Costing Systems and Techniques in Engineering - Assignment Example

and Section # of COSTING SYSTEM AND TECHNIQUES To complete the requirements of this unit, you need to be able to identify and establish appropriate costing systems and techniques for exact engineering business functions. It is also required to be able to measure and appraise the impact of varying activity level on engineering business performance. We will initiate by introduce some common costing systems used in engineering. 1.1 Costing systems Every modem business enterprise needs to consider an effective costing system that take into account the actual cost of manufacturing the product or providing the service to its consumers. Lacking of such a system in business it is impossible to have power over costs and conclude the returns and profit which business make through operations (Mike, 2004, 22). It is essential for company to have cost accounting system for to be capable to exercise control over the real costs incurred compared with estimated expenditure. From this point of view of cost control, a costing system must not just be able to recognize any costs that are going out of control but must also provide a tool that can help in shaping the action that is necessary to put things accurate. 1.1.1 Job costing Job costing is an incredibly uncomplicated costing technique. It typically applies to an inimitable operation, such as fitting a part or carrying out an amendment to a product. In general functions in which job costing is commonly used include: supplying a unique or `one-off item painting and decorating a building Changing or adjusting a product to meet a specific customers requirements. Job costing contains at least three elements: direct labour; direct materials and absorbed overheads. Sometimes there is an additional direct cost-direct expenses. Big companies also prefer to use job costing when they produce a multiplicity of different, and often distinctive, products. These products are often referred to as custom built and each is separately costed as a `job in its own right. This sort of production is illustrated as irregular (and usually referred to as job shop production) to make a distinction from the incessant or assembly-line production linked with the manufacture of a large quantity of identical units. In job costing production, individual manufactured units are in general produced to meet an individual consumer’s requirements and production is not normally speculative. Costs are settled before manufacturing starts and form the basis of a contract between the manufacturer and the customer. 1.1.2 Contract costing Contract costing usually relates to larger jobs (so is theoretically the same as job costing) and is longer lasting. Contract costing is usually used for things like civil engineering, shipbuilding, and defence. Contract costing is more complex than job costing. 1.1.3 Parts costing Parts’ costing is uncomplicated and is simply a question of determining the cost of all of the physical parts and components used in a manufactured or engineered product. This costing works from the bottom-up in other expressions, the cost of every individual component (i.e. per unit cost) is decided on the origin of the given standard supply multiple. As an instance of parts costing. 1.1.4 Process costing Process costing takes into account the cost of a continual manufacturing process and share out part of the cost of each process to an individual product. Usual processes might be: forming, bending, or machining of metal and plastic parts; flow soldering of PCBs; heat treatment of metal parts; Paint spraying and finishing. Process costing is used in industries that operate on a continuous basis, such as chemical plants, petroleum, or food production. In order to carry out process costing it is necessary to show how the flow of products is costed at each stage of the process; Process 1, Process 2, Process 3, and so on to the finished product (Mike, 2004, 24). 1.2 Costing techniques Any engineering business is accountable to incur a variety of costs. These will typically, include: Rent for factory and office premises; Rates; Energy costs (including heating and lighting); Material Cost; Costs associated with production equipment (purchase and maintenance); Salaries and National Insurance; Transport costs; Postage and telephone charges; Insurance premiums. Given the broad range of costs above, it is often useful to classify costs under various headings, including fixed and variable costs, overhead and direct costs, average and marginal costs, and so on. In order to be capable to control costs, it is, of course, vital to ensure that all of the costs incurred are known. Undoubtedly, the end-products of not being completely aware of the costs of a business operation can be terrible! This section examines several unlike methods used by businesses to conclude the total cost of the product or service that they deliver. The most important object of these methods is that of informing commercial decisions such as: How many units have to be produced in order to make a profit? Is it cheaper to make or buy an item? What occurs to our profits if the cost of production changes? What happens to our profits if the cost of parts changes? 1.2.1 Absorption costing One technique of determining the total cost of a given product or service is that of adding the costs of aloft to the direct costs by a process of allocation, apportionment, and absorption. Since overheads (or indirect costs) can be allocated as complete items to production departments, it is probable to arrive at a notional amount that must be added to the cost of each product in order to wrap the production overheads. Makeup = Total of fixed and variable costs to the attribute Total number of units produced 1.2.2 Marginal costing Marginal costing provides us with a substitute way of looking at costs that provides an understanding into the way costs behave by allowing us to scrutinize the associations among costs, volumes, and profits. The marginal cost of a product is equal to the cost of producing one more unit of output (Mike, 2004, 27). Here are numerous benefits of using marginal costing, notably: Marginal costing systems are simpler to operate than absorption costing systems inasmuch as they shun the problems associated with overhead apportionment and recovery. It is easier to make decisions on the basis of marginal cost calculations. Where numerous products are being produced, marginal costing can show which products are making a contribution and which are failing to wrap their variable costs The disadvantages of marginal costing include: The consequence of time (and its effect on true cost) tends to be overlooked in marginal costing. There is a temptation to spread fixed costs (or to neglect these in favour of more easily quantified variable costs). Marginal costing has decisive element for management decision-making match up to to the absorption costing as it evades using estimation to determine overheads. The choice of whether to use absorption costing or marginal costing is usually governed by factors such as: the production system of financial control used in a company (e.g. accountability accounting is unchanging with absorption costing); methods used (e.g. marginal costing is uncomplicated to control in simple processing functions, whereas absorption costing is generally preferred when numerous different products require different plant and processing techniques the importance of the prevailing level of overhead costs 1.2.3 Activity – Based Costing Activity-based costing is an attempt to assess the `true cost of providing a product or service. Knowledge of the `true cost is not only significant in helping us to recognize opportunities for cost improvement but it also helps us to make strategic decisions that are better informed. Activity-based costing is particularly useful when the overhead costs associated with a particular product are important and where an amount of products are manufactured in diverse volumes. Activity-based costing is particularly applicable where competition is severe and the margin of selling price over manufacturing cost has to be precisely decided and determined. The steps required to carry out activity-based costing are as follows: Identify the activities. Determine the cost of each activity. Determine the factors that drive costs. Collect the activity data. Calculate the product cost. Break- even charts Break-even charts provide a simple (and relatively unsophisticated) method for determining the minimum level of sales that a company must achieve in order for the business to be profitable. Consider the simple relationship illustrated in Figure 1.2.3. Here total income has been plotted against total costs using the same scale for each axis. At point A, total costs exceed total income and the operation is not profitable, that is, it makes a loss. If we charge more for the product, whilst keeping the costs fixed, we would move from point A to B. At a certain point, total income exceeds total costs and we move into profit. Finally, let us assume that our total costs increase whilst the total income from sales remains unchanged. We would then move from profit (Point B) to loss (Point C). Break-even point is the volume of sales at which the operation becomes profitable and it marks the transition from loss into profit. A break-even chart takes the form of a graph of costs plotted against volume of product sold. At this point, it is important to recall that the total costs of the business operation are the sum of the fixed and overhead costs with the variable costs of production. Thus: Total cost = fixed cost + overhead cost + variable cost. The income derived from the sale of the product (assuming a constant pricing structure) will simply be the product of the quantity sold (i.e. the volume of product sold) and the price at which it is sold (i.e. the per unit selling price). This relationship (a straight line) can be superimposed on the break-even chart and the point of intersection with the total cost line can be identified. This is the break-even point and the corresponding production volume can be determined from the horizontal axis (see Figure 1.2.4). The break-even quantity can be determined from: Break – even quantity = Fixed Cost Selling Price - Variable (Note that, in the above formula, selling price and variable cost are per unit.) It is also possible to use the break-even chart to determine the profit that would result from a particular production quantity. Profit can be determined from: Profit = (selling price X quantity sold) - (fixed cost + (variable cost X quantity sold)). Example 1.2.4 Centralux has analysed its fixed and overhead costs which together amount to £250000 whilst the variable costs of its domestic central heating controller amount to £15 per unit manufactured. Construct a break-even chart and use this to determine: (a) The break-even production volume when the controller is sold at: i. £25 per unit; ii. £30 per unit; iii. £35 per unit. (b) The profit for a production quantity of 25 000 units if the selling price is £35 per unit. The break-even chart for the Centralux business operation is shown in Figure 1.2.5. (a) From Figure 1.2.5 the break-even points are: i. 25000 units; ii. 16667 units; iii. 12500 units. (b) From Figure 1.2.5 the profit based on 25000 units at a selling price of £35 per unit is £250000. 1.2.4 Average cost The fixed costs associated with production have to be shared between the entire volumes produced. Hence, a proportion of the final cost of a product will be attributable to the fixed costs of manufacture. The larger the quantity produced, the smaller this proportion will be. In other words, the average cost of the product will fall as the volume increases. Average Cost = Total Cost Quantity Produced Example 1.2.6 Determine the average costs of KarKares trolley jack based on fixed costs of £175 000 and variable costs of £21 per unit for production levels of 5000, 10 000, 15 000, and 20000 units. Average Cost = Total Cost Quantity Produced And Total cost = fixed cost + variable cost. Thus: Quantity produced 5000 10 000 15 000 20 000 Fixed cost (£) 175 000 175 000 175 000 175 000 Variable cost (£) 105000 210000 315000 420000 Total cost (£) 280 000 385 000 490 000 595 000 Works Cited Mike Tooley and Lloyd Dingle. Higher National Engineering, Second Edition. Binding: Paperback. Pp 22.2004. Mike Tooley and Lloyd Dingle. Higher National Engineering, Second Edition. Binding: Paperback. Pp 24-26, 2004. Mike Tooley and Lloyd Dingle. Higher National Engineering, Second Edition. Binding: Paperback. Pp 27-30, 2004. Read More