Describe about the Introduction to Management Accounting for Manufacturing Entity.
In a manufacturing entity, such as Seafarer Kayaks, the Product Costing System (PCS) can help the management to efficiently store or retrieve information related to costing of the materials and the product. It can also help the management in managing its costs by linking the information inputs with the entity’s business plan, say Baker & Riddick, (2013). The company can evaluate the following processes through the use of PCS line:
This process controls information related to costs of direct labour, indirect labour and overheads related to them.
This process relates to the products’ design and manufacturing engineering.
This process controls the Gross Margin generated by individual product line or the product.
Once the PCS has been established for controlling the costs, the Manufacturing Accounting System of Seafarer Kayaks can keep track of the costs, generate reports on any variances occurring and post the manufacturing transactions in the general ledger, as per Baker & Riddick, (2013). Before proceeding further, it is essential to calculate the standard cost values, including:
This is for assessing the cost to produce the item.
Calculate difference between the actual and standard costs.
It is also essential for Seafarer Kayaks to maintain an accurate and complete record of the value of inventory in businesses today. It may become unproductive for the company if excessive inventories are maintained. Following the AASB102 is beneficial for Seafarer Kayaks for controlling the above factors, as per Baker & Riddick, (2013).
AASB102 will help the management of Seafarer Kayaks in maintaining a suitable accounting treatment for its inventory maintenance. The basic issue while maintaining inventory accounts is concerned with the amount of cost which can be recognised as an asset and can be carried forward till the management is able to recover the revenue invested, assert Greuning, Scott & Terblanche, (2011). The purpose of this Standard is to provide guidance to the managers in recognising this cost and in distinguishing between the amount as an expense and the amount which has to be written-down as the net realisable value. This Standard applies to all types of inventories, except the:
hence Seafarer Kayaks can make use of this Standard for efficient management of its inventory position.
Schedule of Cost of Goods Manufactured
Seafarer Kayaks while using the manufacturing cost system will debit all the manufacturing costs, including cost of the direct materials, direct labour and the applied manufacturing overheads to the work-in-process account, assert Greuning, Scott & Terblanche, (2011). Once the job routine for a specific period is complete, the amounts shown in the job cost sheet will be transferred to the finished goods account from the work-in-process account. To complete the record, a journal entry, as shown below, will be entered:
Finished Goods A/c $xxxx
Work-in-Process A/c $xxxx
This total cost of the materials which is transferred from work-in-process account to finished goods account, during this specific period, will be termed as cost of goods manufactured. At the end of the specified period, the remaining raw material under process of manufacturing will be termed as work-in-process inventory and will reflect under Current Assets in the Balance Sheet. When the next manufacturing period commences, this amount represents as the opening balance under work-in-process account, as per Mudra, (2014).
CASE STUDY: See Table-1 in Annexure-1 for the calculations.
Schedule of Cost of Goods Sold
The sales revenue generated by Seafarer Kayaks less the direct cost of manufacturing the kayaks is termed as the cost of goods sold. Sales Revenue less the cost of goods sold is the gross profit of the company. As per the accepted accounting principles, cost of direct materials, cost of direct labour and the manufacturing overheads are considered for determining the cost of manufactured goods, asserts Mudra, (2014). Cost of goods sold is calculated in this case study has been derived through the use of the following method:
(Opening Inventory) + (Cost of Goods Manufactured) – (Closing Inventory).
CASE STUDY: See Table-2 in Annexure-1 for the calculations.
Manufacturing overhead are the costs involved in the company’s manufacturing operations. It includes all those costs which are incurred during the manufacturing process, including the costs of direct materials, direct labour and other direct expenses. Direct expenses, according to Taylor, (2013), include depreciation on the factory building, tools and equipment and machinery, wages of factory manager, production workers, factory repair and maintenance expenses, insurance and land tax, cost of electricity and gas used in the manufacturing process and the indirect supplies used in the manufacturing process, such as packing material, as per Keown et al, (2012). Certain costs, such as the factory land tax, which is calculated on the basis of the assessed value of the land and has no connection with the units produced, although not directly linked directly to the manufacturing costs, is still considered as direct expenses, says Kurth, (2011).
T-Accounts
CASE STUDY: See Table-3 in Annexure-1 for the calculations.
CASE STUDY: See Table-4 & 6 in Annexure-1 for the calculations.
CASE STUDY: See Table-5 in Annexure-1 for the calculations.
CASE STUDY: See Table in Annexure-1 for the calculations.
Discussing Overheads
Manufacturing Overhead
Manufacturing or factory overhead of Seafarer Kayaks pertains to those manufacturing expenses which are apart from the cost of the direct materials and direct labour used in the manufacturing process, explains Kurth, (2011).
Preliminary / Estimated Overhead
Since the expenses have to be booked under different specified accounting heads as soon as they are incurred, management of Seafarer Kayaks cannot wait till the end of the specific manufacturing period to decide what will be the exact manufacturing overhead costs. Hence, as per the prevalent norms in all manufacturing entities, the management has to work on the basis of estimates which are based on past working capabilities and on future expectations, assert Marchildon & McDowall, (2013). These are termed as Preliminary or Estimated Overheads.
Applied Overhead
Now, as the production process goes on, the accounts department in Seafarer Kayak will begin posting the actual manufacturing overhead expenses in the books of accounts on the basis of the actual number of machine hours put-in by the workers and multiplying the number by the hourly rate fixed, as cited by Marchildon & McDowall, (2013). This amount will be considered as the company’s “applied overhead” and will be used for determining the cost of goods sold.
Difference between Over-applied & Under-applied Overheads
When the preliminary or estimated estimates of the overhead expenses differs from the actual expenses incurred by Seafarer Kayaks, the resultant difference is termed as over-applied overhead in case the estimates exceed actual overhead expenses or under-applied overhead in case the estimates fall short of the actual overhead expenses, as detailed by Greuning, Scott & Terblanche, (2011).
Implications of Over-applied and Under-applied Overheads
In the account books of Seafarer Kayaks, the actual overhead expenses incurred are debited and the applied overhead expenses are credited at the time of estimation.
In case the Manufacturing Overhead A/c of Seafarer Kayaks shows a credit balance at the end of the specific manufacturing period, it shows that the overhead expenses have been over-applied.
In case the Manufacturing Overhead A/c of Seafarer Kayaks shows a debit balance at the end of the specific manufacturing period, it shows that the overhead expenses have been under-applied.
On the basis of this conclusion, the management of Seafarer Kayaks will, at the end of the income year, will know how the estimated manufacturing overhead expenses have performed in comparison to the actual manufacturing overhead expenses. This proves beneficial for the management while setting estimates for the future, as detailed by Greuning, Scott & Terblanche, (2011).
Standard Costing System
For a company such as Seafarer Kayaks, the process of applying Product Costing has a significant role in its manufacturing performance. Hence, it is imperative for you to make a decision about the process you want to use for your Manufacturing Accounting System. The decision can be between Standard Costing and Actual Costing Methodology. I would advise that you choose the Standard Costing Systems for your manufacturing accounting process. I would also suggest that you set a Standard Cost Component Value System for the Kayaks that you produce.
Detailing the Standard Costing System
Please note that the Standard Costing System uses the practice estimating the costs and eventually substituting these by the actual costs in the accounting books after a specific period, which should usually be on Quarterly basis, as explained by Yona, (2011). After every quarter the periodical variances should be evaluated so as to calculate difference between the estimated and actual costs. In this system, you will be required to commence the manufacturing process with predetermined standard costs of raw material, direct labour and manufacturing overheads, asserts Yona, (2011). You will use these predetermined standard costs for evaluating your Cost of Goods Sold as well as inventories. At the end of the quarter, in case the actual standard costs are varying slightly from the predetermined standard costs, you can assign the resultant variance to the cost of goods sold amount. In case the variance amount is high, it should distributed on a prorate basis between the inventory value and the cost of goods sold, says Taylor, (2013).
Thus, you can understand from the above, that Standard Costing System involves:
Ascertaining and using Standard Costs.
Recording of the actual costs.
Comparing the actual costs with standard costs to find the variance.
Analysing the variance.
Appropriately adjusting the variance as per requirement.
You will find that Standard Costing System has the following advantages:
It serves as a guide for the managers in the process of formulating production policies and deciding the sale prices.
Managers can exercise better cost control in case the process is reviewed at regular intervals and analysed for improving the costing of the products leading to reduced investment.
Managers can investigate and take corrective action on the basis of the variance as its regular measurement helps in detecting inefficiencies and mistakes.
The predetermined standard costs are useful in planning and budgeting exercises undertaken by the managers.
It improves the production efficiency and ultimately leads to reduction in costs, thereby increasing your profits.
A timely implementation of the Standard Costing System leads to cost saving as frequency of the costing system can be reduced.
Effective setting up of costing standards for individual cost centres for the supervisors and the executives allows each cost centre to know the limits which they need to maintain for their Standards.
The system will assist the managers in preparing their Profit and Loss Accounts quickly for those short periods for which they would like to know the trend of their department and the help it can provide to the management in taking decisions for the future course of action.
Standard costing can also be used by you for valuation of inventory. Once the inventory has been valued at its standard cost, chances of fluctuation of profit can be reduced even if different methods of valuations are adopted.
Labour efficiency can be enhanced as this system makes executives as well as the management cost-conscious thereby increasing production efficiency as well, as detailed by Mudra, (2014).
Disadvantages of Standard Costing
Like every system, this too has its disadvantages:
The system is costly as it involves a high degree of technically skilled staff. Organisations with limited financial resources cannot sustain it.
The variances can only be put to advantage if the executives take action of actually controlling them. This requires fixing up responsibilities.
Standards need periodic revisions as they tend to change with the change in the financial conditions and market environments. Such revision of standards can create problems, particularly if inventory adjustments are not controlled.
Standards can either be too rigid or too liberal as these are based on the past results of the averages. Hence, in case the standards have been set very high, this can adversely affect the morale of the management and the motivation factor of the employees, as explained by Mudra, (2014).
References
Baker, H.K. and Riddick, L.A. 2013. International Finance: A Survey. OUP USA, Oxford.
Greuning, H., Scott, D. and Terblanche, S. 2011. International Financial Reporting Standards: A Practical Guide. World Bank Publications, Washington DC.
Keown, A.J., Martin, J.D., Petty, J.W. and Scott, D.F. 2012. Financial Management: Principles and Applications (10th ed). Pearson Education India, New Delhi.
Kurth, S. 2011. Discuss covered interest rate parity (CIRP) with reference to foreign exchange market efficiency. GRIN Verlag, Norderstedt.
Marchildon, G.P. and McDowall, D. 2013. Canadian Multinationals and International Finance. Routledge, New York.
Mudra, J. 2014. International Financial Management (12th ed). Cengage Learning, Stamford, CT.
Taylor, M.P. 2013 Purchasing Power Parity and Real Exchange Rates. Routledge, Oxon.
Yona, L. 2011. International Finance for Developing Countries. Author House, Keynes.
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