Relevance of Product Costing Systems

Frank thinks that there is no requirement of a full time accountant in the company as he thinks that his work is only to sum up all the income and deduct expenses from it. However, to make him realise the need of an accountant first he should know about the relevance of product costing system in a company (Alex, 2012).

Product costing system means recording of all expenses and income of a particular department. The company can keep a track on the expenses and control the unnecessary and wasteful expenditures. As we know, huge expenses can be eliminated low incomes can also be treated if there reasons are clear to us. There are various types of product costing and a company must carry out proper analysis before the final selection. They are-

1. Process costing – The expenses relating to a particular department or process is recorded. It is easy to know the nature of cash flows and keep a control over it.
2. Job costing- In this type of system, different and unique goods are produced in the company. Profits of a particular job are easier to determine because the information that is provided related to a particular job.
3. Hybrid costing- The combination of job costing and process costing is known as hybrid costing (Ball, 1984).

After the selection of a proper product costing system, he needs to choose a cost allocation system that will be best for the company-

• Traditional Costing- The management records all the expenses and these expenses are divided on the per unit basis. This per unit rate is then multiplied with the actual figure of the cost driver available.  There may be under or over absorption as the rate determined earlier was on the basis of estimated data.
• Activity Based costing – The calculation in this system is made on the actual consumption and not on the basis of estimated data. For example, if a department consumes 25 hours for doing a particular job then the cost that has been incurred in that 25 hours will be allocated to the department.

Although the product costing system has a lot of complexity but it has many benefits for the company. It makes the working of the companies more efficient and helps the managers to take decisions wisely (Berman, Knight, & Case, 2013). If a company adopts a system which is best suited for the company then it will not only help to reduce costs but also increase the profits of the company.  

Particulars Save Time On Research and Writing Hire a Pro to Write You a 100% Plagiarism-Free Paper. Get My Paper	Amount
Opening stock of raw materials	12000
Add: Purchases of raw materials	180000
Less: closing stock of raw materials	12000
Direct wages	182000
Prime cost	362000
Add :Factory overhead
Insurance	14000
Repairs and maintenance	8000
Land tax	4500
Factory building depreciation	8000
Factory equipment depreciation	16000
Work cost incurred	412500
Add: Opening work in process	4500
Less: closing work in process	33500
Works cost	383500
Add: Administrative overhead
Administrative salaries	24000
Indirect labour cost	118000
General liability insurance	2400
Depreciation on office equipment	1800
Cost of production	529700
Add: Opening stock of finished goods	11000
Less: Closing stock of finished goods	16000
Cost of goods sold	524700
Add: Selling and distribution expense
Advertisement expense	12000
Sales salaries	90000
Travel and entertainment expense	14100
Cost of sales.	640800

Answer c.

WIP
Particulars	Amount	Particulars	Amount
To Bal b/d	4,500	By Finished Goods	3,33,000
To Raw Material	1,80,000	By Bal c/d	33,500
To Direct Labour	1,82,000
	3,66,500		3,66,500
Raw Material
Particulars	Amount	Particulars	Amount
To Bal b/d	12,000	By WIP	1,80,000
To Accounts Payable	1,80,000	By Bal c/d	12,000
	1,92,000		1,92,000
Manufacturing Overheads
Particulars	Amount	Particulars	Amount
To Actual Overheads	1,68,500	By Finished Goods	1,56,000
		By Bal c/d	12,500
	1,68,500		1,68,500
COGS
Particulars	Amount	Particulars	Amount
To Finished Goods	4,84,000	By Bank	4,84,000
	4,84,000		4,84,000
Accounts Payable
Particulars	Amount	Particulars	Amount
To Bank	1,84,000	By Bal b/d	12,000
To Bal c/d	8,000	By Raw Material	1,80,000
	1,92,000		1,92,000
Finished Goods
Particulars	Amount	Particulars	Amount
To Bal b/d	11,000	By COGS	4,84,000
To Overheads	1,56,000
To WIP	3,33,000	By Bal c/d	16,000
	5,00,000		5,00,000

Overhead is the indirect expense related to the manufacturing of a particular product. If the company adopts traditional costing system for the allocation of cost then there may arise a situation of under and over recovery (Bragg, n.d.). Overhead is charged from the customer based on the predetermined rate that is computed using the budgeted overhead (Tulsian, 2006). When the actual figures of the overhead are available then a comparison can be made and the correctness of the predetermined rate can also be checked. The two situations are explained hereunder-

• Over recovery- There may arise a situation when the overhead charged from the customer is more than the actual overhead expense that has been incurred. Such a situation is known as over absorption or over recovery of overhead.
• Under recovery- This is a situation when the recovery made from the customer is low than the actual amount actually spent (Cafferky, & Wentworth, 2010). This difference in the maount is known as under recovery or under absorption of overhead.

There are many reasons for under/over recovery (Fischer, Cheng, & Taylor, 2002).. The treatment of over/under recovery is on the basis of these reasons. The treatment is as follows-

1. Under / Over recovery due to faulty management- In such a situation the under/over recovery should be transferred to the profit and loss account. Under recover is recorded on the debit side as it is a kind of loss for the company whereas Over recovery is recorded on the credit side as it is a profit for the company(Pratt, 2006).
2. Under / over recovery due to seasonal variation- In such a situation, the amount of under/ over recovery is carried forward to the following years (Garrison, & Noreen, 2003).
3. Under / over recovery due to fluctuations in the price- in the given situation, the under / over recovery for goods that has already been sold should be transferred to the profit and loss account. In respect of the goods that are lying as closing stock in the organisation should be charged a supplementary rate (Ramsey, & Ramsey, 2003).

The supplementary rate can be calculated by dividing the amount of under / over recovery by the number of units actually produced.

If there is under/ over absorption due to any other reason then also it should be transferred to profit and loss account. Under/ over recovery has many adverse impacts on the organisation and so the predetermined rate should be calculated efficiently. Over recovery of overhead increases the burden on the customers whereas under recovery results to losses.  

There are various methods by which cost can be allocated to the different department. One of these methods is Activity Based Costing (Gitman, 1985). This method is usually adopted by manufacturing concerns that does not produce same types of products. The cost incurred by the department is borne by itself and no part of such cost has to be borne by any other department. The cost of particular department is easily measurable. The company before adopting such a system should know everything about it (Goyal, 2012). There are various advantages and disadvantages that should be clearly studied.

The advantages of adopting Activity Based Costing are-

• It provides the managers with so many relevant information that they are prompt and confident for taking any kind of decision.
• This system not only serves the production department but is also helpful to the administrative and selling departments. It enables them to identify the cost and control them wherever possible
• It helps in the identification of wasteful and unnecessary expenses that is incurring in the company and has not been traced yet.
• It reflects the efficiency and effectiveness of the working of an organisation.

The advantages of adopting Activity Based Costing are-

• Activity Based Costing is a time consuming process because it requires proper analysis and study of various information.
• It is an expensive method but once the method Is properly functioning all the cost can be easily recover in the form of savings.
• It is difficult to maintain records of every small transaction and also to measure the cost drivers is a difficult task (Narayanaswamy, 2014)..
• This method should be adopted by the larger firms and not by the smaller firms because only firms that follow cost per pricing can make optimum utilisation of this method(Pandey, 2015). 

References

Alex, K. (2012). Cost accounting (1st ed.). Chennai [India]: Pearson.

Ball, W. (1984). A sense of direction (1st ed.). New York: Drama Book Publishers.

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

Bragg, S. Corporate cash management (1st ed.).

Cafferky, M., & Wentworth, J. (2010). Breakeven analysis (1st ed.). New York: Business Expert Press.

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

Fischer, P., Cheng, R., & Taylor, W. (2002). Advanced accounting (1st ed.). Mason: South-Western/Thomson Learning.

Garrison, R., & Noreen, E. (2003). Managerial accounting (1st ed.). Boston: Irwin/McGraw-Hill.

Gitman, L. (1985). Principles of managerial finance (1st ed.). Harper & Row.

Goyal, R. (2012). Financial accounting (1st ed.). [Place of publication not identified]: Prentice-Hall Of India.

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

Narayanaswamy, R. (2014). Financial accounting (1st ed.). [Place of publication not identified]: Prentice-Hall Of India.

Pandey, I. (2015). Financial management (1st ed.). New Delhi: Vikas Publishing House PVT LTD.

Pratt, J. (2006). Financial accounting in an economic context (1st ed.). Hoboken, NJ: John Wiley & Sons.

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

Tulsian, P. (2006). Financial accounting (1st ed.). New Delhi: Pearson/Education.