hour per day	7
Number of hours p.a	1680
Total Number of Machines	6
Total Machine Hour	10080
Production per hour (units)	200
Production per hour for 6 machines	1200
Production Per annum	2016000
wastage	201600
Net Production	1814400

Process Costing

Table 1: Calculation of number of units per year

(Source: Created by Author)

Calculation of Production cost per unit
Particulars	Amount
Production manager	£       45,000.00
Machinist	£       18,144.00
Project Manager	£       75,600.00
Test Engineer	£       22,680.00
Senior Engineer	£       75,600.00
Depreciation of Machinery	£         5,400.00
Marketing cost	£       30,000.00
Sales engineer	£       35,000.00
Total Cost	£     307,424.00
Less:
wastage	£         2,016.00
Net Cost	£     305,408.00
Production cost per unit	£                0.17

Table 2: Cost per unit Produced

(Source: created by Author)

There are certain assumptions that have been made for the purpose of the above calculation. These assumptions are given below:

• The cost are absorbed using the cost per unit. In case of variable costs, the cost per hour is divided with the number of units produced per hour and then it is multiplied with the total unit per annum. The formula is given below:

Cost per hour/Production per hour X production per annum

• It is assumed that the machineries will be depreciated using the rate of 10%.

The above calculation shows that if the business makes the product then the cost per unit will be £0.17. On the other hand, if the product is purchased externally then it will cost £0.15. Therefore, based on this analysis it is clear that the decision to make the product internally has negative impact for the business. The calculation showing the financial impact of the decision to make the product is given below:

Calculation of profit
Particulars	Amount
Decision to Produce
Sales Price per unit	£                0.25
Production cost per unit	£                0.17
Profit per unit	£                0.08
Total profit (A)	£     148,192.00
Decision to Purchase
Sales Price per unit	£                0.25
Purchase price per unit	£                0.15
profit per unit	£                0.10
Total profit (B)	£     181,440.00
Difference (B-A)	£       33,248.00

Table 3: Profit calculation

(Source: Created by Author)

The calculation above shows that if the business decides to make the product then it will make a profit of £148,192.00. On the other hand, if the business decides to purchase the product from outside then it will make a profit of £181440.00. Therefore, it can be concluded that for the decision of making the product the company will not be able to make an additional profit of £33248.00.

3.

Comparing Budgeted with the actual time scale
Details of work	Budgeted	Actual
Hire Operations Manager	1	5
Purchase 6 milling machines	1	18
Hire Process engineer	1	5
Review current manufacturing process	7	11
System proposal report	1	9
New Machine Installation	21	29
Design the manufacturing layout	21	28
Train 6 CNC setters on the new machines	21	30
Test the manufacturing process	7	12
Prepare operational manuals	14	18
Total days	95	165
Note:
For all the activities where the days are not mentioned in the outlined activities for that it is taken as 1 days.
It is assumed that all the activities are conducted one after another.

Table 4: Comparing actual time sake with the budget

(Source: Created by Author)

The table above shows the comparison between the actual and the budgeted time scale. Based on the above table it can be said that the project will not be able to be completed within the time scale. This will result in increase in cost of the product, as the variable costs that are paid on hourly basis will increase. The calculation is given below:

Comparison of actual and budgeted cost
Particulars	Rate per hour	Budgeted	Actual	Difference
Machinist	£             12.00	£   3,024.00	£   4,320.00	£ 1,296.00
Project Manager	£             50.00	£   4,750.00	£   8,250.00	£ 3,500.00
Test Engineer	£             15.00	£      105.00	£      180.00	£      75.00
Senior Engineer	£             50.00	£   4,200.00	£   5,850.00	£ 1,650.00
Total Cost		£ 12,079.00	£ 18,600.00	£ 6,521.00

Table 5: comparison of actual with the budgeted cost

(Source: Created by Author)

The above calculation compares the budgeted cost with the actual cost. Based on the above table it can be said that the budgeted cost is £12079 whereas the actual cost is £18600. Therefore, it can be said that the company will incur an additional cost of £6521. Based on the above discussion it can be said that the above project is not achievable with the time budgeted scale and budgeted cost.

4. The operational plan is the activities that a company plans to achieve for attaining success. There are different goals for different companies and sometime the company faces problems in achieving those goals. The first step for operational plans lists the major goals of the companies. The second step is to provide the time line for attaining those objectives or activities. In this case, the operational plan for the project along with the details of the cost at each is given below:

Operational Plan along with the budget
Details of work	Start Date	Finish Date	Human Resource	Cost
Hire Operations Manager	08-05-2017 08:00	12-05-2017 05:00	1	£      50.00
Purchase 6 milling machines	15-05-2017 08:00	01-06-2017 05:00		50
Hire Process engineer	15-05-2017 08:00	19-05-2017 05:00	1	£    100.00
Review current manufacturing process	10-03-2017 08:00	20-03-2017 05:00		700
System proposal report	21-03-2017 08:00	29-03-2017 05:00		100
New Machine Installation	22-03-2017 08:00	19-04-2017 05:00		2100
Design the manufacturing layout	30-03-2017 08:00	27-04-2017 05:00		2100
Train 6 CNC setters on the new machines	20-04-2017 08:00	18-05-2017 05:00	6	3612
Test the manufacturing process	28-04-2017 08:00	08-05-2017 05:00	1	1309
Prepare operational manuals	09-05-2017 08:00	26-05-2017 05:00		2618

Table 6: Operation plan

(Source: Created by Author)

Reference

Fawcett, S.E., Ellram, L.M. and Ogden, J.A., 2014. Supply chain management: from vision to implementation. London: Pearson.

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

Phillips, J., 2013. PMP, Project Management Professional (Certification Study Guides). McGraw-Hill Osborne Media.

Potts, K. and Ankrah, N., 2014. Construction cost management: learning from case studies. Routledge.

Seuring, S. and Goldbach, M. eds., 2013. Cost management in supply chains. Springer Science & Business Media.

Shu, F., Weidong, Z., Zhuo, L.Z., Haibin, C. and Yaohui, Z., 2014. The application of time driven activity-based costing in fine cost management of the hospital. Jiangsu Healthcare Administration, 6, p.063.