Importance Of Accurate Product Costing

Use of Cost Information in Decision Making

Importance of accurate product costing:

Product costing is an integral function of system of costing. It involves determining of all the expenses of the business incurred during the production and sales process.  Determination of cost of a particular product is an important function which is usually performed by the management accountant of the company (Pennanen, Ballard & Haahtela, 2010).  To calculate the overall cost of the product, various techniques of management accounting can be used such as traditional costing, activity based cost accounting etc. In a manufacturing concern, product cost information is used by the managers to fix the prices of products produced and sold by it. The process of price fixation involves adding a certain percentage of profit-margin to the cost of the production of different items. Also, the accurate cost information also helps the managers to undertake effective decision making about the business.  The managers of the company can only formulate sound strategies and policies for the effective management of the business, when they have availability of accurate cost data.  Further, the budgetary function of the business requires the managers to collect all the relevant and correct cost data from for the estimation of total amount of spending. If in accurate information is used to prepare the budgets then the management might have to face funds crisis or excessive usage of funds in unnecessary or unproductive business areas (Hilton & Platt, 2013). Further, the accuracy of cost information plays vital role in the situation when managers have to undertake make or buy decisions. Make or buy decisions are those decisions where managers have to ascertain whether a particular item must be produced or it must be purchased from the market. For such decisions, contribution margin is required to be calculated. If accurate cost information is not available with the managers, they might not be able to determine the correct contribution margin and in such cases it could lead to wrong decision making. Furthermore, the preparation of income statement also requires the correct calculation of cost of goods sold of the business (Kaplan, et, al., 2010). If true cost of production and inventory items is not available with the business, then the actual profitability of business could not be ascertained. If incorrect cost information is used by the managers then it could lead to determination of misleading profitability position of the business. Moreover, cost information is also helpful in decisions like shutting down of product unit or business unit. If ranking of multiple projects is undertaken on the basis of contribution margin which has been determined using inaccurate cost information, then it may lead to incorrect decisions which could finally result in heavy losses to the business.

Price Fixation and Budgetary Functions

Therefore, it is necessary for the management accountants to determine the accurate cost of the business so as to enable the managers to use correct cost information while making various decisions (Schulze, Seuring & Ewering, 2012).

Overhead Costs	Calculations Save Time On Research and Writing Hire a Pro to Write You a 100% Plagiarism-Free Paper. Get My Paper	Overhead Rate
Soldering Cost	$    1,165,725.00	$                       0.66
number of solder points	1766250
Shipment Cost	$    1,064,250.00	$                     47.30
number of shipments	22500
Quality Control	$    1,534,500.00	$                     17.60
number of inspections	87188
Purchase Cost	$    1,176,120.00	$                       5.50
number of orders	213840
Machine Power Costs	$          71,280.00	$                       0.33
machine-hours	216000
Machine Set up Costs	$        928,125.00	$                     27.50
number of set-ups	33750

Overhead Allocation

	Rate	Workings	Lexon	Workings	Protox
Soldering Cost	0.66	(1333125*0.66)	$      879,862.50	(433125*0.66)	$      285,862.50
Shipment Cost	47.30	(18225*47.3)	$      862,042.50	(4275*47.3)	$      202,207.50
Quality Control	17.60	(63225*17.6)	$  1,112,760.00	(23963*17.6)	$      421,748.80
Purchase Cost	5.50	(90113*5.5)	$      495,621.50	(123727*5.5)	$      680,498.50
Machine Power Costs	0.33	(198000*0.33)	$        65,340.00	(18000*0.33)	$          5,940.00
Machine Set up Costs	27.50	(18000*27.50)	$      495,000.00	(15750*0.33)	$          5,197.50
Total Production Overheads			$  3,910,626.50		$  1,601,454.80

Profitability Analysis:

Sales	$  23,760,000.00	$       7,524,000.00
Total Cost of Goods Sold	$  13,678,626.50	$       6,208,254.80
Gross Profit	$  10,081,373.50	$       1,315,745.20
Number of units sold	24000	6000
Gross Profit Per unit	$                420.06	$                   219.29
GP %	42%	17%

Workings:

Total Cost of Goods Sold
	Lexon	Protox
Direct Material	$    5,491,200.00	$       3,854,400.00
Direct Labour	$        475,200.00	$          277,200.00
Machine	$    3,801,600.00	$          475,200.00
Production Overheads	$    3,910,626.50	$       1,601,454.80
Total Cost of Goods Sold	$  13,678,626.50	$       6,208,254.80
Sales	Lexon	Protox
Number of units sold	24000	6000
Selling Price per unit	990	1254

The case study in the present question deals with case of Beztec Limited which is a manufacturing concern engaged in the business of manufacturing of printers of different models. The company is presently producing Lexon and Protox model of printers. For the calculation of overall cost of the business, traditional costing method is being used in Beztec Limited. The allocation of production related overheads of the business is made by using a single overhead recovery rate (Hart & Dowell, 2011). The overhead rate is applied to both the models on the basis of machine hours used in the production of such printers. However, all the production overheads are not related to the machine hour consumption and hence it is not feasible to allocate the overhead cost on the basis of a single overhead recovery rate (Sani & Allahverdizadeh, 2012). The cost per unit as calculated in the present case study of Beztec Limited is not correctly determined. It could lead to incorrect decision making by the top management of the company. As the management of the company is using such cost information to determine as to which printing model is profitable and which is generating the losses for the business. The results of traditional costing have shown that Lexon Model is generating lesser profits than Protox Model and top management of the company is of the view that Lexon must be phased-out of the business. However, before reaching at the final conclusion as to which product must be phased out, the company must make use of activity based costing. As the business of Beztec Ltd involves different activities for the production of printers, the costs related to each activity must be allocated to both the printer models on the basis of its appropriate cost driver (Ross, 2017). If allocation of different production overheads of the business is done according to the system of activity based costing, the cost allocation will be done appropriately and it will allow the management accountant of the company to provide accurate cost information to the top management of the company so that they can undertake correct decision making (Kaplan & Anderson, 2003).

From the present case study, it has been observed that Steve Kay, the CEO of Beztec Limited is earning sizable amount of incentives based on the performance of its both product divisions. Hence, the CEO is of the view that the company must continue working with the traditional costing system as it providing favourable results to the top management of the company. However, Miss Sue Smith has found that traditional costing technique is not offering the true cost information to the company therefore, activity based costing system must be adopted by the company. To undertake the feasibility and appropriateness of ABC technique, management accountant of Beztec Limited has allocated thw production overheads of the business to both the printing models in the ration of their relevant cost drivers. The cost allocation on this basic has been proved to be more appropriate due to the involvement of multiplicity of activities in the production of printing machines (Dale & Plunkett, 2017). Miss Smith has shown the results of activity based costing method to the CEO of the company, who in turn, rejected the proposal of Miss Smith by asking him to alter the results figured out under ABC method because of the fear that there will be a huge reduction in the bonuses of CEO.

Make or Buy Decisions

In this case, the management account must now refer to the codes of ethics as prescribed in APES 110- Code of Ethics for Professional Accountants. This code is meant for all the individuals who belong to accounting profession and holds the prescribed qualification as prescribed by the profession. The code requires the accountants to adopt the principles of integrity, professional competence and skills, objectivity, professional behaviour and confidentiality, while performing the professional duties so as to respect the accounting profession. The profession of accounting has a districting feature of acting in the public interest. Hence, the management accountant in the current case must not be influenced with the suggestions of company’s CEO about the alteration of cost results which are calculated under ABC approach. The management accountant must apply the principle of objectivity by applying own professional judgement as per the requirements of the situation so as to act in the interest of the overall company not merely in the favour of company’s CEO. Moreover, the accountant must apply all his professional knowledge and skills to accurately determine the true cost of the products in order to avoid negligence towards any of its professional obligations.

In order to understand the concept of disposition of under or over applied overhead, it is important to understand the meaning of applied overheads. Applied overhead are those overheads which are determined by applying budgeted overhead recovery rate to the actual overheads whereas, actual overheads are those overheads which are actually incurred in the course of production (Andersson, et. al, 2014).

Under-application of overhead is defined as the situation when applied overheads are less than the actual overheads while overheads are said to be over-applied in the situation when, applied overheads exceeds the amount of actual overheads.

In both the situations of under-application as well as over-application of overheads, the balanced overheads have to disposed- off in the following manner:

By adjusting the amount to the cost of goods sold:

If overheads are under-applied then it means that less amount overheads have been charged to the products. In such cases, the cost of goods sold account must be debited with the differential amount of applied overhead and actual overhead. On the other side, in case of over-application of overheads, the cost of goods sold account must be adjusted by crediting it with the differential amount of applied overhead and actual overhead.

However, in case when there is a significant difference in the actual overheads and applied overheads, the disposition off under- applied or over-applied overhead must be done in such a way that such differential amount must be bifurcated to the three different accounts- work in progress inventory, finished goods inventory and cost of goods sold. Under this approach, the closing balances of these accounts will be adjusted for such allocation of differential amount.

References:

Andersson, G., Cuijpers, P., Carlbring, P., Riper, H. and Hedman, E., 2014. Guided Internet?based vs. face?to?face cognitive behavior therapy for psychiatric and somatic disorders: a systematic review and meta?analysis. World Psychiatry, 13(3), pp.288-295.

Dale, B.G. and Plunkett, J.J., 2017. Quality costing. Routledge.

Hart, S.L. and Dowell, G., 2011. Invited editorial: a natural-resource-based view of the firm: fifteen years after. Journal of management, 37(5), pp.1464-1479.

Hilton, R.W. and Platt, D.E., 2013. Managerial accounting: creating value in a dynamic business environment. McGraw-Hill Education.

Kaplan, A.L., Agarwal, N., Setlur, N.P., Tan, H.J., Niedzwiecki, D., McLaughlin, N., Burke, M.A., Steinberg, K., Chamie, K. and Saigal, C.S., 2015, March. Measuring the cost of care in benign prostatic hyperplasia using time-driven activity-based costing (TDABC). In Healthcare (Vol. 3, No. 1, pp. 43-48). Elsevier.

Kaplan, R. and Anderson, S., 2003. Time-driven activity-based costing. Available at: https://rozup.ir/up/paper/paper/1/Time_Driven_Activit_Based_Costing.pdf Accessed on 13.09.2018.

Pennanen, A., Ballard, G. and Haahtela, Y., 2010, July. Designing to targets in a target costing process. In Annual Conference Of The International Group For Lean Construction Vol. 18, pp. 161-170.

Ross, J.E., 2017. Total quality management: Text, cases, and readings. Routledge: UK.

Rumble, G., 2012. The costs and economics of open and distance learning. Routledge: UK.

Sani, A.A. and Allahverdizadeh, M., 2012. Target and kaizen costing. World academy of science, engineering and technology, 6(2), pp.40-46.

Schulze, M., Seuring, S. and Ewering, C., 2012. Applying activity-based costing in a supply chain environment. International Journal of Production Economics, 135(2), pp.716-725.