EXECUTIVE SUMMARY

The purpose of this assignment is to identify important costing methods, budgeting methods for achieving their goals. Thus to calculate the unit cost of their products, to determine the unit price. Based on unit cost we can price our products with profits.

Therefore through this assignment we try to evaluate costing methods and identify appropriate costing method and budgeting method for the organizations. Also another important management accounting concept is budgeting process. Generally budgets are prepared for coming period. By this the entity can arrange their financial resources for next period and manage them. This concept also evaluated under this report.

There is another concept called standard costing also very important because from this concept we contrast budgeted cost and actual cost and identify differences and take corrective actions. Hence through this report we can elaborate different kinds of management accounting concepts and their effectiveness for the operations.

 

01. Different types of Cost

(A) Actual Cost

Actual cost is defined as the cost or expenditure which a firm incurs for producing or acquiring a good or service. The actual costs or expenditures are recorded in the books of accounts of a business unit.

Examples: Cost of raw materials, Wage Bill etc.

(B) Opportunity Cost

Opportunity cost is concerned with the cost of forgone opportunities/alternatives. In other words, it is the return from the second best use of the firms’ resources which the firms forgoes in order to avail of the return from the best use of the resources. It can also be said as the comparison between the policy that was chosen and the policy that was rejected. The concept of opportunity cost focuses on the net revenue that could be generated in the next best use of a scare input.

(D) Incremental Cost

Incremental costs are addition to costs resulting from a change in the nature of level of business activity. As the costs can be avoided by not bringing any variation in the activity the activity, they are also called as “Avoidable Costs” or “Escapable Costs”. More ever incremental costs resulting from a contemplated change is the Future, they are also called as “Differential Costs”

Example: Change in distribution channels adding or deleting a product in the product line.

(I) Accounting Costs

Accounting costs are the actual or outlay costs that point out the amount of expenditure that has already been incurred on a particular process or on production as such accounting costs facilitate for managing the taxation need and profitability of the firm.

Examples: All Sunk costs are accounting costs

(J) Economic Costs

Economic costs are related to future. They play a vital role in business decisions as the costs considered in decision – making are usually future costs. They have the nature similar to that of incremental, imputed explicit and opportunity costs.

(K) Direct Cost

Direct costs are those which have direct relationship with a unit of operation like manufacturing a product, organizing a process or an activity etc. In other words, direct costs are those which are directly and definitely identifiable. The nature of the direct costs is related with a particular product/process, they vary with variations in them. Therefore all direct costs are variable in nature. It is also called as “Traceable Costs”

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Examples: In operating railway services, the costs of wagons, coaches and engines are direct costs.

(L) Indirect Costs

Indirect costs are those which cannot be easily and definitely identifiable in relation to a plant, a product, a process or a department. Like the direct costs indirect costs, do not vary i.e., they may or may not be variable in nature. However, the nature of indirect costs depends upon the costing under consideration. Indirect costs are both the fixed and the variable type as they may or may not vary as a result of the proposed changes in the production process etc. Indirect costs are also called as Non-traceable costs.

Example: The cost of factory building, the track of a railway system etc., are fixed indirect costs and the costs of machinery, labour etc.

1.1. Different costing methods.

Methods of costing for ascertainment of actual cost may be identified in many names according to the variation of procedure adopted to determine cost for different types of product. Broadly there are two group of costing method specific order, costing. Specific order or job costing is applicable for specific jobs, batches or contracts each of which is undertaken by specific order or contract job costing. Batch costing and Contract costing are included in this group.

Job Costing

Job costing is concerned with the finding of the cost of each job or work order. This method is followed by these concerns when work is carried on by the client request, such as printer general engineering work shop etc. under this system a job cost sheet is required to be prepared find out profit or losses for each job or work order. Costing technique used to ascertain cost of a job or work-order is called job costing.

Process Costing

Some products are to pass through different stages of production before their completion. The different stages of production are called ‘process’ and each process is distinct and well defends. Output of one process is used as raw material for the next process. It may be in a saleable state. It is necessary to ascertain total cost of each of such processes and cost per unit at each process. So a separate account for each process is maintained and that method of maintaining record and ascertaining cost of production is known as process costing. Sometimes, it is also referred as ‘average’ costing. It is used in case of textile, chemical, paints, food product, paper, sugar, etc.

Operating Costing

This is suitable for industries where production is continuous and units are exactly identical to each other. This method is applied in industries like mines or drilling, cement works etc. Under this system cost sheet is prepared to find out cost per unit and profits or loss on production. This method of costing is applicable to ascertain cost of operating a service, such as bus, railways, water supply, nursing home, etc.

1.2. Calculate and analyze cost using appropriate techniques.

For this we can use CBA analysis.

As a technique, it is used most often at the start of a programme or project when different options or courses of action are being appraised and compared, as an option for choosing the best approach. It can also be used, however, to evaluate the overall impact of a programme in quantifiable and monetized terms.

CBA adds up the total costs of a programme or activity and compares it against its total benefits. The technique assumes that a monetary value can be placed on all the costs and benefits of a programme, including tangible and intangible returns to other people and organizations in addition to those immediately impacted. As such, a major advantage of cost-benefit analysis lies in forcing people to explicitly and systematically consider the various factors which should influence strategic choice.

Decisions are made through CBA by comparing the net present value (NPV) of the programme or project’s costs with the net present value of its benefits. Decisions are based on whether there is a net benefit or cost to the approach, i.e. total benefits less total costs. Costs and benefits that occur in the future have less weight attached to them in a cost-benefit analysis. To account for this, it is necessary to ‘discount’ or reduce the value of future costs or benefits to place them on a par with costs and benefits incurred today. The ‘discount rate’ will vary depending on the sector or industry, but public sector activity generally uses a discount rate of 5-6%. The sum of the discounted benefits of an option minus the sum of the discounted costs, all discounted to the same base date, is the ‘net present value’ of the option.

02. Routine cost reports

Routine cost report means any report which is produce by cost department for relating of goods. These reports are required to be prepared and submitted periodically on matters required by the organization so as to help the management of the organization to take decisions in the matters relating to day to day affairs. The main objectives of routine reports are to let the management know as to what is happening in the organization, what is its progress where the deviation is, what measures have been taken in solving the problems and what to do so that the organization may run smoothly and efficiently. Routine reports are generally brief. They only give the facts. No comments or explanations are usually offered in such reports. Generally forms are prescribed for preparation and submission of such reports.

2.1. Performance indicators to identify potential improvements.

In most businesses, the employees represent both an organization’s biggest expense, and its most valuable asset. This means the company’s productivity, and ultimately, its profitability Key Performance Indicators (KPIs) are a company’s measurable goals, typically tied to an organization’s strategy, as revealed through performance management tools such as the Balanced Scorecard. depend on making sure all of its workers perform up to, if not exceed their full potential.

Implementing the key performance indicators of a balanced scorecard typically includes four processes:

  • The company translates its corporate vision into measurable operational goals that are communicated to employees.
  • These goals are linked to individual performance goals which are assessed on an established periodic basis.
  • Internal processes are established to meet and / or exceed the strategic goals and customer expectations.
  • Finally, Key Performance Indicators are analyzed to evaluate and make recommendations to improve future company performance.

2.2. Suggest improvements to reduce cost and enhance value and quality.

  • Communication – effective engagement with key stakeholders is vital to ensure clarity of purpose and respective roles, responsibilities and expectations. Effective communication promotes buy in and lessens the risk of resistance to change or poor results.
  • Continual improvement in the quality and effectiveness of products.
  • Increased operational efficiency.
  • A foundation for multi-site global manufacturing.
  • Spend wisely instead of cutting costs.

03. Purpose and nature of budgeting process.

3.1. Budgeting methods.

Incremental budgeting

Prepared based on the current period’s budget with some added amounts regarding inflation or planned increases in sales and costs

Zero-based budgeting

In the mid-20th century, money got tighter and problems associated with incremental budgeting began to give rise to a feeling that changes were needed.• By the 1960, ZBB emerged in the concept.• ZBB definition It starts each budget period from a base of zero, with no reference to the prior period (Anon, 2010). Every department function has to justify the resources used for their relevant activities. Unless the activity is justified, there will be no resource allocation for it.

Top-down budgeting (Imposed budgeting)

Top-Down Budgeting is the term given to a budgeting process based on estimating the cost of higher level tasks first and using these estimates to constrain the estimates for lower level tasks.

Bottom-up budgeting (Participated budgeting)

Bottom-up budgeting begins with identifying all the constituent tasks that are involved in implementing a project and working out the resources and funding required by each

3.2. Prepare a cash budget

The cash budget contains an itemization of the projected sources and uses of cash in a future period. This budget is used to ascertain whether company operations and other activities will provide a sufficient amount of cash to meet projected cash requirements. If not, management must find additional funding sources.

The inputs to the cash budget come from several other budgets. The results of the cash budget are used in the financing budget, which itemizes investments, debt, and both interest income and interest expense.

Beginning cash
Sources of Cash

+ Cash sales

+ Accounts receivable collected

+ Asset sales

= Total cash available

XX

XX

XX

XXX

Uses of Cash

– Direct materials

– Direct labor

– Manufacturing overhead

– Selling & administrative

– Selling & administrative

– Dividend payments

= Total uses of cash

X

X

X

X

X

X

XX

Net Cash PositionXXX

 

04. Calculate variances, identify possible causes and recommend corrective actions.

What is the variance analysis?

Variance analysis is the quantitative investigation of the difference between actual and planned behavior. This analysis is used to maintain control over a business. For example, if you budget for sales to be $10,000 and actual sales are $8,000, variance analysis yields a difference of $2,000.

4.1. Prepare an operating statement

Combining the revenue, direct costs and overhead costs enables you to prepare a monthly operating statement. This records income and expenditure (as does the profit and loss), not receipts and payments. It may ignore some items such as depreciation or bad debts. It should, however, give a close approximation to the actual profit and loss account. Each month, you should compare your actual performance with your forecast both for the month and, ideally, for the year to date.

4.2. Report findings to management in accordance with identified responsibility centers.

Responsibility centers are identifiable segments within a company for which individual managers have accepted authority and accountability.

Responsibility centers any given department deepens on which aspect of the business has authority over.

Managers prepare a responsibility report evaluate the performance of each responsibility center. This report compares the responsibility center’s budgeted performance with its actual performance, measuring and interpreting individual variance. Responsibility reports should include only controllable cost so that managers are not held accountable for activities they have no control over. Using a flexible budget is helpful for preparing a responsibility report.

01. Under this context we are going to identify the different types of cost relating to the “Toys manufacturing industry”.

Type of costExamples
Direct costDirect materialPlastic

Grey

Direct LabourSeamstress
Direct otherCotton wool

Salaries for labour

 

Indirect cost

Indirect materialButtons

Yarn

Indirect LabourSupervisors

Managers

Indirect otherRent

Machine depreciation

Electricity

Sunk costInitial investment to build the factory.
Opportunity costThe land would be used for provide parking facilities and earn.

02. There are many costing methods such as Job costing, Batch costing, Process costing and so on. As we discussed in detailed manner about these costing methods in 1.2.we can identify what is best costing method for manufacturing industry like “Toys manufacturing industry”. Generally there are so many different types of toys are produced focusing on kids. Therefore they need different different raw materials for each batch and costs are various from each other, Hence the “Batch Costing” is appropriate for these kind of industries.

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06. Task 02

As per this task we will understand what are differences between marginal costing method and absorption costing method from following example.

Standard production costs

“000”

Direct Labour 3hrs at Rs.6000 per hr. 18

Direct materials 4kg at Rs.7000 per kg 28

Production Overhead: Variable 3

Fixed 20

Standard production cost per unit 69

Normal output is 8000 units. Variable selling, distribution and administration costs are 20% of sale value. Fixed selling, distribution and administration costs are Rs.90000/=.There are no units in finished goods in opening inventory. The selling price per unit is Rs.140, 000.Production and sales budgets are as follows.

Production 8500

Sales 7000

  1. Marginal Costing Method

“000”

Sales (Rs.140 per unit) 980

Opening inventory –

STD variable cost (Rs.49 per unit) 416.5

416.5

Closing inventory (W1) 73.5

343

637

Variable selling and so on cost 196

Contribution 441

Fixed costs: Production (W2) 160

Selling & so on 90 250

Net profit 191

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  1. Absorption Costing Method

“000”

Sales (Rs.140 per unit) 980

Opening inventory –

STD cost of prod 🙁 Rs.69 per unit) 586.5

586.5

Closing inventory (W1) 103.5

483

Over/under absorption overhead (10)

473

Gross profit 507

Selling & so on costs

Variable 196

Fixed 90 286

Net profit 221

Workings

Units

  1. Opening inventory –

Production 8500

8500

Sales 7000

Closing inventory 1500

Marginal cost valuation (Rs.49) 73.5

Absorption cost valuation (Rs.69) 103.5

 

“000”

02. Budgeted Fixed production overhead = 8000*20

Rs.160

03. Normal output 8000

Budgeted output 8500

Difference 500

Std fixed prod: overhead *20

Over/Under absorbed overhead (10)

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The difference in profits reported under the two costing methods is due to the different inventory valuation methods used.

  1. If inventory levels increase between the beginning and end of a period, absorption costing will report the higher profit because some of the fixed production overhead incurred during the period will be carried forward in closing inventory (which reduce s cost of sales) to be set against sales revenue in the following period instead off in full against profit in the period concerned.
  2. If inventory levels decrease ,absorption costing will report the lower profit because as well as the fixed overhead incurred, fixed production overhead which had been carried forward in opening inventory is released and also included in cost of sales.

 

 

 

 

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07. Task – 03

01. The purposes and nature of the budgeting process was described under topic no 03 in 3.1.

02. This also described under topic no 03 in 3.2. And the incremental budgeting method because we considered past periods’ data.

03. Prepare sales budget, production budget, material purchase budget, Debtor budget, Creditor budget and the cash budget for the month of April, May and June 2015 on monthly basis according to the selected budgeting method. (To improve the content any required assumptions can be used further.

Assumptions

Budgeted sales for month of April is Rs.1, 000,000

Sales budget

“000”

AprilMayJuneTotal
Budgeted sales unis1000160025605160
Selling price per units60/=60/=60/=60/=
6000096000153600309600

Production budget

AprilMayJuneTotal
Budgeted sales

(+)Ending stock

1000

640

1640

1600

1024

2624

2560

1638

4198

5160

1638

6796

(-)Begging stocks(9)(640)(1024)(6796)
Units to be produce1631198431746398

Direct materials purchase budget for X

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AprilMayJuneTotal
Budgeted units1631198431746398
Material per units3kg3kg3kg3kg
Total materials48935952952219194
Price per unit6/=6/=6/=6/=
Budgeted cost for purchase X293583571257132115164

Direct materials purchase budget for Y

AprilMayJuneTotal
Budgeted units1631198431746398
Material per units1 kg1 kg1 kg1 kg
Total materials1631198431746398
Price per unit2/=2/=2/=2/=
Budgeted cost for purchase X32623968634812798

Debtor budget

AprilMayJuneTotal
1st month back

Receivables

2nd month back

1500

6500

1000

1500

 

6500

1000

Total receivables1500650010009000

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Creditor budget

AprilMayJuneTotal
Material X

One month

Back

Material Y

One month

Back

164

3262

29310

3968

29474

7230

16432623327836704

Cash budget

“000”

AprilMayJuneTotal
Expected cash inflows

Receivables

Commission income

Loan receivable

Expected cash outflows

Purchase

Additional exp:

Fixed O/H

Installments

Sales commission

Opening accrued exp:

1500

164

2

200

12

10

55

6500

3

1000

3262

2

200

12

16

1000

5

29278

2

200

12

25.6

9000

8

1000

36704

6

600

36

51.6

55

Cash surplus/defect

+Opening balance

1057

125

4011

1182

-27444.6

5193

-27444.6

5193

Ending balance11825193-22251.6-22251.6

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08. Task 04

Calculate the variances in direct material cost, direct labor cost, variable overhead, fixed overhead and sales as much detail as possible (price, usage, expenditure & efficiency variances), identify possible causes and recommend corrective actions.

Direct materials cost variance (150350)

Actual Purchase * Actual Price

92150 * 9 = 829350

Price Variance = 189350 (Adverse)

Actual Purchase *Standard Price

92150 * 7 = 695050

Usage Variance = 33950 (Favorable)

Standard Usage * Standard Price

97000 * 7 = 679000

Direct labor cost variance (261900)

Actual working hours * Actual rate

19400 * 5 = 989400

Price variance = 19400 (Adverse)

Actual working hours * Standard rate

19400 * 50 = 970000

Efficiency variance = 292500 (Adverse)

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Standard hours * standard ate

24250 * 50 = 1212500

Variable overhead cost variance (197000)

Actual overhead expenditure = 582000

V / O / H /E / variance = 38800(Adverse)

Actual working hours * Absorption rate

19400 * 28 = 543200

V / O / H /E / efficiency variance = 185800 (Adverse)

Standard hours * Absorption rate

24250 * 28 = 679000

 

F / O / H variance

Actual F/O/H = 655000

F / O / H expenditure variance = 79000 (Adverse)

 

Actual working hours * Absorption rate

19400 * 40 = 776000

F / O / H volume variance = 224000 (Adverse)

Budgeted hours * Budgeted rate

25500 * 40 = 1020000

 

Sales value variance

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Sales margin price = Actual sales (Standard margin – Actual margin)

= 48500 ( 17- 19)

= 97000 (Favorable)

Sales margin volume = Standard margin (Standard sales – Actual sales )

= 17 ( 5100 – 48500)

= 42500 ( Adverse )

Reconciliation of budgeted & actual profit

Statement

FavorableAdverseTotal
Budgeted net profit

48500 * 17

Sales variance

  • Sales margin profit
  • Sales margin volume

Direct materials

  • Price
  • Usage

Direct labor

  • Price rate
  • Efficiency

V / O / H

  • Expenditure
  • Efficiency

F / O / V

  • Expenditure
97000

33950

42500

184300

19400

242500

38800

185800

79000

824500
130950714700
Actual Profit163150

04. BEP is the point of balance making neither appoint profit nor a loss. The

term originates in finance, but concept has been applied widely since. According to the given scenario management may be decide what would be best point for the organization based on BEP analysis.

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09. Conclusion

Management accounting concepts are most important tools for specially manufacturing companies for their major operations are manufacturing, distributing and so on. Therefore they have to determine their total production cost, unit cost and selling price. Hence those tools are much significant them. Among those concepts we considered only costing and budgeting concepts for this assignment.

Also we were able to enhance our knowledge regarding different types of costing methods, budgeting methods and concept of standard costing. Also among the above task we could get arithmetical knowledge from calculating cost of production, preparing budgets and calculating variances.

According to the above practical scenarios we would be able to known how those theoretical concepts take into practical scenarios and make calculations. Finally we analyze those things relevant to the selected organizations and select best approaches for them. Therefore, as we learners this is most valuable for us and others may able to find new knowledge from this report.

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10. Recommendations

  • Introduction of a standard form of costs management order, with court discretion to depart from the standard form of order as the circumstances of the case require.
  • Generally, the court should only budget future costs, leaving incurred costs for detailed assessment if not agreed. However, it should be given the power to comment on or summarily assess incurred costs or set a global budget figure for any phases, including both incurred and future costs.
  • Better judicial training, including compulsory attendance at a costs management course.
  • Programmes frequently cut across operational departments and may be funded from different sources. The programme manager must understand how the budget is funded so that cost reports can be fed back to the appropriate stakeholders.

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11. References

(Prime Minister’s Strategy Unit. 2004)

Return-on-investment calculator, developed by the NHS Institute of Innovation and

Improvement:

http://www.institute.nhs.uk/quality_and_service_improvement_tools/quality_and_service

_improvement tools/Return_on_Investment_ (ROI) _calculator.html

Coates, J.B., Richwood, C. and Stacey, R.J. (1996) Management Accounting for Strategic and Operational Control, Oxford, Butterworth-Heinemann.

Davenport T.H. and Prusak, L (1997) Working Knowledge, Boston, MA, Harvard Business School Press.

Professional Accountants in Business Committee (2009). Evaluating and Improving Costing in Organizations (International Good Practice Guidance). International Federation of Accountants. p. 7. ISBN 9781608150373.

“Cost Management”. Thomson Reuters.( 2011). Retrieved November 12, 2011.

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