ACC200 Introduction to Management Accounting

Our competitors are using and I want to know more about it. I need you to tell me what it's all about and whether it would suit us. They are calling it ABC or something like that. It is said to be a better costing system but I am not sure. Tell me more about it. I need to know how it works, its benefits and its limitations. If it works for us, I would like to implement it as well. I do not want to be left behind I" 

REQUIRED:

Prepare a report (no more than 10-pages) for Frank Burgess that addresses the following:

a) The purpose of a product costing system.

b) Preparation of a Schedule of Cost of Goods Manufactured and Cost of Goods Sold. (The schedules may be in the appendix). Explain why some items have been excluded from the schedules.

c) Complete the T-accounts and determine the following:

i. Work in Process at the end of April;

ii. Raw materials purchased in April;

iii. Overhead applied in April;

iv. Cost of Goods sold in April;

v. Raw materials used in April; and,

vi. Over- or under-applied overhead in April.

d) Discuss how overheads can be over- or under-applied and how the company should deal with the over- or under-application.

e) Evaluate whether ABC should be introduced. (Hint: remember to consider both the costs.

Every company needs a financial accountant as well as a cost accountant in order to record proper accounts. But frank does not realise the importance of them and he is of the opinion that recording the sales and expenses is enough. So, to make him know of the importance he should first know about the different product costing system (Berman, Knight and Case, 2013)..

Cost accounting system is an accounting process that enables the company to track the expenses properly that has been incurred while converting the raw material to finished goods. All the cost whether of direct nature or indirect nature must be ascertained and recorded. A company must always try to reduce and control costs because it ultimately affects the price of the commodity that has to be sold in the market. If the prices are high than the competitors then the customers may lose interest and the sales of the company may fall drastically (Bragg, 2014).

There is not a single product costing system. But a number of product costing system has been known and the product costing system may differ from one company to another. Some of the product costing systems are as follows-

• Standard costing – In this costing system, an estimate is made for all the expenses and then the it is compared with actual figures to measure the variation. Standard costing cannot be used independently. However, it can be used along with other product costing system (Brigham and Ehrhardt, 2017).
• Process costing- After the completion of each stage of production, cost per unit of the product is ascertained. Process costing can be used by the concerns that produce identical products.
• Job costing- The process in which a cost sheet is prepared is known as job costing. Such cost sheet gives proper information relating to cost of goods manufactured, the cost of goods sold, the profit margin and also the cost of goods sold.
• Hybrid costing – The combination of process costing and job costing is known as hybrid costing.

If a company uses its product costing system wisely then a lot of solutions to a problem is being traced out. Following are the things that a company comes to know-

• The level of efficiency of the product line.
• The percentage of overhead in the total cost of the product.
• The reason for the increase in the price of the product, if there be any.
• The increased unit of production and its influence on the cost per unit.
• It helps to know whether the management is working effectively and taking decisions wisely or not (Ehrhardt and Brigham, 2011).
• It tells about the success and failure of a particular project. 

1. b) Cost of goods manufactured is the sum total of the direct material, direct wages and the manufacturing overheads. In simple terms, the directly attributable cost that has been incurred to produce a finished product is known as the cost of manufactured product.

Cost of goods sold is the difference between the sales and the profit. It can also be calculated by summing up value of opening inventory with the cost of goods manufactured and after that deducting the value of closing inventory (Garrison, Noreen and Brewer, 2012).

 These are the accounts that are required by frank-

 In a manufacturing concern there are various types of cost that are incurred. These cost may be direct or indirect in nature. The direct cost are easily measurable and attributable so it is easy to recover such costs from the customer but indirect cost are neither directly attributable nor easily measurable so a proper record has to be maintained about all the indirect expenses (Gitman and Zutter, 2012). If the records are not properly maintained there may be a situation of under recovery and over recovery.

Over recovery is the situation when the cost recovered from the customer on the basis of the predetermined is more than the cost of overhead actually spent.Under recovery is the situation when the predetermined rate is not efficiently computed and because of which the overhead recovered is less than the overhead incurred (Hoyle, Schaefer and Doupnik, 2015).

There are various reasons of under and over recovery and the treatment for them is as under:

1. If the under recovery is due to faulty management or because of any abnormal cause then it should be charged to the profit and loss account.
2. The over recovery is like a profit earned for the company and so it is credited to the profit and loss account (Kinney and Raiborn, 2011).
3. If the under or over recovery is due seasonal variation then such amount of under/over recovery should be carried forward to the subsequent years.
4. If the reason is due to changes in the price level then in respect of the goods that have already been sold the amount should be charged / credited to profit and loss account as the case may be. But in respect of goods still lying in the stock a supplementary rate has to be charged (Koster, 1997).

If the overhead cost is recovered more then the price of the product increases and thereby lowering the sales. Under recovery introduces loss in the company and so we can conclude that both under and over recovery is harmful for the company (Mondy, 2015).

1. Frank has got to know about ABC analysis from somewhere. However, he is only aware of the name (Pratt, Anthony and Clement, 2003). He does not know the use and advantages of using it. It is very important for frank to have good knowledge about ABC analysis before introducing it in the company. He can take his decision of implementing this method after evaluating its contribution in the company.

  The cost of raw material has a higher proportion in the total cost of the product. So, it is important to manage inventories, having high or low inventory both can be bad for the company. If the holding of material is more then the company has to incur more carrying cost and if the holding of inventory is low the company can undergo opportunity loss.  The company should analyse and then invest in the materials accordingly (Ramsey and Ramsey, 2003)..

ABC analysis is a process of managing and controlling the materials in the company. The other name for ABC analysis is “Selective inventory control”. In this method of material control, the inventories are sub categorised under three heads on the basis of their value. Category A materials usually has the highest value and therefore the control over it is stricter than the other two categories. Category B materials has moderate value i.e. less value than A but more than C. So the control is also moderate. Category C has goods with a very low value and so the control over the material is also very less (Schipper, 2012).

The advanatages of using ABC analysis are-

• Reduces investment- The delivery period that is accepted by the management is always very low and so the investment required is also less.
• Savings in time-As the control over the material is done category wise, hence less importance is give to Category B and C. So, there is a savings of time (Weil, 2014).
• Minimum carrying cost- If the companies buy materials in bulk which is more than required. Then it will result in higher storage cost. So material control through ABC also helps to reduce the carrying cost.
• Strict Control- The materials having higher values are managed and controlled more strictly when compared to others.
• Economical- ABC analysis does not involve huge cost. Therefore, it is considered economical.
• Increases efficiency- The management efficiency increases because of the proper management and control, the burden becomes very less.
• No opportunity loss- If the company keeps a proper check on the materials of the management then it can take orders promptly and start working. It does not have to wait for the delivery of materials. However, if materials are not there when required the company may lose the opportunity of accepting the order.

There are also some limitations of ABC analysis that Frank should know

1. This method cannot be adopted if the materials present in the stores are not standardised.
2. Price is the one factor kept in mind while carrying out ABC analysis. All the other factors are ignored.
3. ABC analysis involves huge time.

ABC should still be recommended because the limitations are negligible when compared to the advantages. This method clearly makes us understand that all inventories have different values.

References

Berman, K., Knight, J. and Case, J. (2013). Financial intelligence. 1st ed. Boston, Mass.: Harvard Business Review Press.

Bragg, S. (2014). Corporate cash management. 1st ed. Centennial: Accounting Tools.

Brigham, E. and Ehrhardt, M. (2017). Financial management. 1st ed. Boston, MA, USA: Cengage Learning.

Cafferky, M. (2014). Breakeven analysis. 1st ed. New York: Business Expert Press.

Ehrhardt, M. and Brigham, E. (2011). Financial management. 1st ed. Mason: South-Western Cengage Learning.

Garrison, R., Noreen, E. and Brewer, P. (2012). Managerial accounting. 1st ed. New York, N.Y.: McGraw-Hill/Irwin.

Gitman, L. and Zutter, C. (2012). Principles of managerial finance. 1st ed. England: Pearson Education Limited.

Hoyle, J., Schaefer, T. and Doupnik, T. (2015). Advanced accounting. 1st ed. New York, NY: McGraw-Hill Education.

Kinney, M. and Raiborn, C. (2011). Cost accounting. 1st ed. Mason, Ohio: South-Western Cengage Learning.

Koster, R. (1997). The on production budget book. 1st ed. Boston: Focal Press.

Mondy, R. (2015). Human resource management. 1st ed. [Place of publication not identified]: Prentice Hall.

Pratt, J., Anthony, J. and Clement, R. (2003). Financial accounting in an economic context. 1st ed. New York, N.Y.: Wiley.

Ramsey, D. and Ramsey, S. (2003). Financial peace revisited. 1st ed. New York: Viking.

Schipper, K. (2012). Financial accounting. 1st ed. [Place of publication not identified]: South-Western.

Stickney, C. and Weil, R. (2003). Financial accounting. 1st ed. Mason, Ohio: Thomson South-Western.

Weil, R. (2014). Financial accounting. 1st ed. Mason, Ohio: South-Western.