Objectives of Cost Accounting

Transcription

1 Q.1 Distinguish between Costing and Cost Accounting. Discuss the objects of Costing? Costing- A cost can be defined as the monetary value spent to acquire something and costing is the process of determining and recording cost. Costs are incurred by both manufacturing and service organizations. For instance, if a manufacturing organization is considered, it will incur costs in the form of material, labor, and other overheads and produce a number of units. The total cost incurred can be divided by the number of units produced to arrive at the unit cost of production.. Cost Accounting is a systematic process of analyzing, interpreting and presenting costing information to the management to facilitate decision making. The scope of cost accounting involves preparation of various budgets for the company, determining standard costs based on technical estimates, finding and comparing with actual costs and quantifying the reasons of by variance analysis. Objectives of Cost Accounting Estimating Costs Costs for the upcoming accounting year has to be estimated at the end of the current financial year through the preparation of budgets. A budget is an estimate of incomes and expenses for a period of time. Budgets can be prepared in two ways: incremental budgets and zero-based budgets. In incremental budgeting, an allowance for costs and incomes are added to the upcoming year based on resource consumption in the prevailing year. Zero-based budgeting is a method of justifying all costs and incomes for the next year disregarding current year s performance. Accumulating and Analyzing Costing Data This is done through standard costing and variance analysis. Standard cost for units of material, labor and other costs of production for a pre-determined time period will be assigned for each activity of the business. At the end of this period, the actual costs incurred may be different to the standard costs, thus variances may arise. These variances should be analyzed by the management and reasons for the same must be determined. Cost Control and Cost Reduction This will be done based on the results of variance analysis. Unfavorable variances relating to costs should be corrected through proper cost control. This can be achieved by eliminating nonvalue adding activities and further strengthening business processes. Determining Selling Prices Cost accounting is the basis used to finalize selling prices since the prices should be set to facilitate achievement of profits. Inaccurate costing information may also result in determining high selling prices, which will lead to a loss of customers.

2 Cost accounting is a practice carried out in order to provide information for internal stakeholders in the company, especially management. Thus, the manner information is presented, the format of reports are tailor-made to suit the requirements of the management. This is different to financial accounting where information should be presented in rigid specific formats. What is the difference Between Costing and Cost Accounting? Costing is an exercise of determining costs. Costing involves classifying and recording costs according to their effect on the business. Costing is not used for decision making, this is merely classifying and recording costs incurred within a period of time. Costing vs Cost Accounting Process Decision Making Q.2 Elaborate the steps involved in activity based costing? Cost Accounting is used to analyze, interpret and presenting costing information to the management to facilitate decision making. Cost Accounting involves estimating, accumulating and analyzing of costing information. Cost Accounting is used by management to take vital decisions regarding cost control and cost and determining selling price. ABC Costing is a supplemental method of cost accounting that provides the decision-making information absent from traditional costing methods. While ABC costing is not limited by business unit boundaries, it can not fully supplant traditional costing methods as it often fails to meet financial reporting requirements for businesses. ABC Costing focuses on costs contributing to production of a product. It does not attribute other general costs that do not have at least an indirect relationship to the product. While traditional costing systems focus on direct costs and burden a product with other fixed costs, activity based costing increases accuracy of indirect cost assignment. Implementation Steps Step #1: Activity Identification First, activities must be identified and grouped together in activity pools. Activity pools are the supporting activities that tie in to a product line or service These pools

3 or buckets may include fractionally assigned costs of supporting activities to individual products as appropriate during the second step. Step #2: Activity Analysis ABC continues with activity analysis, clearly identifying the processes which support a product and avoiding some of the systemic inaccuracies of traditional costing. ABC costing requires activity analysis, similar to the process mapping found in lean manufacturing. This activity analysis identifies indirect cost relationships and allows assignment of some percentage of that activity to an end product directly. Step #3: Assignment of Costs Based on the findings of step #1 and #2, costs are assigned to an activity pool. For example, human resources costs would be assigned to indirect administrative or indirect management costs. These pools will each have some contribution to object cost. Step #4: Calculate Activity Rates Initial analysis may include direct labor hours, or indirect support labor. These activities must be assigned a value in real currency. All weightings must be added at this step. For instance, production labor hours should be in terms of a weighted labor rate including benefit costs. Step #5: Assign Costs to Cost Objects Once activity costs, pools and rates are identified and clearly defined, the next step is to assign them to cost objects. Objects are generally defined as the results offered to a customer. In both manufacturing and non-manufacturing environments, this product should have some saleable value to compare to the assigned costs. Step #6: Prepare and Distribute Management Reports Once ABC costing analysis is complete, that cost data should be placed in a concise and coherent manner for cost object and process owners. This communication of the costing analysis is critical to justify the cost of the analysis, as often this is not an inconsequential cost. Conclusion

4 ABC costing does nothing for the organization if the information is collected but no action follows. The key to the value of this form of costing is that it is actionable. This analysis allows companies to make decisions about product lines, where to direct sales efforts, and to validate the true value provided by capital equipment. Q.3 What is budgetary control? Also enumerate the various budgets prepared by firms? A budget is a plan of action.it is a document of formal planning and control The primary focus of a budgeting system is the provision of prior information for direction and control of activities. These two aspects could be called budgetary planning and budgetary control. Objective and Functions- To guide action. To co-ordinate different activities. To motivate employees. To provides basis for performance evaluations. To implement MBO and MBE. (Management by objective) (Management by exception) Process of setting Budgets Organization for budgeting. Budget committee Budget officer/ budget controller Budget manual Fixation of the budget period. Determination of the key factor. Making a forecast. Preparation of budgets. Scope and Kinds Time Functions Flexibility long term sales fixed short term production flexible current Rolling cost of production purchase research cash master (i) Long term budgets >5 year duration. (ii) Short term budgets - up to one year duration. (iii) Current budgets -very short term periods. (iv) Rolling (Progressive/continuous budget) - Budget prepared for 1 year After a quarter new budget is prepared (for 1 yr). Some advanced budget will always remain

5 Q.4 What is a transfer price? What are different types of transfer prices? A transfer price is the price at which divisions of a company transact with each other, such as the trade of supplies or labor between departments. Transfer prices are used when individual entities of a larger multi-entity firm are treated and measured as separately run entities. A transferprice can also be known as a transfer cost. Some important types of transfer pricing methods used in International Marketing are as follows: Market-based Transfer Price Market conditions which are appropriate for adoption Are generally appropriate in a perfect market, where there is homogeneous product with only one price for both sellers and buyers and no buying or selling costs. In a perfect market, Selling Division (SD) will be operating at full capacity and can sell whatever quantity of intermediate product it can produce in the external market. In this situation, internal transfers will result in a need to sacrifice external sales. The benefit forgone that is the contribution lost (opportunity cost) from sacrificing external sales should be included in the transfer price. Thus in this situation TP=MP will be consistent with the general TP rule. TP=MC+OC = MP In a perfect market, the minimum TP is also the maximum TP. Thus, both SD and BD will be happy with a transfer price set as the market price. The adoption of market-based transfer price in a perfectly competitive market meet the criteria of a good transfer price, that is it will promote goal congruent decisions, preserve divisional autonomy and provide an equitable basis for performance evaluation. Limitations (i) As a result of product differentiation, ther may be no comparable product or a single market price. (ii) Market price may vary because of over-supply or under-supply, promotions, or product dumping by foreign competitors. Full-cost based Transfer Price Market conditions which are appropriate for adoption In an imperfect market, it may be unwise to always set transfer price exactly at the

6 variable costs of production, as such prices do not provide for the replacement of fixed assets. The Supply Division (SD) will want to base the transfer price on total absorption cost to ensure that it will provide a contribution to cover the fixed overheads. Full-cost based transfer price is widely used because managers require an estimate of long-run marginal cost for decision-making. However, traditional absorption costing systems tend to provide poor estimates of long-run marginal cost for decision-making. ABC will provide better estimates of long run MC. Limitations (i) It can lead buying division (BD) to make sub-optimal decisions because BD regards the transfer price (which includes the fixed costs) as a wholly variable cost. Negotiated Transfer Price Market conditions which are appropriate for adoption In an imperfect market (different selling costs for internal and external sales, differential market prices), transfer prices set at the prevailing or planned market price are not optimal i.e. will not induce SD and BD to adopt optimal output level. Central/corporate management intervention is necessary in order to ensure that optimal output levels are set but this process may undermine divisional autonomy. In this situation, it is more appropriate to adopt negotiated transfer prices. If both managers had been provided with all the information and were educated to use information correctly, it is likely that a negotiated solution would have emerged which would have been acceptable to both the divisions and the group. When there is unused capacity, the transfer price range for negotiations generally lied between the minimum price at which SD is willing to sell (its marginal cost) and the maximum price BD is willing to pay (the external supplier price net off any external purchase related costs). Limitations (i) Can lead to sub-optimal decisions (ii) Time-consuming (iii) Strongly influenced by the bargaining skills and power of the divisional managers (iv) Inappropriate in certain circumstances (e.g. no market for the intermediate product or an imperfect market exists as the SD will have a bargaining disadvantage) Q.5 Distinguish between marginal costing and absorption costing? also examine their relative appropriateness?

7 Difference Between Absorption Costing and Marginal Costing As we have now understood the two terms separately, we will compare the two in order to find other differences between Absorption Costing and Marginal Costing. Definition Absorption costing is a method of costing a product in which all fixed and variable production costs are apportioned to products. Marginal costing is an accounting system in which variable costs are charged to products and fixed costs are considered as periodic costs. Inventory Valuation Absorption Costing values inventory at full production cost. Fixed cost relating to closing stock is carried forward to the next year. Similarly, fixed cost relating to an opening stock is charged to the current year instead of the previous year. Thus, under absorption costing, all fixed cost is not charged against revenue of the year in which they are incurred. Marginal Costing values inventory at a total variable production cost. Therefore, there is no chance of carrying forward unreasonable fixed overheads from one accounting period to the next. However, under marginal costing, the value of inventory is understated. Effect on Profit As inventory values are different under absorption and marginal costing, profits too differ under two techniques. 1. If inventory levels increase, absorption costing gives the higher profit. This is because fixed overheads held in closing inventory are carried forward to the next accounting period instead of being written off in the current accounting period. 2. If inventory levels decrease, marginal costing gives the higher profit. This is because the fixed overhead brought forward in opening inventory is released, thereby increasing the cost of sales and reducing profits. If inventory levels are constant, both methods give the same profit. Treatment of Fixed Cost Outcome Absorption Costing includes fixed production overheads in inventory values. However, fixed overheads cannot be absorbed exactly due to difficulties in forecasting costs and volume of output. Therefore, there is the possibility that overheads could be over or under absorbed. Overhead is over-absorbed when the amount allocated to a product is higher than the actual amount and it is under absorbed when the amount allocated to a product is lower than the actual amount. In Marginal Costing, fixed production overheads are not shared out among units of production. Actual fixed overhead incurred is charged against contribution as a periodic cost. Usefulness of the Technique Absorption Costing is more complex to operate and it does not provide any useful information for decision making like marginal costing. Cost data produced under absorption costing is not very useful

8 for decision making because product cost includes fixed overhead obscuring cost-volume-profit relationship. However, absorption costing is required for external financial reporting and income tax reporting. Marginal Costing does not allocate fixed manufacturing overheads to a product. As a result, marginal costing could be more useful for incremental pricing decisions where a company is more concerned about additional cost required to build the next unit. Identification of variable costs and contribution enables management to use cost information more easily for decision making. Presentation in Financial Statements Absorption Costing is acceptable under IAS 2, Inventories. Thus, absorption costing is required for external financial reporting and income tax reporting. Marginal Costing is often useful for management s decision making. Exclusion of fixed cost from inventory affects profit. Therefore, true and fair view of financial statements may not be clearly transparent under marginal costing. Summary Absorption Costing vs Marginal Costing In this article, we have attempted to understand the terms absorption costing and marginal costing followed by a comparison to highlight key differences between them. The basic difference between Absorption Costing and Marginal Costing lies in how fixed overhead cost is treated in management decisions of valuation of inventory and pricing. In absorption costing, fixed cost is included in both value of inventory and cost of the product when making the pricing decision whereas marginal costing avoids fixed overheads in both decisions.