Cost Accounting of Mother Dairy Foods Processing, Ltd - Case Study Example

COST ACCOUNTING MOTHER DAIRY FOOD PROCESSING Ltd 17th DECEMBER, 2008 COMPANY PROFILE Mother Dairy Foods Processing, Ltd founded in the year 1974 functions as a milk processing company in India with a wide range of products comprising of milk, ice creams, ghee, UHT milk, butter, cheese, curd, lassi, flavoured milk, and dairy whitener. Mother Diary also markets other product lines including edible oils, fruits and vegetables, juices etc thorough its dedicated sales and distribution division. The wide spread area covered by the organization in India includes many states such as Delhi, Haryana, Kolkata, Punjab, Rajasthan, Uttaranchal, Uttar Pradesh, Maharashtra, Andhra Pradesh, and Gujarat (Mother Diary Review, 2005) . The company is established under the Operation Flood Programme and is now recognized to be a subsidiary company of the parent company of National Dairy Development Board (NDDB), 2008. Mother dairy milk and other products are priced plausibly and its availability in almost all general stores of every small or big market of Delhi and nearby towns is commendable. It’s an interesting area to find out about the costing of the company’s products. The selected category amongst its varied product range is supply of ‘cheese’. COST ACCOUNTING Cost accounting is a quantitative method that helps in classifying, accumulating, summarizing and interpreting financial information to accomplish the main objectives of operational planning and control, special managerial decisions and specific product decisions (Kishore M R, 2003). From the perspective of the organization, cost accounting aims to provide enormous information to management in order to take effective decisions regarding the functioning of different product line. The main focus of cost accounting is to determine the actual selling price of a commodity, determining and controlling efficiency, helping in preparation of the financial statements and providing a platform on the basis of which operational policies could be framed (Kishore M R, 2003). Cost accounting systems are part of an organization’s information system and indicate towards the internal cost tracking and allocation systems to control costs and expenditures. There are probably no definite rules how cash flows must be controlled however there are few formal methods based on which cost allocations may be processed. Cost accounting being an integral part of the form of management accounting, has no obligations to follow standards such as GAAP, because the main use of cost accounting is for internal managers rather than external stakeholders and the decision for computation is decided rationally and practically (Kishore M R, 2003). The main five parts of the cost accounting system include: Input measurement system Inventory valuation system Cost accumulation method Cost flow assumption Recording interval capability The main elements of cost which are taken into consideration for determining the actual cost of any product in general and specific to ‘cheese’ product of Mother Dairy which would be analyzed further in the report comprise of: Material: the material from which the product is made which may be in any form, raw or manufactured state. In the current study the main material used is ‘milk’, therefore its quantity of consumption on a daily basis and pricing would be determined. Materials can be further classified into direct and indirect category, direct which is integral part of finished products and indirect which are ancillary to the main product. Labour: is a very important part of costing as human effort in production of a product is inevitable. Labour can also be direct and indirect. Expenses: direct expenses are those which can be allocated to specific cost centers and indirect which cannot be associated with the cost units. Overhead: includes all indirect costs related to factory, office and administration, selling and distribution costs. There are various methods of costing which can be applied to determine the costing of ‘cheese for Mother Dairy on daily production basis such as job costing, contract costing, cost plus costing, batch costing, process costing, operation costing, unit costing, operating costing etc. ‘Unit costing’ would be preferred for the production of the specific product The techniques of costing depend on the nature of product and the business and the context in which is it used. Marginal costing, direct costing, absorption or full costing, uniform costing are the available options out of which direct costing is the most suitable option for the current product (Horngren T C, Foster G, Datar M S, 1997). The general cost classifications which would help in costing of the product include variable costs which change in accordance with the total level of production. For instance if the milk production increases by 5%, its variable cost would also increase by about 5%. Fixed Costs remain constant irrespective of the level of production. For instance the cost on the equipments of procuring milk or producing cheese remains the same irrespective of the quantity of product produced. Direct Costs are those related with direct labor and material used in the production of the product or delivering the specific service. Indirect Costs/Overhead Costs are not related with the production of cheese. Opportunity Costs are those costs which are sacrificed in choosing cheese and foregoing other products which the company might have produced. Sunk Costs have been incurred in the past and cannot be changed by current actions (Horngren T C, Foster G, Datar M S, 1997). LIMITATION OF COSTING On the whole it can be analyzed that Organizations like ‘Mother Dairy’ which have a wide range of products and services offered have many processes which are uniform to the many finished products common to several finished items, which makes cost allocation immaterial. Due to which the costing measures applied above can actually distort the ascertained cost of the product. The irrelevant figures can actually lead managers to make decisions that actually do not reduce costs or maximize profits. COST ACCOUNTING AND EQUIPMENT COST IN THE PRODUCTION OF ‘CHEESE’ Accounting is of primary importance in knowing the cost price of the cheese product; hence it becomes utmost important to determine the amount of milk received and products obtained on a daily basis. Reception For reception, the following data should be ascertained. “The village dairy” Randomized Dates for finding average daily quantity Amounts of milk received % of fat 12 March 385 3.6 13 March 405 3.7 14 March 395 3.6 Standardization If the entire quantity of milk received at the warehouse of the firm contains 40 g of fat per litre, and the milk for cheese-making has to be standardized to a fat content of 36 g per litre, the following balance is obtained: 100 litres of milk at 50 g/l X – Litres of milk at 36 g/l (100 – X) litres of cream at 500 g/l 100 × 50 = 36x + 500 (100 - x) 5000 = 36x + 5000 - 500x 464x = 45 000. x = 96.98 litres. Therefore, 100 litres of milk with a fat content of 50 g per litre will produce 96.98 litres of milk containing 36 g per litre of fat and 3.02 (100-96.98) litres of cream with a fat content of 500 g per litre. Cheese-making As per the company specification in the making of cheese, the yield specifications would be around 11 kg of cheese per 100 litres of milk approximately. According to the balance resulting from the standardization as calculated above, 96.98 litres of milk for cheese-making will result in an output of: 11*97/100 = 10.67 kg of cheese Similarly for the production of butter, the output is as follows, after standardization, 3.02 litres of cream at 500 g per litre are obtained. The total amount of fat content will be therefore: 1 510 g. The butter will have a fat content of 82 percent, and so the butter yield will be: 1510 * 100/82 = 1.8 kg of butter The analysis for butter and cheese-making is as follows: Reception: 100 litres of milk at 50 g/l Standardization: 97 litres of milk at 36 g/l: 10.67 kg of cheese 3.02 litres of cream at 500 g/l: 1.8 kg of butter The above statistics reveal the amount per product after milk processing which will be further analyzed with the actual amounts discovered. If there is a significant difference in the costs then one must try to figure out the causes for the deviations and discrepancy for instance measurement of the volume of milk received, the determination of fat content, or errors in calculation or estimation of the quantities of milk and cream after standardization, etc could the possible reference areas for variance analysis. ESTIMATION OF COST PRICE Study of the cost price of each element in the production of a specific product is essential in order to determine the final selling price of the product. The calculation of cost price is based on average daily production and actual output obtained. In the above mentioned case which includes 100 litres of milk, the cost price of cheese and butter is established as follows. Raw Material cost After observing the years daily milk reception, it was found that on an average 100 litres of milk is received daily. It is assumed that this milk will be paid E per litre. The cost, therefore, of the raw material, is: 100 × E The usual consumption is that in 1 litre of milk the value of the fat content represents 50 percent of the price of the milk. It can therefore be concluded that the purchase price of 1 g of fat content, if the milk has an average rate of 50 g per litre, is: E * 50 * 1 / 100 * 50 = 1E/100 The butter contains 82 percent fat content so the cost price of 1 kg of butter will be based on the cost of 820 g of fat content. This makes the cost price of 1 kg of butter: 820 * 1 * E/ 100 = 8.2 E The above example shows that 100 litres of milk with a fat content of 50 g per litre will supply 97 litres of milk with a fat content of 36 g per litre, for cheese-making. The next step is to determine the value of the milk used for cheese-making. This milk is composed of: Milk solids ( 50 percent of the milk value) E 50 + fat content of milk 36 * 1* E/100 The cost price of 1 litre of milk for cheese-making is therefore: E * 36 E/ 50 * 80 The cheese yield of 100 litres of milk for processing is therefore approximately 11 kg of cheese. The material cost, therefore, of 1 kg of cheese for accounting purposes is: E + 36 E 50 100 * 100 11 As a further example, assuming that for milk 160 monetary units are paid in a local currency, then the material cost price of the butter would be : 8.2 * 160 = 1312 10.25 × 160 = 1 640 As for the material cost for 1 kg of cheese, the figure is calculated as follows. 160 + 36 * 160 = 3.2 + 57.6 = 60.8 ( the cost of 1 litre of milk for cheese making, with a 50 100 fat content of 36 g per litre) The cost of 1 kg of cheese would be: 60.8 * 100 / 11= 552 The above data helps in estimating of the cost of raw materials for making butter and cheese. To obtain the total cost price per product, the processing costs also needs to be added: The processing costs include both fixed costs and variable costs. The only cost involved in collection of the milk is the salary of the individual who is procuring milk from the village dairy. In processing, salaries of the supervising staff and expenses for fuel and other products used during processing like packing material etc have to be included. Collection cost If the milk procurers salary is 6 000 monetary units and he collects an average of 100 litres of milk per day (two 50-litre cans) the monthly collection will total 3 000 litres. The collection costs, therefore, for one litre of milk are: 6000/3000 = 2 monetary units 25 percent of this will be reserved for the repairs and maintenance of the transport vehicle: 2 * 25/ 100 = 0.5 Collection cost ( per litre of milk) = expenditure Salary + Maintenance = 2 + 0.5 = 2.5 Assuming that 10 litres of milk are needed to make 1 kg of cheese, the collection cost per kg of cheese would be : 2.5 × 10 litres or 25 Processing costs Assuming the processing unit employs 4 people on a full-time basis and each employee is entitled to a salary of 40000 (monetary units), the total payroll will come to: 40 000 × 4 = 16 0000(monetary units). Salary costs will then be broken down per kg of cheese. Knowing that the monthly average milk collection is 500 litres per day or 15 000 litres per month, from which the cheese output is approximately 10 percent, and then the salary costs per kg of cheese are: 160000/ 1500 = 106 monetary units Knowing the monthly expenditure to be 36 000 monetary units for power (to heat the milk) and for processing aids then the cost per kg of cheese can be ascertained as : 36000 / 1500= 24 monetary units The cost of processing cheese from milk is therefore: 106 + 24 = 130 (monetary units) Packaging costs The packaging materials required are estimated on a monthly basis and the price in terms of the individual package. If the total monthly cost of the packaging is assumed to be 6 000 (monetary units), the packaging cost per kg of cheese will then be: 6000/1500 = 4 (monetary units) Transport costs: The cost of transporting the products is also estimated on a monthly basis. If the monthly transport cost is assumed to be 24 000 monetary units, the cost per kg of cheese is then: 24000/1500 = 16 (monetary units) Marketing costs: If these monthly expenses are assumed to be 60 000 monetary units, the sale cost per kg of cheese is then: 60000/ 1500 = 40 (monetary units) SUMMARY The following table summarizes all costs to be included in the sale price of 1 kg of cheese. Accounting service Cheese-making cost price per kg of cheese   Monetary units Raw materials 552 Milk collection 25 Production costs   • salary 106 • supplies, power 24 Packaging 4 Transport 16 Marketing 40 TOTAL 767 This gives us a cost price of 767 monetary units for 1 kg of cheese. The profit will depend on local market conditions, but generally includes a normal range of 25 percent profit of the cost price. Hence the profit margin would be 191.75 monetary units (767*25/100) This would make the sale price of the product (1 kg of cheese) 767 + 191.75 = 958.75 monetary units In this case the percentage of costs with respect to the sale price would be as follows: Distribution of costs as % of sale price   % Raw materials 57.0 Collection 2.6 Processing costs 13.5 Packaging 0.4 Transport 1.67 Marketing 4.17 Profit margin 20.0 TOTAL 100.0 (app) ESTIMATING EQUIPMENT COSTS (FIXED COSTS) Milk collection equipment   Estimated cost in US$ Vehicle 400 Milk can 100 Milk volume measuring can 100 Funnel 50 • Portable laboratory equipment including:   Salut acidimeter 50 Glass cylinder 10 Lactodensitometer 20 Milk reception equipment 50 litre milk can 500 Milk scales 100 Funnel with filter 50 Milk pail 50 Milk stirrer 25 Milk sampler 25 Laboratory equipment Instrument for determination of fat content 1 000 Equipment and accessories for determination of milk acidity 50 Glasswork 25 Reagents for one year 75 Milk standardization equipment Hand-operated separator: 300 1/hour 100 Cream bucket 100 Milk can with pressure lid 50 litre capacity 50 Cheese-making equipment • Stainless steel curd cutter 200 • Cheese stirrer 50 • Cheese thermometer 50 • Curd scoop 50 • Mould-filling tray 100 • Minor equipment such as brushes, aprons, cheese samplers, etc. 500 Butter-making equipment • Hand-operated pinewood barrel churn: capacity 30 litres of cream 200 Equipment for preparation of processing aids • Minor equipment used in the preparation of starter cultures and rennet 300 REFERENCES Horngren T C, Foster G, Datar M S, 1997, Cost Accounting: A Managerial Emphasis, Ninth Edition, Prentice Hall of India, New Delhi Kishore M R, 2003, Cost & Management Accounting, University Edition, Taxmann Allied Services Ltd, New Delhi Kishore M R, 2003, Cost Accounting, Third Edition, Taxmann Allied Services Ltd, New Delhi Company Profile, 24th March, 2008, NDDB to merge Mother Diary and Dhara subsidiaries, retrieved on 17th December, 2008, http://www.domainb.com/industry/Foods/20080324_dhara_subsidiaries.html Mother Dairy Review, 2nd May, 2005, , retrieved on 17th December, 2008, http://www.mouthshut.com/review/Mother_Dairy-73784-1.html Read More