The purpose of an efficient costing system is to determine the cost and profitability of each manufactured unit of product or service. In addition, the system enables managers to closely monitor the performance of divisions by comparing actual outcomes to budgeted costs numbers. This will enable the executives to take corrective action when necessary or to alter the company's policy if necessary. Thus, an efficient pricing system aids management in their duties of planning, organizing, and controlling the actions of employees and the firm's overall performance. This study provides an analysis of several components of Packwell Limited's costing system.
The current business environment is so complex and competitive that an increased reliance on automated manufacturing processes and cutting-edge technology equipment is the norm. With each new technological advancement, the obsolescence of items and processes has increased, resulting in a reduction in the life span of the products. As is the case in the communication business, items are only used for a few years before being replaced by newer models based on revolutionary technological advancements. The firms' management must account for the rapid technical changes occurring in the market in order to remain competitive. In order to maximize the firm's profits, managers must have a comprehensive awareness and appreciation of the expenses associated with the various phases of a product's manufacturing cycle. In order for different manufacturing organizations to stay globally competitive, strong competition on worldwide markets, the adoption of innovative technical changes, and enhanced production processes have forced drastic modifications in their management accounting systems. The application of effective management accounting alongside standard financial accounting will improve the organization's overall performance. This paper examines the contribution of management accounting, as well as the various facets of an effective costing system in general, in relation to an effective costing system. In addition, this document also gives a report on the different components as they are applied to Packwell Limited.
Financial Accounting and Management Accounting Are Crucial
Financial accounting assists business organizations in making financially sound decisions on the operation of their company. Accounting encompasses the maintenance of books of accounts for recording a business's financial transactions and the creation of financial statements for a certain period based on these transactions. Thus, the primary goal of financial accounting is to generate financial statements based on the organization's books of accounts, which will contain comprehensive information about its financial performance. Investors, creditors, banks, and tax authorities frequently refer to a company's financial accounting statements when making choices for a variety of purposes. Management Accounting measures and reports financial and non-financial data that assists managers in making decisions to achieve an organization's objectives. Accounting for management focuses on internal reporting. Financial accounting measures and records business transactions and provides financial statements for investors, government regulators, and other external stakeholders (Horngren et al 2002). Management accounting has the unique advantage of including performance measurement. The measurement of performance includes the formulation of budgets that take into consideration the financial objectives of the organization. The primary responsibility of the management accountant is to ensure that the organizational goals and the individual goals of organization members are aligned.
Different Cost Categories
A cost is the resource that a company foregoes in order to attain a specific business or other aim. Cost is the monetary value associated with the acquisition of particular goods and services. A typical costing system identifies two distinct stages: cost buildup and cost allocation. Cost assignment is the act of tracing collected costs to a specific cost object and allocating accumulated costs to a specific cost object. Cost accumulation is the process of collecting cost data using an organized accounting system. In order to analyze the profitability of a product or a particular client cost may be ascribed to the respective product or customer. On the basis of the link between the cost and a particular cost object, direct and indirect costs can be distinguished.
The costs associated with a single cost object are "direct costs" that may be attributed to that object. For instance, the costs associated with the cans or bottles used to package soft drinks are direct costs. The fundamental aspect of direct costs is that it should be feasible to track such charges to a single cost object in a cost-effective method. Indirect costs, on the other hand, are costs that are associated to a certain cost object, but cannot be tracked back to that cost object in a cost-effective manner. For instance, the cost of quality control for every manufactured product will be indirect because it will be difficult to attribute the cost to a specific product (s).
On the basis of cost-behavior patterns, costs linked with the products or services can be divided into variable and fixed costs. Cost that varies proportionally to the overall level of activity or volume is referred to as variable cost. For instance, the cost of steering wheels acquired for the production of automobiles is a variable cost because the quantity of steering wheels to be purchased fluctuates directly with the number of automobiles produced. In contrast, a fixed cost is one that does not change throughout a specified time period, regardless of the degree of activity associated with it. Costs are categorized as fixed or variable based on their relationship to a certain cost object and a given period. For instance, the lease and insurance costs associated with a car manufacturer's manufacturing site are classed as fixed costs because they remain constant throughout time.
Average Cost (AVCO) Inventory Record Maintenance Method
Below is the inventory report for Packwell Limited for the month of June 2009.
Stock Account Statement for June 2009
Receipts Issues Balance
Price per Kg
per kilogram £ Total Price £ Quantity
per kilogram £ Total
cost £ Quantity
kg Total £
Balance 1 June
10 June 12,000 2.60 31,200
8,000 2.40 19,200 10,000 24,000
20 June 1000 3.50 3,500
6,000 2.50 15,000 5,000 12,500
Under this approach of stock valuation, issues of raw materials for production are evaluated using a weighted average. In contrast to the 'First in First Out' (FIFO) and 'Last in First Out' (LIFO) methods, the average stock method values inventory at the end of the accounting period at its average cost for inclusion in the balance sheet. Under this system, the cost of sales attributable to the profit and loss account is the average cost of materials issued.
The average cost is computed by summing the various prices at which the materials are purchased during the time and dividing the sum by the quantity of materials purchased. Despite displaying the average value of the inventory at the end of the year, this technique of costing conceals the fact that the quantities purchased in each batch may not be same. To circumvent this issue, the company employs a weighted average cost. Even weighted average costing has the disadvantage that a new average must be determined whenever a new delivery is made. Another concern is that the weight-based average may not reflect the real price paid for the acquisition of commodities (Pizzey, 1989, p 47). For example, 6000 kilograms are provided on June 29 at a price of £2.50 per kilogram, whereas the previous transaction cost £3.50 per kilogram.
Costs of direct and indirect labor
At each level of the production process, the direct labor hours and costs should be separated by task or process. This difference must be made from the time labor is hired in the first department or process until the process is completed and the material is transferred to the second department. It is customary to account for indirect labor expenditures, such as those incurred for supervisors, clerical workers, and other administrative personnel, in terms of hours or days worked. The expense of maintenance labor is allocated proportionately to the manufacturing departments to which the supporting staff performs the service. The hours of indirect labor performed by factory employees who divide their time between direct and indirect labor are recorded on their daily time cards. (Blocker, 2007, p 166) The following table displays Packwell Limited's direct and indirect labor.
Costs of direct and indirect labor are computed.
Hourly Rate £ Overtime
Hourly Rate £ Normal
Wages £ Overtime
Total wages in pounds
Standard Hours 350 8:00
One-and-a-half-time overtime wages 60 8.00 4.00 480.00 240.00 720.00
Double-time overtime 40 8.00 8.00 320.00 320.00 640.00
3,600.00 560.00 4,160.00
According to the company's policy, the entire labor cost for making 18,000 pharmaceutical bottles of type 'X' in June 2009 is £ 4,160, of which £ 3,600 is to be charged as direct labor and the total overtime earnings of £ 560 are to be charged as indirect labor.
Allocation of Operating Expenses
"In cost accounting, production overhead costs are allocated to products and services within a period using allocation bases or cost drivers." (2008) Kinney & Raiborn Overhead costs indicate those expenses, which cannot be neatly identified with any single product or activity. Unlike materials and labor, overheads are intangible expenditures associated with a final product. However, overhead expenses are an essential input in the production process, similar to material and labor costs. The management of overhead costs is a demanding work for managers, and an effective management of these costs demands managers' ongoing attention. It is also essential to comprehend the foundation for allocating overhead expenses when executing a manufacturing process change.
Distribution of Overhead Expenses
Fixed Aerial Allocation or distribution basis Total cost
Molding Plastics for £
Plastics Extrusion of £
Protection for machinery The net book value of fixed assets is $24,400, 14,640, 7,319, and 2,441.
Prices and rent Occupied Square Meters: 58,800 32,340 23,520 2,940
Number of Employees 191,600 89,413 76,640 25,547 Indirect Labor Cost
136,393 107,479 30,928
274,800 154,950 119,850
The basis for allocation is established by the kind of overhead costs. The net book value of fixed assets is thought to be the appropriate basis for allocating insurance costs, given that insurance premiums are often calculated using the book value of assets. Regarding the rent and taxes, the square meter occupied by each department is used as the foundation for apportionment, since rent is often calculated per square meter. Even if the budgeted expenditures can be used as a foundation for allocating indirect labor costs, it would be more practical to allocate indirect labor based on the number of employees in each department.
Product Price Determined by Marginal Costing
Different companies utilize various costing systems, such as job costing, batch costing, process costing, contract costing, marginal costing, standard costing, and activity based costing (ABC), depending on the nature of the companies' activities. Each method of costing has its own advantages and disadvantages that affect the efficacy of the company's costing system.
Using the marginal costing method, the product cost per batch of Microwave containers is displayed in the following table.
Description Total Cost £ Per-Batch Cost £
Direct Materials Cost 160,256 250.40
Labor Cost Direct: 251,008 $392.20
Total Variable Cost 91,520 143.00
Cost of Margin 502,784 785.60
Total fixed costs amount to 136,960 214.00
Total Cost 639,744 999.60
The definition of marginal costing is the accounting method in which variable expenses are charged to cost units and the fixed costs of the period are fully written off against the total contribution (Tutor2u, n.d.). Contribution is the remainder of sales income after removing the marginal cost.
Marginal costing is a more straightforward way of costing, because it precludes the inclusion of any portion of the current year's fixed expenses in stock valuation. To increase the profitability of a corporation, marginal costing substantially facilitates managerial judgments about varying sales and production planning scenarios. With the use of breakeven analysis and cost-volume-profit, marginal costing enables a relevant study of the company's short-term financial strategy. The method also facilitates a comparison of the firm's financial performance across various products or divisions. This assists management in improving deficient regions.
Despite the aforementioned benefits, minimal Costing has limitations. The following are:
The process of separating costs into fixed and variable components is laborious. This problem may occasionally result in uneven outcomes. Under marginal costing, inventory and work in progress are generally undervalued. The separation of fixed costs and stock valuation tends to diminish the firm's profitability. This split also impacts the depiction of the firm's real and fair financial condition, as the status may not be clear. Due to the estimate nature of fixed overheads, instances of under- or over-absorption may emerge into the financial system.
Expenses Related to Employment
"Job costing is the process of comparing the expenses incurred on a project to the income generated by that project."
(Snyder, 2009) A job-costing system can be implemented when production is performed based on the individual requirements of a customer order and the jobs can be identified independently. In this procedure, individual work costs are added to determine the total cost and resulting profitability. Task costing enables the comparison of actual job costs to estimates, which indicates the efficiency of individual jobs, and enables the precise calculation of profit or loss on each job. Identifying and allocating indirect costs for each project will be a time-consuming procedure under job costing.
Process Cost Accounting
The process costing system is beneficial for products that are manufactured through a series of processes in which the end-products of one process become the raw material for the next process. "By adding a component or performing an operation, each procedure will contribute to the final product. Each of these operations or procedures constitutes a natural cost centre for the accountant." (Pizzey, 1989)
The primary benefit of process costing is that it enables the company to identify inefficient individual processes. The downside of this pricing system is that process transfer costs are based on an excessive number of assumptions.
Standard Costing Methodology
"A standard cost is the budgeted production cost for one unit of output. Standard costs are computed using engineering estimates of standard input quantities and budgeted input prices." (Caplan, 2007) While the standard costing approach is acknowledged as a practical method for comparing budgeted to actual overhead expenses, it is nevertheless deficient in several areas. Standard pricing identifies too many aggregated deviations, and establishing standards is frequently a complicated task. This causes the standards to come at a very late stage, and as a result, they may not be used to limit time variances. Standard costing presupposes a highly steady production environment. Consequently, the usual costing system may not be compatible with the altered industrial environment. The standard costing system focuses heavily on the cost of goods and labor with the sole purpose of minimizing expenses. The system places little emphasis on the quality of the product, the enhancement of customer service, and other key contemporary challenges that are mostly technological in nature. This renders the typical costing system obsolete for today's production environment.
For the studied manufacturing company, the task costing system can be identified as the most suitable costing method. The cost object for job-based costing is a particular unit, batch, or lot of a distinct product or service known as a job. Typically, the product or service is manufactured to order. Because the products and services are separate, job-costing systems can gather expenses by each individual product, service, or job. In a job costing system, the organization aggregates costs incurred on a task along the whole value chain, including R&D, design, production, marketing, distribution, and customer service.
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Kinney, M.R., and C.A. Raiborn (2008) published Cost Accounting: Foundations and Evolutions. The New York location of Cengage Learning.
Pizzey, A., 1989. Introduction to Cost and Management Accounting for Students. Sage Publications, London.
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