Necessity of Product Cost System

Describe about the Management Accounting for Product Ascertain.

It is important to calculate cost of goods and cost of services properly. The manufacturing unit and service concerns are required to ascertain the cost of product, to compute the selling price of the product and to ascertain the net profit of the concern. According to AASB 102 cost of inventories, include cost related to purchase, cost related to inventories, and other costs (Hart et al. 2012). For instance, a production unit takes into account the whole expenditure of the product, but in general, the unit should include only the amount spent on raw materials. Therefore, it is important to calculate the proper cost spent on various units. On the other hand, product-costing means a system of costing, which is required to obtain the cost, related to product or services. It can be calculated by allocating all the expenses of the business under various head to calculate total cost of production. It takes into account all the requirements and procedures of AASB to ascertain the cost of product.

The method is beneficial for both the manufacturing unit as well as for service unit because it is helpful in ascertaining the cost of product and services. The main purpose of this system is to calculate the product cost and the determination cost of the concern.

The primary objectives of this system are as follows:

To determine the cost of purchase and sale: It is necessary to ascertain the cost related to production so that the management can ascertain the accurate cost of production. Moreover, it is helpful in calculating the future loss of the department (Kaplan and Atkinson 2015).

It is helpful in calculating expenses: A business concern spends lot of money on various heads. It is not necessary that all the expenses be of production. In this case, it is important to note that the basic cost of any business unit is the cost of production. If the production cost is not accurate than it is not easy to calculate the selling price of the product, i.e. if the cost of production is high than it will effect either the selling price of the product or the profit/loss margin of the concern. According to AASB, the production cost is to be calculated only on the cost related to production, so that the actual expenditure spent by the company on production can be, ascertain. This will help the company to determine the various heads of expenditure (DRURY 2013).

Primary Objectives of Production Cost

It is helpful to calculate the selling price of the product: The firm ascertain the price of the product by adding certain amount of profit to it. The firms determine this amount based on the market price of other products. In this case, the production cost will help the company to calculate the selling price of the product so that the company can easily calculate its profit. In other words, cost of sales-cost of production= profit. Hence, product cost is very important for a concern to obtain the net profit and selling price of the product.

These are related to the management and decision making system of the firm. The importance of this system is as follows:

For better control: The management of the firm always tries to control the production cost of the firm because it helps the management to control the product cost efficiently. Now, the firm can easily identify its expenditure and can control it according to it (Horngren et al. 2013).

It is helpful in preparing Budget: The firms maintain various types of budget either monthly or yearly basis. Production cost of the firm helps in preparing this type of budget. Now the firm can easily calculate its expenditure and by analyzing this cost, the firm can easily forecast its future expenditure. Hence, the importance of production cost can be seen in the firm.

It helps in increasing the efficiency level of the product: The firms can increase its efficiency level by determining the production cost of a product. The firm can now easily compare the efficiency levels of various departments because the product costing technique provides all the relevant data, which is required to control the system. Hence, it helps the firm to increase the efficiency level of production of various departments.

It helps in decision-making: The information provided by the costing system helps the management to ascertain the overhead expenditure of the product. The management can easily calculate its break-even point and contribution point by obtaining the production cost (Demski 2013).

It provides the management with the information related to the total cost of production. It includes various costs, which is related to production to obtain the cost of manufacturing expenses. The basic cost of the product can be calculated by adding direct cost of material and labour referred to as prime cost. Again, the calculated prime cost is added with the expenditure of factory overhead to calculate the factory cost. Factory overhead includes all the indirect expenses of the firm. The firm must calculate work in progress before calculating the cost of sales because production is a continuous process, lot of activities remains incomplete in the production. For this purpose, it is important to calculate work in progress. It is necessary to adjust the amount of opening and closing work in progress so that the company can obtain the basic idea about the incomplete work. After calculating and adjusting all the above-mentioned cost, the company can calculate the cost of production for the year.

Secondary Objectives of Production Cost

Calculation of cost of goods manufactured:

Particulars Raw material Add: opening balance Less: closing balance DIRECT MATERIAL Add: direct labour PRIME COST Indirect labour Factory manager’s salary Factory supplies Depreciation on factory building Depreciation on factory equipment Insurance cost of factory Repairs & maintenance Land tax related to factory FACTORY COST Add: opening WIP Less: closing WIP COST OF GOODS SOLD

Amount ($) 120,000   25,000 (24,000) 35,700 15,000 12,000   5,000   6,500   8,900   5,000   2,500   2,200    8,000  (7,500)

Amount ($) 121,000 156,700 213,800 214,300

Cost of goods sold: It is prepared to calculate the total expenditure of the unit. It is quite common that the business firm cannot sell all the units at the end. Some of the finished goods left with the firm, these goods are known as closing stock. To ascertain the profit it is necessary to calculate the total cost of goods sold. Gross profit can be calculated based on the expenditure of the goods sold and income received from the sale. In other words, Cost of Goods Sold= Opening finished goods- Closing finished goods. Cost of goods sold includes the expenses related to advertisement increase in sale (Needles et al.2013). Hence, these costs are not included in the cost related to manufacturing and sales. Therefore, the expenditure on depreciation of goods related to sale, sales manager salary, and so on is deducted from the cost of schedules (Warren et al 2013).

Particulars Opening finished goods Less: closing finished goods   COST OF GOODS SOLD Cost of manufactured goods Less: finished goods

Amount 12,500 (13,600) 214,300     (1,100)

Amount (1,100) 213,200

Calculation of various types of T- Accounts:

Raw material account

Date 01/07 01/07

Particulars To balance brought down To accounts payable Total

Amount( DR)  25,000 120,000 145,000

Date 30/06 30/06

Particulars By WIP account By balance carried down Total

Amount (CR) 121,000   24,000 145,000

Work in progress account

Date 01/07 01/07

Particulars To balance brought down To raw materials Total

Amount (DR)     8,000 121,000 129,000

Date 30/04 30/04

Particulars By finished goods By balance carried forward Total

Amount (CR) 121,500     7,500 129,000

Finished Goods account

Date 01/07 01/07

Particulars To balance brought down To WIP Total

Amount (DR)   12,500 121,500 134,000

Date 30/06 30/06

Particulars By cost of goods sold By balance carried forward Total

Amount (CR) 120,400   13,600 134,000

Manufacturing overhead cost account

Date 30/06

Particulars To bank account Total

Amount (DR) 57,100 57,100

Date 01/07

Particulars By cost of goods sold Total

Amount (CR) 57,100 57,100

 

Date 30/04 30/06

Particulars To bank account To balance carried forward Total

Amount (DR) 117,500   22,500 140,000

Date 01/07

Particulars By balance brought down By raw material account Total

Amount (CR) 20,000 120,000 140,000

Cost of goods sold account

Date 30/06

Particulars To finished goods account To direct labour cost account To manufacturing overhead account Total

Amount (DR) 120,400   35,700   57,100 213,200

Date 30/06

Particulars By income statement Total

Amount (CR) 213,200 213,200

Calculation of overhead cost

Pre-determined overhead Actual overhead Under applied overhead cost

Direct labour hours 850

Direct labour hour cost $63

Total overhead cost   $53,550 ($57,100) ($3,550)

Journal entry:

Cost of Goods Sold account              debit    $3,550

Manufacturing overhead account      credit    $3,550

Reasons for over and under calculated overhead: The business concern needs to prepare budget to obtain better future cost. It has been observed that the amount of overhead expense is different from the budgeted amount (Needles and Crosson 2013). These differences are of two types over applied and under applied. Over applied overhead are those overhead where the actual overhead are higher than the budgeted amount, whereas, in case of under applied overhead vice versa occurs. The reason behind this is as follows:

Difference in actual output level.

Difference in actual unit of consumption like material, energy.

Difference in actual unit of cost per unit cost of factors (Maher et al. 2012)

Over consumption of different types of elements due to inefficient manufacturing process.

Strong budgetary control and implementation of advanced technology (Weygandt et al. 2015)

Journal entry:

In case of over applied

Manufacturing overhead account      debit

Cost of Goods Sold account            credit

In case of under applied

Cost of Goods Sold account            debit

Manufacturing overhead account    credit (Needles et al. 2013)

It is helpful in implementing proper budgetary control over the production process. Here the opening balance of direct material is calculated based on the standard rates and units (Drury 2013). The calculated balance is adjusted with the actual expenditure incurred from the cost elements. It is helpful for the management in case any difference arises in between actual and forecasted amount. To overcome with this situation the company can make proper arrangements (Ward 2012). It is advisable for the management to choose that amount which is lower than the budgeted amount. This type of variances is called favorable variance. The owners of Seafarer Kayaks can have certain benefits if they use Standard Costing System in their concern. These are as follows:

Strong control over budget.

Recording the actual expenditure and budgeted expenditure by rectifying it.

Identifying and analyzing the difference of variances within the financial period.

Using accurate measures of operation at the starting period (Collier 2015)

Conclusion:

It can be conclude from the above discussion that in today’s generation it is very important to maintain a correct product costing method because it helps the management to analyze the cost of the product and services. It also helps in decision-making process. Hence, it is advisable for the owners of Seafarer Kayaks to select and implement the accurate costing technique so that they can continue their manufacturing activities more efficiently in the near future.

References:-

Collier, P.M., 2015. Accounting for managers: Interpreting accounting information for decision making. John Wiley & Sons

Demski, J., 2013. Managerial uses of accounting information. Springer Science & Business Media

Drury, C., 2013. Costing: an introduction. Springer

DRURY, C.M., 2013. Management and cost accounting. Springe

Hart, J., Wilson, C. and Fergus, C., 2012. Management Accounting: Principles & Applications. Pearson Higher Education AU

Horngren, C.T., Sundem, G.L., Schatzberg, J.O. and Burgstahler, D., 2013.Introduction to management accounting. Pearson Higher Ed

Kaplan, R.S. and Atkinson, A.A., 2015. Advanced management accounting. PHI Learning

Maher, M.W., Stickney, C.P. and Weil, R.L., 2012. Managerial accounting: An introduction to concepts, methods and uses. Cengage Learning

Needles, B.E. and Crosson, S.V., 2013. Managerial accounting. Nelson Education

Needles, B.E., Powers, M. and Crosson, S.V., 2013. Financial and managerial accounting. Nelson Education.

Needles, B.E., Powers, M. and Crosson, S.V., 2013. Principles of accounting. Cengage Learning

Ward, K., 2012. Strategic management accounting. Routledge

Warren, C.S., Reeve, J.M. and Duchac, J., 2013. Financial & managerial accounting. Cengage Learning

Weygandt, J.J., Kimmel, P.D. and Kieso, D.E., 2015. Financial & Managerial Accounting. John Wiley & Sons