Product Cost Systems

Abstract

Describe about the Product Cost Systems.
 

In any given organization, keeping complete records with regard to the value of their inventory is one of the major concerns. This is because keeping too much stock that is unprofitable or using inappropriate product cost measures may result into a company making losses. It is, therefore, necessary for a company to have an effective product cost system that will be able to provide relevant information when needed.

Manufacturers have different methods that they use to determine the product costs. The decision used is usually based on various factors including marketing, and distribution among other factors. It is necessary for an organization to have well outlined mechanisms that may be used to determine the prices for its products so that the company does not incur losses. Having an effective mechanism for determining the product cost will also be necessary for the management of an organization during the decision-making process. Effective product cost measures are necessary to managers for long-term or short-term decisions.

This report, therefore, will discuss the concept of product cost and some of the necessary product cost measures that are important to the management while making decisions regarding the price of a particular commodity. This will include providing a clear picture of some of the features of used by the various product cost mechanism to determine the price of a commodity. Also a case study using CSL Limited annual report 2014-2015 will be done to describe the common product cost systems and how the company has used these systems to establish the prices for their commodities. The report will also discuss the various purposes of product cost measures in an organization especially the CSL Limited.

The report will conclude, by describing the types of product cost systems and commenting on how CSL Limited has adopted the two systems in its price evaluation strategy for its products. This will include comparing the two strategies and recommending on the effective system for the company.  

Product cost is used to define the costs that a company incurs in producing a product. The cost could be described in terms of the cost that a company incurred for the direct labor, and raw materials that were used to produce the product. The costs incurred to market and distribute the products can also be used to determine the product cost. On the other hand, product cost can be described as the cost a company will incur for the direct labor used while providing service to a client. In this case, the product cost will be based on the cost that relates to the service offered such as employee’s benefits, and taxes among others (Banker, Data, Kekre & Mukhopadhyay 1990). Therefore, to determine the product cost for a given unit; a company will consider a batch of various units that were involved in the production process and the total number of product units produced in a given period that is,

Product cost = (cost of direct labor + Cost of direct materials + Consumable supplies units + company overheads)/ Total number of units produced

Types of Product Cost Systems

Product cost is very necessary to the management of a company as it provides information that is useful for decision-making. Another use of the product cost is in the preparation of external reports. This report will therefore discuss in detail the product cost and the purpose of the product report. Examples based on CSL Limited will be provided to further describe the concepts of product cost and its purposes to the management of the company. 

The paragraph provided outlines the various concepts of that are used to describe the product cost. From the paragraph, the product cost concept to be used by a given company will depend on the on the purpose that the managers of a company want to achieve. For instance, there are product costs that are necessary for external reporting while there are those that may be useful to the management of a company as they will be used in the decision-making process. This, therefore, implies that consideration needs to be done so as to determine an effective product cost mechanism to use for any particular company. Despite this, it is important to note that all product cost measures are necessary for inventory evaluation.

Hence, product cost measures in a given organization will depend on the purpose such that if the need is to do perform external reporting then the product cost measure will be done based on the cost that was incurred while producing or manufacturing the product. On the other hand, if the purpose is to provide information to the managers of a company that will help in making decisions related to the product such as its price then the product cost measure should be able to provide in detail all the information that is related to the product from the initial point of production to the final stage (Beattie,Taylor, & Watts 1985). This information may include the cost involved in manufacturing, marketing, and distribution of the product. The information provided should also include any information regarding the services that were offered to the clients. It is, therefore, necessary for a given company to consider the purpose of the product cost before choosing the type of product cost measure to use. This, therefore, implies that every organization has to have an effective product costing system.  

Product costing systems are used in an organization for various purposes. For every organization that produces goods or services, it is necessary for them to have a mechanism for measuring the product cost. This information will be made available in the accounting documents for a company. When an organization expands, it becomes complex to calculate the product cost. The product cost for a given business may be calculated monthly, quarterly or yearly depending on the organizational needs of an organization (Kaplan & Atkinson 2015).There are the necessary factors and steps to be followed by a company while calculating the product cost for a given period of time. These steps include: (1) Identifying the cost object; a cost object may be defined as a product or service whose price is to be determined. The cost object usually depends on various factors such as the cost required to produce the product, and the cost of raw materials among other factors. To calculate the cost of a given product, the product units are grouped into a unit and their cost is determined. Hence, where one needs to calculate the cost of an individual unit then the batch price will be divided with number of units, (2) Identifying the direct costs; this follows after one has identified the cost object.  Direct costs are normally calculated based on the cost object or the product that an organization produces. In general, management accounting defines two systems that are used to determine the cost of a product; direct cost and indirect cost (overhead costs). It is therefore necessary for an organization to consider the two systems while calculating the product cost. Direct costs define the cost that relates to the product in question that is, the cost can be traced easily to the product that is in question. For any particular company, direct costs are attached directly to the products being produced. Material costs define the materials that have been used to produce a certain product and can easily be traced to a given batch of product.  Generally, direct costs define those costs that can be traced back to a given product produced by an organization, (3) Identifying the overhead costs; this defines the cost of product which is really not attached to the product but instead is used to facilitate the entire operations of the company. This may range from a range of factors include the electricity bill, material costs or costs involved in maintenance. In management accounting, these costs are treated in the following ways; (a) an accountant may chose to ignore them, (b) they can also be treated as a lump-sum, (c) they may be allocated to their cost object, (4) Determining the cost allocation base; the cost allocation base may be defined as the link used to relate the overhead cost and the cost object. The cost allocation base may be taken to be the total number of goods that are produced by a company over a certain period. For example, the total numbers of drugs produced by CSL Limited. The value chosen as an allocation base should be applied uniformly to all the cost objects, and (5) Developing the overhead rates; the overhead rates define the numbers of dollars that are used to represent overhead costs per unit of the cost allocation base. The general formula for calculating the overhead rates is given as a ratio of the cost pool overhead dollars in the numerator and the total quantity of the cost allocation base that is, Overhead rate = Overhead costs in the cost pool/ Total quantity of the allocation base. From CSL Limited annual report 2014-2015 the following is an example on how to determine the product cost;

Item	Directed Cost	Overhead Cost	Product Cost
Sales revenue	762,200,000		762,200,000
Cost of Sales	467,700,000		467,700,000
Sundry revenue	199,100,00		199,100,00
Dividend Income	1,290,300,000		1,290,300,000
Interest Income		55,400,000	55,400,000
Research and Development		189,300,000	189,300,000
Selling and marketing	64,000,000		64,000,000
General and administration		113,200,000	113,200,000
Finance cost	6,300,000		6,300,000
Income tax expense		4,900,000	4,900,000
Total	2,590,500,000	362,800,000	2,953,300,00

Case Study: CSL Limited Annual Report 2014-2015

The product cost determined can be used by an organization for two main purposes. This will usually depend on the management of a company: (1) Decision Making; the decision-making product costs are used to calculate the approximate the marginal costs. In this case, for short-term decision making process, labor costs are considered as a fixed cost because the labor costs tend to remain constant over a wide range of output (Shepherd 2015). Additionally, Overhead costs tend to change only when there are some restructuring processes in a company. Therefore, the only costs to consider in this case are the costs that change with the production that is, it includes the costs that increases the total costs that a company incurs after the production of an extra unit of product, and (2) External Reporting; product costs measures are also important to an organization as they help in generating external reports. External reports are used to describe the cost that an organization incurs which does not depend on the units produced over time.  Such costs could be material cost or other overhead costs the organization encounters. The material cost in an organization is calculated from the bills that the company pays to support its operations. The material cost is also known as the unit variable cost. In general, external reporting may not be necessary to managers while making short-term decisions. Thus, depending on the purpose of the product cost, managers can choose the product measure to use.

In general, there are two main types of product cost system used in the evaluation of the inventories in an organization. The two types include: (1) Direct Cost; this refers to the cost that can be clearly related to a given product or service. These are used by managers in an organization to make incremental decisions. Direct costs in an organization may include direct raw materials, manufacturing supplies, and commissions. However, while doing the inventory evaluation both the direct and indirect costs should be considered, (2) Indirect costs; these are costs that cannot be attached or traced directly to a particular product or activity. Therefore, they are only allocated to a product or service. Thus, indirect costs not only include the cost associated with producing the product but also the cost that are involved in maintaining a company. An example of a company’s indirect costs includes the costs of maintaining a given machine. Indirect cost can also be varied or they can be fixed.  From the foregoing, it is necessary for a company to consider in detail how to classify the various expenses in a firm as this will determine how taxes are charged on different products. 

To conclude, product costing system is a very important aspect for any given organization as it will be used to determine the profitability of a company. Product costs are used by managers of various organizations to make long-term and short-term decisions. In addition, the product cost is also used for preparation of external reports. Depending on the purpose that the managers want to accomplish, an organization may decide to choose among the two different types of the product cost system that is, the direct cost system and the indirect cost system. An organization should consider the two systems while classifying its expenses as direct costs or indirect costs as this has an impact on the taxes charged. From the case study of CSL Limited, the company has effectively applied the concept of product cost in its operation. The company has adopted the use of both direct costs and indirect costs. Direct costs has been used to help the company’s managers in the decision making process. This includes the direct labor involved in the manufacturing drugs among others. On the other hand, indirect costs have been used in improving the operations of the company. This has been the case where the CSL Limited has expanded its operations with the recent opening of various facilities such as 300,000 square feet expansion in Kankakee and the state of the art manufacturing facility that was launched in Switzerland. This will have to be considered while determining the prices for its products.  The product cost systems will be important to the CSL Limited considering its expansion to various regions of the World. The direct cost will be used by the management to decide on various aspects of manufacturing including raw materials required, and direct labor such as doctors and pharmacists among others. The indirect costs incurred will be used in the improvement of the operations of CSL Limited. 

References

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