Purpose Current / Future Product Costs Short-term decisions: product mix, pricing Future Longer-term strategic decisions Long-term pricing Plan future product-related costs Control of product costs Current Reimbursement contracts External reporting (inventory calculation) All the information cannot come from one source. The main accounting system may accumulate current and past costs but for much decision-making and planning estimates of future costs will need to be generated outside of that accounting system. ARQ. 3 How common are product costing systems in practice?
Why might a business choose to do without a product costing system? L-S, T & H, page 134. A recent survey of members of the Chartered Institute of Management Accountants (COMA) found that less than 50 per cent of respondents had yester for costing products in their organization, and in small organizations this figure fell to 34 per cent (COMA, 2009). The range of costs included within a product costing system varies from one organization to another. A comprehensive picture of product costs requires the inclusion of upstream and downstream costs.
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In practice many businesses confine their product costing systems to manufacturing costs. This is particularly true of small to medium-sized manufacturing businesses since more comprehensive costing systems cost more to implement and maintain. The costing systems that only include manufacturing costs produce the inventory valuations for external financial reporting required by Australian accounting standards. Any additional product-related costs must be identified through special studies.
Often, smaller businesses do not have the resources for special studies, and managers may rely on product costs developed for external reporting for making a whole range of decisions. This does not seem ideal, although it must reflect management’s assessment of the costs and benefits of obtaining more relevant product cost information! ARQ. 5 ‘We don’t need a product costing system. We are a small manufacturer with a just-in-time approach so that our inventories are minimal. We have no influence over product price; whatever the big fellows do, we follow.
Anyway, our accountant only comes in on Fridays and she is already far too busy to bother with a product costing system. ‘ Is this a reasonable attitude? Explain why. L-s, T & H, pages 130-134. This is not entirely satisfactory. There are a range of decisions that product costs may be useful for. Even though the business is a ‘price-taker’, they may well need to consider whether they should be making all of the products in the range, as some may be unprofitable. A wrong decision on one product ay cost the firm more than it does to keep a costing system going.
A product costing system may well help them control production costs and recognize problems before it is too late. The firm will need some product costs at year-end to value inventory even if it is minimal. ARQ. Describe the flow of costs through a product costing system used to value inventory. What special ledger accounts are involved, and how are they used? L-S, T & H, pages 134-136. When direct material, direct labor and manufacturing overhead costs are incurred, they are applied to work in process inventory by debiting the account.
When goods are finished, the costs are removed from the work in process account with a credit, and are then transferred to finished goods inventory by debiting that account. Us abstinently, when the goods are sold, the finished goods inventory is credited and the costs are added to the cost of goods sold, with a debit. See Exhibit 4. 3 below: ARQ. Paying manufacturing overhead to products involves four steps. Describe each step. L-S, T & H, page 138. Firstly, what is manufacturing overhead? Manufacturing overhead is indirect costs attributed to manufacturing activities.
Some examples of manufacturing overhead costs are depreciation f production machinery, quality inspectors salary, local council rates for the factory, and electricity costs. These costs cannot be easily traced to particular products so a proportion of these costs must be assigned to each product. The easiest way to do this is to accumulate overhead costs in one or more cost pools and then allocate these costs to products using cost drivers. The three steps followed when applying manufacturing overhead to products are: (1) Aggregating the overhead costs into cost pools.
Gathering up similar costs into cost pool(s). (2) Identifying the overhead cost driver, which is the actor that causes the overhead costs to be incurred; (3) Calculating the predetermined (or budgeted) overhead rate per unit of cost driver, which is usually based on the budgeted annual manufacturing overhead cost, divided by the budgeted annual volume of cost driver; and (4)Applying manufacturing overhead costs to products, by multiplying the predetermined overhead rate by the amount of cost driver consumed by the product. ARQ. What are the causes of underplayed and oversupplied overhead? When should the oversupplied or underplayed account be closed? Explain your answer. L-S, T & H, pages 139-140. Oversupplied or underplayed overhead is caused by errors in estimating the predetermined overhead rate. These errors can occur in the numerator (budgeted manufacturing overhead), or in the denominator (budgeted level of the cost driver). The text book recommends that the oversupplied or underplayed overhead account should be closed at the end of the year only.
If the oversupplied or underplayed is closed at the end of each month, the monthly fluctuations in overhead costs and cost driver volumes are shifted out to the cost of goods sold. Over the year many of these fluctuations are likely to average out. Oversupplied and underplayed overhead should be considered for the whole year, not at the end of each month. ARQ. ID Briefly describe two ways of disposing of oversupplied and underplayed overhead at the end of the accounting period. L-S, T & H, page 140.
Oversupplied or underplayed overhead can be closed directly into cost of goods sold, or it can be prorated among work in process inventory, finished goods inventory and cost of goods sold. If the amount of underplayed or oversupplied overhead is significant, it should be prorated. ARQ. 11 Explain the difference between job costing and process costing. Give three examples other than those in the chapter) of businesses that you would think would use: a. A job costing system b. Process costing system. Explain your choices. L;S, T & H, pages 140-141.
In a job costing system, costs are assigned to batches or job orders of production. Job costing systems are used by firms that produce relatively small numbers of dissimilar products. Job costing would be used in any situation where products are produced to customers’ specifications, such as in a dressmaking business, an architectural firm, or in a panel-beating shop. In a process costing system, production costs are averaged over a large umber of product units. Process costing systems are used by firms that produce large numbers of nearly identical products, such as paint, beer or bricks.