Industries Qatar & Applications of Costing Methods - Term Paper Example

Industries Qatar Q.S.C. has three (3) major operations one for the petrochemicals, (2) the second for fertilizers, and (3) a third for steel. Itis important to know the products and nature of operations in order to see which method of costing would be most applicable for the business enterprise. Petrochemicals include [1.1] Ethylene which “is , used as a feedstock for a wide range of chemicals” (IQ 2012, p.11),;[1.2] Low-density Polyethylene (LDPE) used for thermoplastics for “films, pipes, cables, and wires and other moulded products” (p.12); [1.3] Sulphur from ethylene process which gets sold to China and Indian sub-continent; [1.4] Pyrolysis Gasoline; [1.5] Mixed Liquified Petroleum Gasoline; [1.6]Methanol exported to Asia, Far East, and Europe, and used for manufacturing solvents and other chemicals; and [1.7] Methyl-Tertiary-Butyl-Ether (MTBE), a gasoline additive. All these are under Qatar Petroleum Subsidiary of Industries Qatar. The subsidiary for fertilizers is Qatar Fertilizer Company QSCC. Its operations produce [2.1] 80% of ammonia used as feedstock in the production of Urea, while 20% exported; [2.2]solid Urea in granular and prilled (free flowing) particles for export; and [2.3] UFC-85 or Urea Formaldehyde Condensate (a chemical agent that prevents Urea from forming cake-like appearance instead of granules or prills. The subsidiary for steel is Qatar Steel Company. This group produces [3.1] “Hot Bricked Iron (HBI) and Direct Reduced Iron (DRI)” (p.13) sold to Middle East, Far East, and India at a volume of 700,000 metric tons per year; [3.2] Steel Billets (see picture below), [3.3] Steel Coils. How do Steel Billets look like? Of the three groups or subsidiaries, Qatar Petroleum “holds 70% of the share capital of Industries Qatar”(p.15). The total revenue ending December 2011 amounted to QR 16.5 billion out of which QR 3.4 billion was the result of price increase. Compared to the previous year, 2010, this revenue reflected a 34% increase (p.18). And the net profit actually realized was QR7.9 billion due to a 48% average profit margin for all subsidiaries combined in 2011 (p.24). The Petroleum and Fertilizer industries were estimated to generate 60% profit margin while the Steel industry reaped 29% profit margin (p.26). However, the presentation of accounting values in the 2011 Industries Qatar Annual Report is not in such a way that the profit margin percentages can be computed. Instead, only direct costs are shown but not the total cost of manufacturing the products. Thus, gross profits appearing in 2011 as per the consolidated income statement showed 53.75% gross margin, while in 2010, it showed 48%. See Appendix Section Consolidated Income Statements of Industries Qatar. Application of Chapter 2: An Introduction to Cost Terms and Purposes The basic costs incurred by IQ included direct cost which was clearly shown in the Income Statement and indirect costs. Combined, these actual costs should average about 52%. Since the 2011 direct cost was 46.25%, the difference of 5.75% would be the indirect cost of producing the desired output for each of the three subsidiaries. Also according to the forecast for 2012 which was shown in the same annual report 2011, there was a budgeted cost allocated for the investment in new facilities for 2012. Thus, the actual Cost Objectives of Industries Qatar are as follows: Cost Objectives Actual Findings for Industries Qatar Products that are in demand and that should be produced. Petroleum products (See p. 1 paragraph 2 for the different petroleum products.) Fertilizers (See p. 1 paragraph 3 for details.) Steel (See p. 1 paragraph 4 for details.) Services Although the company is not in the services industry, within the subsidiaries, there are many business services being performed that also contribute to achieving the objectives, e.g. accounting, planning and budgeting, public relations, marketing, and delivery of products. Project The company will add new equipment and replace old ones. Although the value will be charged to investments, depreciation costs and maintenance costs will be reducing the value of equipment each year due to wear and tear. Customer Satisfaction Demand of customers for the products produced by Industries Qatar would have to be met on a timely basis. Activities Manufacturing of Petroleum products, fertilizer products, and steel products; safe and secured storage and handling up to a certain agreed point of the transaction; and delivery also up to the shipping company Departments Public relations with Stakeholders, Investors, and International buyers would have to be well maintained in order to be assured of steady demand and availability of capitalists, creditors, or investors for the long term operations. In the assignment of costs to their products, IQ subsidiaries would have to independently identify labor and materials cost of producing Petroleum, Fertilizers, and Steel as direct costs. Wages of labourers in the production site will certainly serve as direct labor cost. All other manufacturing overhead not directly connected to producing the goods would have to be classified as indirect labor and indirect materials costs. For example, maintenance of facilities which have to be incurred but which does not change as a result of increases or decreases of the output of production, will require indirect labor and indirect materials. Power consumption paid for and taxes that have to be paid are the other examples of indirect costs. Chapter 2 defines direct and indirect costs, fixed and variable costs, and mentions cost concepts of materiality, different costs incurred in the different parts of the business operations and manufacturing processes. From the Consolidated Income Statement of IQ, although it does not explicitly say which costs are variable, and which ones are fixed, one can logically say that production labor costs will be generally direct labor. Since all the final products are raw materials of other companies that use petroleum products, fertilizes and steel products, the materiality of needed direct materials to arrive at final products is most likely relatively small compared to direct labor. Instead, depreciation of durable equipment would be the expected bigger indirect cost. The figures actually showed how big the amount of depreciation is being charged as indirect fixed costs (most probably included in the General & Administrative Expense account found in the Income Statement). QR 673,511,000 was shown as the depreciation cost in the Cash Flow Statement for 2011. See Appendix B. It represented the biggest expense next to Direct Costs. Application of Chapter 3: Cost-Volume-Profit Analysis IQ has a consolidated financial statement and does not show details for each of the subsidiaries. It only says that the Petroleum industry accounted for 70% of the capital share of all three companies combined. Therefore, the Cost-Volume-Profit Analysis for IQ based on the available financial statements in the 2011 annual report will be limited only to an analysis of cost and profitability for the entire IQ operations. The readers of the annual report will have to depend on the reported analysis of the annual report’s author which states that there was an average profit margin of 48% for all of the three companies combined (p.24). It means that given the total revenue of QR 16.5 billion, the total variable cost is about QR 8.58 billion for all three companies or 52% of Total Revenue (TR). The value of fixed cost can only be estimated based on the accounts shown in the Income Statement and Cash Flow Statement. From the latter, depreciation expenses would be QR673,571,000 / year and from the former or the Income Statement, the Finance Charges amounted to QR 156,428,000. Let us assume that the Other Expenses represent the salaries and wages that do not fall under direct costs. It amounts to QR 255,590. These would represent the fixed costs amount equivalent to a total of QR 1,085,529,000. The other costs and expenses are probably variable costs. Chapter 3 invites the reader to be familiar with the Cost-Volume-Profit (CVP) Analysis. The sensitivity analysis potion is also not possible due to lack of information about the volume of production per product and the price per product. However, determination of the BEP amount is possible. BEPQR = QR 2,261,519,000. This assumes that salaries and wages were considered as Other Expenses. A business cannot operate without people running it. There would have to be salaries and wages not part of the direct costs. Such a QR 2.26 billion BEP means such total revenue will allow IQ to operate and pay its debts, maintain the equipment for regular operations, and pay for indirect costs in salaries and wages. But there will be no profit for IQ and the stakeholders. Application of Chapter 4: Job Costing Although IQ may not have been using Job Costing for each order received, the 2011 IQ Annual Report is silent as to which one. The topic of Job Costing requires specific products with specific figures that can be assigned to the production of each product. It assigns cost to that specific product based on realistic areas of responsibility, materials, labor, and various other expense accounts directly or indirectly connected to a product. In the case of IQ, the financial statements are consolidated. There is no breakdown of figures into the respective set of products and for each product within a specific business operation. To summarize what Job Costing is all about, this system requires logical grouping of costs and expenses which can be associated with producing a product.A little about process cost accounting was presented. It is not good for mass production similar to that of IQ’s Petroleum and Fertilizer products. It cannot be useful for the Steel Manufacturing when mass production is done. This will require a more thorough awareness of the operations within each subsidiary because there are usually many departments involved. It also teaches how to journalize and account for costs and expenses under the job order and process accounting methods. Application of Chapter 6: Master Budgeting and Responsibility Accounting IQ would have an idea of the next year’s forecast depending on the results of a Strategic Plan that considers Internal and External factors affecting the operations of its businesses. Some expenses will increase and some will decrease. This is the same with both revenues and costs. A forecast of the Income Statement, Cash flow, Cost of Production, and Balance Sheet along with the Sales Forecast would have to be justified by quantitative computations and qualitative analysis of the various factors affecting business. All costs and expenses are usually subject to approval by the top management. Budgeted figures have to be aligned with the plans and strategies arrived at after thorough evaluation of the facts, ideas, and anticipated events. These will be the basis for the following year’s operating costs and expenses. Normally, an increase in the forecasted revenue will mean an increase in the level of operations as well as the costs and expenses. The amounts needed to motivate sales people would have to be allocated. In times when one department’s budget becomes insufficient, top management will decide where to get the funds. The master budget will show which department might have excess allocations. The master budget allows for uninterrupted business operations to achieve targets for the year. Application of Chapter 7: Flexible Budgets, Direct-Cost Variances, &Management Control It is this chapter which talks about a situation when IQ might encounter variances in the budget. Sources of variance will be the price changes of materials purchased or the fluctuation in prices of its own products, which can result in higher or lower demand. Variances are known after the actual data are known. The knowledge of changes can then guide those preparing the new budget into becoming more accurate with a plus or minus variance that should be anticipated. Those not anticipated are called management exceptions because the planners will have to decide what to do under undetermined circumstances. But not all figures will encounter a variance, e.g. depreciation cost and finance charges if there are no planned additional equipment to depreciate and no planned additional borrowings. IQ had a planned investment in equipment. Thus there will be an increase in the budget allocation for depreciation for purposes of determining th forecasted profits. Such information are generally not made known to the public. And so the application for this chapter is not possible. Application for Chapter 8: Flexible Budgets, Overhead Cost Variance, and Management Control The difference between Chapter 8 and 7 is with the proper management of Overhead Cost Variance and the proper management of Direct Cost Variance. Standard overhead is allocated to the volume or quantity of production. There should be no problem with determining the variance for direct costs in IQ because the consolidated Income Statement clearly identifies the Direct Costs yearly. It means all three subsidiaries identify their direct costs yearly and those groups would be easily able to see the discrepancy versus the master budget figure for the direct costs. But for the Overhead Cost Variance, a more careful scrutiny will have to be done by top management per subsidiary. An audit would identify if there has been any change in the standard costing per unit. If so, which cost item caused the change? Why? For the Direct Costs of IQ, it is very likely that the bulk of this would be the direct labour cost and very limited direct materials involved since the output are raw materials, unlike for a BMW with many parts. For the management control of overhead cost, the cost items should be identified in order that such costs can be controlled. Could it have been due to inferior tires purchased for delivery trucks? Application of Chapter 17: Process Costing Unlike Job Costing which is not recommended for IQ, process cost accounting would be a better alternative because the system is recommended for mass production of chemicals and items that are more or less the same, e.g. steel bars. However, for practice use purposes, the annual report does not segregate the financial statement of each subsidiary company and does not show any units of production or units sold. All figures were consolidated. The cost accounting method of process costing assigns the various costs to each unit by first knowing the total output of specific products and knowing the total cost for each product. If the total cost of producing steel bars is known and number of steel bars produced is also known along with the work-in-process, the average unit cost of the steel bar can be computed accurately. It is simply cost of finished goods divided by number of finished steel bars. Usually, work-in-process beginning receives materials and ends up with work-in-process ending. This will then be accounted for to arrive at the cost of goods sold (CGS). It is important to use CGS because the usually available number of units would be those identified with sales. And so cost of goods sold can be divided by the units sold to arrive at cost percentage per unit. It will also make it easy for the management to see the gross margin percentage during profitability analysis. References IQ (2012). Industries Qatar Annual Report 2011. Retrieved from http://www.industriesqatar.com.qa/IQ/IQ.nsf/en_Pages/en_InvestorAffairs_Downloads/$File/IQ_annual_report_2011_english_SM.pdf [Accessed May 20, 2013] Appendix A. Industries Qatar 2011 Consolidated Income Statement Compared to 2010 Performance [Source: Industries Qatar 2011 Annual Report, p.36] B. Industries Qatar Consolidated Cash Flow Statement [Source: Industries Qatar 2011 Annual Report, p.40] Read More