Classification of Day-to day Costs - Term Paper Example

First of all, I would like to thank the executive committee of Ms. Home Improvements and Extensions for giving me an opportunity to benefit you from my experience and insight on the topic of management accounting and cost controls. From my experience and knowledge of management accounting, I can safely say that two broad categories in which the daily costs can be classified into are fixed costs and variable costs. Since the construction business we run cannot thrive without paying either of these costs, therefore, it is very important to understand both of these concepts. Fixed costs, on one hand, are those costs that are incurred whether the business is running or it is closed. These are incurred even if we the level of activity is very high or it is nil. Some examples of fixed costs are insurance, rent, and depreciation and fixed utility charges. Even if the firm is not operating, it will have to bear these costs. For your company, the fixed costs are: insurance, rent of premises, utility charges and salaries of those personnel who are on fixed wages. Similarly, the other broad category of costs is variable costs. These costs vary with the level of activity. If the level of activity is really high, then these costs will be higher than at low level of activity. Some of variable costs include fuel costs, wages of labor that are paid on hourly basis and costs such as transportation costs, material costs etc. Variable costs for our construction company will include material costs, labor costs and variable utility costs. These were two main broad categories of cost. However, another category of costs exist which is neither fixed nor variable. These costs do agree with the definitions of either fixed or variable costs. Therefore, expert cost accountants have come up with a new category of cost called semi-variable costs. These costs are different from fixed and variable costs as they remain fixed up to a certain point, after which they become variable. As I have noticed that there are several personnel in Ms. Home Improvements and Extension, who earn a basic fixed wage and then they are paid commission, the salaries paid to these workers can classified as semi-variable cost. Another category of costs that exist is called sunk costs. Sunk costs are those costs that are necessary for starting up a business, but cannot be recovered later. These costs include basic start-up costs like obtaining a license to start up operations of a company. Since, it is in my knowledge that Ms. Home Improvements and Extensions obtained a license to start up their business; these costs will be classified as sunk costs. TASK TWO: In cost accounting there are various costing options available for businesses to choose from. However, many businesses try to choose those methods that are best suited for their businesses and reflect the costs as accurately and as fairly as possible. It is the role of management accountant to help the firm into deciding which of the method from among the various alternatives to choose from. The job is not easy and therefore services of a professional helps the business into choosing the best possible alternative. There is no one absolute answer for all businesses, but instead the accuracy and usability of various alternatives differ from one business to another. The various costing methods that can be used are job costing, absorption costing and marginal costing. In absorption costing all the direct costs are added to the cost sheet whereas overheads are absorbed taking into account overhead absorption rate. Here all the costs are to absorbed by the number of units of produced. This is different from marginal costing. Marginal means cost of producing one extra unit. Here cost of producing extra units will be absorbed by the product. The main features of this type of costing are that accountants or a company needs to know the marginal cost. Here fixed costs are never charged to production but instead they are written off against profit. The best method of costing for Ms. Home Improvements and Extensions is job costing, since it is a construction. Here it is very easy to ascertain the cost of material, labor and overheads incurred after which profit is added to arrive at the cost price for the customers to be mentioned in the quotation for customers. Job costing is better than absorption costing because here different jobs are treated as different as whole month’s production. Therefore, it is better to use job costing as it will reflect a fairer picture when pricing a job or a project. Job costing is better than marginal costing which is based on historical data and hence cannot be used by the management when they have to make decisions pertaining to future or future events. Similarly, fixed cost of production is ignored in marginal costing and hence does not portray an accurate picture. On the other hand, job costing takes into account all relevant costs including cost of production, so it is a better method to cost products and project. It also helps the firm to earn a predetermined rate of profit which is very difficult to apply to marginal or absorption costing. SAMPLE COST REPORT JOB COSTING $ $ $ Direct Labor 5000 Direct Material 20,000 Overheads: Fixed 20,000 Variable 3000 Total Overheads 23,000 Total Cost 48000 Add: Profit Margin 10% 4800 Quotation Price 52800 This is hypothetical cost statement based on hypothetical cost figure. Here as we can clearly see that total costs accounted for $48000. After which a 10% profit margin was added to arrive at quotation price which is $52,800. This statement is easy to use by people who have no prior knowledge of accounting and as a result managers and people who do not have accounting background can use it to their advantage. TASK THREE: To: The Directors From: TYPE YOUR NAME HERE Date: 14 June 2010 Sub: STOCK VALUATION METHODS FOR MS. HOME IMPROVEMENTS AND EXTENSIONS Respected Sir(s): I would to report on various stock valuation methods that can be taken into account by our firm in order to value its stock as fairly as possible. There are basically three method of stock valuation used by cost accountants. These methods are FIFO, LIFO and AVCO. FIFO stands for FIRST IN FIRST OUT. Here those products which are purchased before are sold first. Therefore, initially the cost of units that are purchased at a price before and added into cost of production first and then we move onto the price on which the stock is valued in the second purchase, so on and so forth. Similarly, LIFO is exactly opposite to FIFO. LIFO stands for LAST IN FIRST OUT. Here the latest price at which the stock is purchased will be added to the cost first and the first purchase at the very last. This method has obvious advantages over FIRST IN FIRST OUT (FIFO) method. This method of stock valuation covers the increase in prices due to inflation through increased cost sheet total and increased quotation prices for the customer. This method increases the cost of goods sold and hence reduces gross profit and net profit in turn and reduces the tax burden on the firm. However, the only advantage that FIFO has over LIFO is that it does not exaggerate prices suddenly and hence customer retention is easier for firms using FIFO than LIFO. The last method that is being used by firms to value their stock is AVCO. AVCO stands for Average Costing. Here, the different price at which the stock is purchased is added and divided by the number of units of stock. This brings us to the average price. The main advantage of this method is the price fluctuation is low and yet it covers the inflation and price hike. This method does not account for over stated profit as happens in FIFO and under stated profit as happens in LIFO (Last in First Out) method. The best method to value stock for our building and construction firm is AVCO method. This does not lead either over stated or too high price nor too low price. In other words, this method accounts for the realistic valuation of stock which helps the company to determine its price which gives the firm a fair profit and at the same time providing it ability to remain competitive in the market. This method also makes customer retention possible as it does not exploits customers by charging too high price nor does it inhibits the company’s ability to earn decent returns and profits. I would also like to recommend this method because it aggregates the company’s purchase at lower prices with purchases at high prices to prevent the company from over charging or under charging consumers and hence making it more competitive in the market. TASK FOUR: The company can test the market for its new product by Velux windows by using either surveys or field trials. In surveys, the product idea will be conveyed to consumers and they will be asked to give their own opinion about the new product. This method is one of the most widely used methods in testing the market for new products. This method makes it easier to test the market and to provide the company with accurate data about what consumers think about the product and how well the product will do in the market. The obvious disadvantages in using this method and that a lot of time is required in gathering the first hand primary data. Another main advantage of using this method is the cost of collection of data. There are a lot of cost incurred in printing the questionnaire and then collecting and collating data. Sometimes consumer’s response is bias because of the way questions are designed and asked and hence the result may not reflect the actual thinking of the consumers. The other method that can be employed by Ms. Home Improvements and Extensions is by undertaking a field. Here the sample of the product will be shown to consumer and they will be told about the specification of the product and then their response will be recorded to assess the viability of the product. If the response is positive, then the product will be launched in the market and if the response is negative it will withheld. The major disadvantage is that a lot of thinking and effort will be levied in designing the product and if the consumer response about the product is negative it will become a sunk cost. The advantage here is that since the product’s sample is shown to the consumer, the response will be unbiased. The company that I have researched is Granite Constructions, which is one of the largest civil contractors in America. The company’s annual turnover for last 5 years is shown in the table below: Year 2005 2006 2007 2008 2009 Turnover $2641352 $2969604 $2737914 $2674244 $1963419 Year Profit % Change From Last Year 2005 2641352 2006 2969604 12.4% 2007 2737914 -7.8% 2008 2674244 -2.3% 2009 1963479 -26.6% TASK FIVE: To: The Directors From: TYPE YOUR NAME HERE Date: 14 June 2010 Sub: COST REDUCTION TECHNIQUES FOR MS. HOME IMPROVEMENTS AND EXTENSIONS! Respected Sir(s): I would first like to thank you for giving me the opportunity to report on the one of the main problem that our company is facing. In the recent years, our costs have exceeded our increase in turnover. This is particularly bad as it has eroded our company’s profitability and has moved us toward the peril of closing down business operation. I would like to bring certain cost reduction method to your knowledge, which should decrease our cost structure and move us towards increased profitability again. The main problem we face is from utility wastage. This wastage exists in the form of electricity and water wastage. Similarly, a lot of our employees are found to using their office time to solve their personal matters. This also contributes to wastage. Probably, if we could reduce this wastage, we will become competitive again and our costs will be reduced. Another method that I can suggest to reduce cost is by moving to a smaller business which is ideal to cater our needs. This will help us reduce our rent, insurance and sundry costs. This will enable the firm to cut down some of its fixed costs and will bring us toward more profitability and reduce cost. The last alternative for us is to tighten the control on employees to make sure that they are not using company’s resources for their private matters. This can be done by installing a CCTV and other monitoring system and will make sure that employees are devoting them to work. In the end, I hope that these methods will help us reducing our costs and will move towards more efficiency and effectiveness and will make us more competitive, which hopefully, will increase our business in the future. References: Investopedia, Investor’s Encyclopedia, Visited on 20 June 2009 http://www.investopedia.com/ Harold Randall, Accounting, 1996, 3rd Edition , Letts Education Richard L. Daft. Management. 2002. 5th Edition. Dryden Publishing Frank Wood. Introduction to Accounting. Low-Price-Edition. Pearson Read More