Costing and Information Systems of the Worplestrop - Essay Example

Costing and Information Systems of the Worplestrop It is important to start by defining what is cost, budget so that we can easily discuss the different budgetary cost control system. Cost can be defined as the actual expenditure which is incurred in getting a product, service or a good. The actual value incurred in performing a task e.g. in the expenditure incurred in producing one loaf of bread. The word budget simply means the plan or frame work of activities express in financial terms. therefore we can defined cost budgetary control system as those methods which management are using to control the actual expenditure in the running of an organization express or laid down in financial plan. There are majorly two types of product costing namely; Marginal product costing Absorption product costing. Marginal product costing Product costs are identified with goods produced or purchased for resale in an organization. In marginal costing only variable cost are charged as a cost of sale and we get the contribution is which normally is given by sales revenue less the variable cost of product sold. The closing stock of goods which are work in progress or finished goods in store is valued at variable production cost. Fixed cost are normally treated as period cost and are charged in full to the profit and loss accounts of the accounting period in which they are incurred. The marginal production cost per unit of an item usually consist of the following items Direct materials Direct labour Variable production overhead. The principle of marginal costing of a product is that in a particular period, fixed cost will always be the same, for any volume of sales and production provided that the level of activity is within the relevant range or the budgeted range , therefore, by selling an extra item of product or service the following will happen. Revenue will increase by the sales value of the item sold. Cost will increase by the variable cost per unit Profit will increase by the amount of contribution earned from the extra item Similar if the volume of sale, if the volume of sales falls by one item, profit will fall by the same amount of contribution earned from the sale of items. Profit measurement should therefore base on analysis of total contribution. Since fixed cost relates to a period of time, and do not change with either increase or decrease in the sales volume, it is misleading to charge units of sales with a share of fixed cost from total contribution of the period to get the profit figure. When one unit of a commodity is produced then an extra cost must be incurred in its production as a variable cost but fixed cost will always remain constant. Then it is true to say that it is in order to value the closing stock as variable cost. Absorption product costing It is sometimes called full costing, in this costing, all the manufacturing cost incurred in any particular period is accounted for, and also until the product is sold fixed overheads will remain a product cost. In this type of product costing, there is no distinction between variable cost and fixed cost and for this case is not advisable to use it in analyzing CVP. And is calculated by sales revenue minus cost of goods sold to remain with gross profit. Worked example to show how the marginal costing is done Caleb ltd makes a product the tapes which has a variable production cost of $45000 Production, administration, sales and marketing, there were on any variable marketing cost. Calculate the contribution and profit for 19x3 using marginal costing principles, if sales were as follows a)10,000 tapes b) 15,000 tapes c) 20,000 tapes in order to calculate the profit, first we have to identify the variable cost then after that the contribution. The fixed cost are usually deducted from the contribution for us to get net profit.. the assumption here is that stock is valued at marginal cost ($6 per unit) Marginal costing example 10,000 tapes 15,000 tapes 20,000 tapes Sales (at $10) 100000 150000 200000 variable production cost 120000 120000 less value of closing stock 60000 30000 variable cost of sales 60000 90000 120000 Contribution 40000 60000 80000 less fixed cost 45000 45000 45000 profit/loss -5000 15000 35000 Profit/loss per unit ($0.5) ($1.0) ($1.75) Contribution per unit $4 $4 $4 In the above calculation it can be seen that profit is varies at different levels of sales this is so because the average fixed overhead cost of each unit usually changes with the changes in volumes of output of sales. The contribution per unit is constant all through in each level of level output. I comparing the marginal costing and absorption costing, the following calculation can help us draw the major distinction in the two product costing systems. Two right feet company manufactures one single product , the clown. The figures below relates to the cost ad units produced in one year. Activity level 50% 100% Sales and production units 8000 1600 Production cost: variable Fixed 3200 1600 6400 1600 Sales and distribution cost: variable Fixed 1600 2400 3200 2400 Usually the level of activity for the whole year is 800 units. Fixed units usually are incurred equally through the year and are the same as the budgeted cost. In the first quarter of the year, 220 units were manufactured and the units which were sold are 160. Therefore calculate; a) Fixed production cost absorbed by clown in the initial quarter of the year b) Get the profits in absorption costing method? c) Get the profits using the marginal costing method? d) Explain to the management the difference between the methods hence advise them accordingly on which method to be used in management decision and budgeting control system. Worked The fixed production costs absorbed by the clown product in absorption quarterly are given below. Budgeting fixed production cost /budgeted output =$1600/800 units Absorption rate is going to be $2 per each unit produced. During the quarter, the fixed production overhead absorbed was 220 units*$2= 440 b) The over or under recovery of overheads for the quarter can be given below; Actual fixed production cost overhead $ 400 (1/4of $1600) Absorption production fixed overhead 440 Over absorption of overhead 40 c) Profit calculation using absorption method. Sales 3200 production cost variables (220*8) 1760 fixed overheads (22*2) 440 Total 2200 production cost of sales 600 adjustment for over absorption 1600 total production cost 40 1560 Gross profit 1640 less: sales and distribution cost variables(160*4) 640 fixed cost (1/4*2400) 600 1240 net profit 400 The calculation using marginal absorption method marginal costing profit Sales 3200 variable production cost 1760 less closing stock (60*8) 480 variable production cost of sales 640 1920 total variable cost of sales 1280 total contribution less fixed production cost 400 fixed sales and distribution cost 600 1000 net profit 280 It is now clear that there are differences on the profit on the two approaches on how the product costing is arrived at. This difference comes about as a result of different stock valuation. In absorption there is cost carried forward to the next accounting period. It is shown below. Absorption costing profit is 400 Fixed production carried forward 120 Marginal costing profit 280 In advising the management the following conclusion can be mad Marginal costing and absorption costing are totally different approaches in analyzing profit. The two methods or approaches give different result if there are changes in stock level but if the opening stock and closing stock volumes or quantity are the same then the two methods will give the same profit. Absorption in most cases are used for daily to daily profit reporting in it is compulsory that is used in financial accounting purposes while marginal costing method is usually used for management purposes in planning, budgeting and decision making purposes. Marginal costing usually help the management to calculate breakeven point where the production manager will produce goods without making any loss or profit even if the trading is not good then the company will still thrive in the market. This breakeven figure will also help the marketing managers to know the market expectation which he or she needs to market at any given point hence the company will be all round and manage to produce goods without surplus or demand deficit. Marginal costing is also very useful in analyzing cost volume profit analysis. this is the analysis which involve analyzing the relationship between the cost of product, level of activity and the level of profit at any given point. This analysis will help the management to know the effect of; Production methods changes in an organization Effect of changes in product mix The ultimate effect or the impact of price changes on profit as price changes The viability of a particular sales promotion techniques and promotion campaign The management should also know the relevant cost which should be taken into consideration, the relevant information here will be either that cost is avoidable or unavoidable. Decision making may be either; short run operation decisions or short term tactical decision and or longer term strategic planning decision. The Worplestrop Company should adopt marginal product costing method for decision making. In cost accounting there are majorly two extensive systems used in any organization, they include; Interlocking cost accounting system Integrated cost accounting system In interlocking cost accounting system there are two different sets of books of account are kept though all of them uses the same accounting data. In financial accounting books they have the normal debit and credit books and in addition to that they also have cost ledger control accounts. The ledgers kept here include; The general ledger Creditors ledger and the Debtor’s ledger Integrated accounting system in the other hand only makes use of one book to record all the transaction in it. Integrated accounts have some important features which the management should consider using instead of interlocking accounting system. They are; Only one book of account is used for both costing and financial accounting purposes There is no need to reconcile the books of accounts that is the profit unlike the interlocking one the reconciliation of the profit must be done Removal of duplication of effort in maintaining the two sets of books of accounts It is user friendly as it is compatible with most computer based systems hence managers can easily use them to calculate the cost volume profit analysis. So Worplestrop Company should consider using it instead of interlocking accounting system. References Cost management and accounting By The Institute of Cost Accountants of India 12, SU DER STREET, KOLKATA - 700 016 Cost accounting and principles of budgeting b By Salemi .M. http://www.amazon.com/Cost-Management-Strategic-Emphasis-Edition/dp/0073128155/ref=pd_sim_b_2 Gibson, M. (2007). ‘Credit Derivatives and Risk Management.’ Board of Governors of the Federal Reserve System Finance and Economics Discussion Series paper 2007-47. Read More