Process Costing Methods Analysis - Essay Example

? Process Costing Grade Outline Introduction……………………………………………………………………….…..3 Importance of the Study………………………………………………………….…...3 Literature Review……………………………………………………………………..3 Conclusion…………………………………………………………………………….6 References……………………………………………………………………….…….8 Introduction Tracing production costs can be a challenging task especially when one is dealing with both direct and indirect expenses. Companies need to know the amount of money spent on their products before they can set appropriate selling prices. Firms that fail to accurately determine process costs can find themselves setting too low prices that lead to losses or too high prices that scare away customers. Accurate process costing helps to set right prices or adjust the process if costs cannot allow reasonable pricing. Importance of the Study Although many researchers have contributed to this topic, little can be seen in terms of standardization of the approaches of determining process costs. This paper is a literature review aimed at determining major points of divergence that have prevented standardization of process costing methods. Four scholarly articles are analysed to determine gaps, discrepancies and common grounds in relation to process costing. The paper will make suggestions on the best way forward as well as lay ground for future research. Literature Review One of the articles reviewed is a research study done by Cooper and Slagmulder aimed at determining process costing methods used by different Japanese firms (2002). According to Cooper and Slagmulder (2002), the main purpose of process costing is to reconcile product costs with quality in a manner that facilitates customer satisfaction and takes care of the company’s long terms goals. Cooper and Slagmulder interviewed employees involved in process costing in six firms. The researchers picked well known international corporations to represent the rest of companies in Japan. This was not a good sampling approach because failure to give all firms equal chances of being included in the sample introduced some biasness in the study (Dillman, Eltinge, Groves & Little, 2002). The interviewers made notes while taping interviewees’ responses. The findings indicated that most Japanese firms preferred target costing as opposed to process costing. In this regard, target costing is a projection of costs of future products with the aim of determining whether the assigned expenses can allow reasonable pricing to generate profits or not. The difference between process costing and target costing is that the latter is applied on future products while the former on complete or semi-complete products (Cooper & Slagmulder, 2002). All interviewed firms indicated that they relied on target costing and only applied process costing when they find discrepancies at the end of the production process. In another study, Everaert, Germain and Werner sought to investigate process costing methods used by different companies in Belgium (2002). The researchers based their study on four companies that were selected randomly (2002). After getting approval, they issued questionnaires to process costing officers in the selected firms and collected them after two weeks (Everaert, Germain and Werner, 2002). The results indicated that three out of the four sampled companies used weighted average method of process analysis. The remaining firms used the first-in first-out (FIFO) method. The FIFO method treats costs from different periods separately and has four steps comprising of analysis of physical flow of units, calculation of equivalent units, computation of unit costs and analysis of total costs (Everaert, Germain and Werner, 2002). The company that used FIFO said the method is reliable because separate calculation of costs for different periods gives a fair assessment of current performance as compared to averaging costs for two or more periods. Firms that used the weighted average method said it is easier to use and reasonably accurate (Everaert, Germain and Werner, 2002). In a similar study, Shim & Siegel sought to determine the process costing approaches that companies in the United Kingdom prefer (2009). The researchers used both quantitative and qualitative research methods. They used questionnaires that were filled by researchers during interviews with accountants from seven firms that were randomly sampled (Shim & Siegel, 2009). Out of the seven firms that participated, two used the standard costing method, one used FIFO and four firms used the weighted average method. The firms that used FIFO said it was good for assessing current performance of managers in relation to cost management (Shim & Siegel, 2009). Similarly, firms that used weighted average method cited easy application and reliability as the reason for their choice. On the other hand, firms that used standard costing said that the method is easier, reliable and straight forward. Standard costing uses estimation of expected costs in comparison with actual costs at the end of production (Shim & Siegel, 2009). In this method, variances between expected and actual costs are calculated and their causes determined. One of the advantages associated with the standard method is that it enhances efficiency due to thorough analysis of the process before standards are set. Ahmadzadeh, Hossien and Pifeh carried out another study to determine factors that influence selection of activity based system in Iran (2011). The researchers used simple random sampling method to get a sample of 170 firms. Self-administered questionnaires were issued to the companies and only 57 were returned for analysis. It should be noted that reduction of sample size by more than 20% can significantly change the outcomes of a study (Dillman, Eltinge, Groves & Little, 2002). The result indicated that choice of the activity based costing depends on the size of the organization, nature of the industry, cost structure, importance of cost information as well as product diversity. Table 1 Study Aim Results Conclusion Cooper & Slagmulder, 2002 Determine process costing methods preferred by Japanese firms. All the six firms involved used target costing to manage costs. Weighted average seems to be preferred by many firms. However, the preference is informed by its simplicity in terms of application than reliability. Therefore, there is need to find an approach that is both simple and reliable at the same time. Everaert, Germain and Werner (2002) Determine process costing methods preferred by US firms 3 out of 4 firms used weighted average method. 1 used FIFO method. Shim & Siegel (2009) Determine process costing approaches preferred by UK firms. 2 out of 7 firms used standard costing, 1 used FIFO method and 4 used weighted average method. Ahmadzadeh, Hossien and Pifeh (2011) Determine factors that influence selection of activity based system in Iran Size of the company, industry type, cost structure, importance of cost information and product diversity. Conclusion Process costing is important for realization of short term and long term profit plans. This review finds that there is no particular pattern followed by firms in their choice of process costing methods. In this regard, lack of particular trends implies that there is no sufficient information to guide firms in their strategic decisions related to process costing. Therefore, there is need for extensive research in this area to determine actual process costing needs for different firms and suggest a more reliable approach. References Ahmadzadeh, T., Etemadi H. & Pifeh A. (2011). Exploration of Factors Influencing on Choice the Activity-Based Costing System in Iranian Organizations. International Journal of Business Administration, 2(1). Cooper, R. & Slagmulder R. (2002). Cost management in Japan. Journal of Cost Management, 12 (1), 7-41. Dillman, D. A., Eltinge, J. L., Groves, R. M., & Little, R. J. A. (2002). Survey nonresponse in design, data collection, and analysis. In R. M. Groves, D. A. Dillman, J. L. Eltinge, & R. J. A. Little (Eds.), Survey nonresponse, 3-26. New York: John Wiley & Sons. Everaert, P., Germain B. & Werner B. (2002). Working process costing methods. Journal of Business Finance and Accounting, 41 (2), 11-32. Shim, J. K. & Siegel, J. G. (2009), Modern cost management and analysis 3rd Ed. 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