Product Costing System Types: An Analysis
|✅ Paper Type: Free Essay||✅ Subject: Accounting|
|✅ Wordcount: 2219 words||✅ Published: 25th Apr 2018|
Contents (Jump to)
Strengths and Weaknesses of Conventional Costing
Time-Driven Activity Based Costing
Relevance of Costing Systems – Modern Organisations.
Management accounting as defined by Chartered institute of Management Accountants as “the process of identification, measurement, accumulation, analysis, preparation, interpretation and communication of information used by the management to plan, evaluate and control within an entity and to assure appropriate use of and accountability for its resources.” It supports the managers in their task of enhancing both customer and shareholder value by efficient and effective use of organisational resources. (CIMA official Terminology, N.D)
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During the late 1980’s despite of the rapid changes in the business environment the management accounting practices remained unchanged. Cost control techniques are an indicator to present the distinction between traditional and innovative management accounting practices. Cost accounting is the central method used in management accounting, but traditionally management accountants used variance analysis to compare actual cost of raw materials and labour used in the production with the budgeted. Management accounting uses costing system to allocate cost over different cost objects.
Product Costing is the process of studying and listing down all the expense which incurred for manufacturing and sale of a product, from acquiring raw materials to the cost of transporting the final product to the retail business. In this competitive business economy it is extremely regarded as the important component in evaluating and planning business strategies. As John A Lessner indicated in Journal of Accountancy “In today’s hotly competitive business environment, accurate product costing has been critically important to business survival.”
Product costing practices have been over the past 50 years. Earlier it was calculated nothing more than the total manufacturing cost. In the late 50’s direct costing was implemented to separate variable cost and fixed cost. However there was no tangible relationship between product and consumed resources, both where separate entities. (Wilson, Frank C, 1991)
New theories and practices emerged in the early 1980’s to meet the challenges of the modern diversified structures. The Activity Based Costing (ABC) was implemented to improve the allocation of manufacturing overhead cost which then expanded to include non-manufacturing costs. (Hongren et al, 2006)
Product costing systems
I. Conventional Costing
Conventional Costing techniques was followed around more than 60 years they used to have traditional volume-based costing system, budgeting, variance analysis and responsibility accounting, to meet the needs of managers in traditional manufacturing environments. Following Costing techniques were followed such as volume based measures such as labour hours or labour dollar to allocate indirect costs. They were suitable to allocate overheads in the 1920’s but were not suitable for advanced manufacturing environments of the 1980’s.
Some of the different conventional costing systems followed were:
In this type of costing, the cost object is a unit or multiple units of a distinct product or service called a job. Each uses different types and amounts of resources. Job Costing systems assign cost to distinct production jobs that are significantly different. In a job costing direct material, direct labour are tracked to their values and is recorded till the completion of the job. Job costing is usually done for a specific work or if it’s unique.
(Horngren et al 2009)
The Chartered Institute of Management Accountants (CIMA) defines process costing as “The costing method applicable where goods or services result from a sequence of continuous or repetitive operations or processes. Costs are averaged over the units produced during the period”. Process costing is suitable for those manufacturing units producing uniform composition of products and where production is a continuous flow. The costs of the products are averaged over the number of units produced.
Some of the Important Jargons used in Process Costing are: (Lang field – Smith, 5th edition, 2009)
1. Weighted- Average Method
2. First in First out (FIFO).
3. Last In First Out (LIFO):
A set of production processed in a single unit, which includes all the Direct, Labor and manufacturing cost occurred in a single batch.
Strengths of conventional Costing (Liaqat Ali, 2006)
1. Used to allocate manufacturing overhead cost to products using Volume-based cost driver.
2. Traces direct material and direct labour cost
3. Non- Manufacturing Cost is not assigned to products.
4. Strong correlation between O.H. cost and cost driver to ensure that the product cost are accurate.
5. It is measured by volume of production in the number of units produced.
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Weakness of Conventional Costing methods (Liaqat Ali, 2006)
1. They provide inadequate information to support organizational learning and improvement.
2. The techniques used to allocate overhead to products/service weren’t accurate.
3. The direct labour based methods weren’t suitable for advanced manufacturing environments.
4. The variances used weren’t easily understandable by frontline employees and do not promote an integrated process view of the organization.
5. There is not any direct, tangible relationship between product and consumed resources costs.
6. Traditional costing omits the functions of activities which consume input resources and generate output products / services
II. Activity based costing
Activity based costing; costing system which evolved in the mid-1980’s to improve the allocation of manufacturing overheads to products… It calculates the cost of individual activities and assign costs to cost objects such as product and services on the basis of activities needed to produce each product and services.
Barrett Richard (2005) states that strength of ABC as:
1. It is more accurate costing of products, services, customers & distribution channels.
2. ABC system provides good payback to the business. It enables to analysis the cost and mainly focuses on the profitable sector which improves the revenue of the firm.
3. With the web based applications in ABC the users of the information can refresh the data according to their requirements. It enables the managers to retrieve reports from their desktop which allows them to make better decisions in their area of responsibility.
4. Projects which adopts the ABC systems tends to be more sensible than they were in past.
Kaplan et al (2007) states the weakness of ABC as:
1. ABC is more time consuming to collect data and laborious worth implementing. Collection of non stored data in any software system is a tedious job. The data used in ABC are abstract and difficult to authorise
2. It does not add value, it merely correlate with other variables that are true value drivers.
3. It could not be easily restored to the changing situations. It is suited for the situation for which it is developed.
4. It does not consider the power of unused capacity which makes it theoretically incorrect.
Time-Driven Activity Based Costing
Time-Driven ABC is the revised version of traditional ABC system. Prof. Robert Kaplan known as the father of ABC has proposed a new technique which can overcome the problems of traditional ABC Systems. The time-driven ABC is more accurate than the traditional ABC. Timely and costlier surveys are taken away in time-driven ABC. (Kocakülâh Mehmet C et al,2009)
Relevance of Costing Systems – Modern Organisations.
ABC started gaining popularity in the 1980’s, at that time this was something that could be only afforded by large scale industries as the cost of installation was very high i.e., it came between $150,000 – 175,000 and at the same time it was a very time consuming process as it took around 6 months for installation process. It also requires help of professional side as the construction was very expensive and needed experienced hands.
During this period the small firms and medium firms couldn’t even imagine of implementing such a system as it was too expensive for them which would even have affected their sustainability. As the conventional system was affordable and could be easily implemented the small & medium firms have no other option rather than going for conventional system.
As time changed developments increased its pace, softwares which computes ABC system were readily available to the smaller firms at a price which could be afford by them and was very user friendly and the implementation was also simple. ABC helps the smaller firms in the areas of computing cost related to non value adding activities. This helps them to conduct business in an efficient manner in comparison to the large size firms. The usage of ABC helps the smaller firms in improving their performance and increasing their competitiveness in the market, thereby it helps in improvising the standards which helps them to sustain the global competition
ABC brings a new horizon before the manger despite of the unresolved problems caused. Activity Based Costing System is beneficial to any firms irrespective of their scale of operations. The advantages of ABC are that it permits precise product costing. Use of an ABC system helps the firm to be flexible in the changing market environment as it helps in identifying profitable and non-profitable activities.
- Langfield- Smith Thorne Hilton 2009, Management accounting 5E,McGraw-Hill Australia Pty Ltd
- (Horngren.T, Datar.M, Foster 2009, Cost Accounting 13th E ,Pearson Prentice Hall Upper Saddle River New Jersey 07458
- Liaquat Ali (2006), ‘Applications of Contemporary Management Accounting Techniques in Indian Industry, pages 1-4 , retrieved September 19,2009 from world wide web http://www.managementparadise.com/forums/principles-management-p-o-m/56145-applications-contemporary-management-accounting-techniques-indian-industry.html
- Mehmet C Kocakülâh, James Bartlett, Marvin Albin (2009). Journal of Cost Management, ‘ABC FOR CALCULATING MORTGAGE LOAN SERVICING EXPENSES’ 23(4) 8, retrieved September 25, 2009 from world wide web http://proquest.umi.com.elibrary.jcu.edu.au/pqdweb?index=2&did=1821682251&SrchMode=3&sid=1&Fmt=4&VInst=PROD&VType=PQD&RQT=309&VName=PQD&TS=1254219418&clientId=20960&aid=1
- Richard Barrett (2005). Business Performance Management Magazine, ‘Time-Driven Costing: The Bottom Line on the New ABC’ 3(1) 35, retrieved September 20,2009 from world wide web
- Robert S Kaplan, Steven R Anderson (2007). Journal of Cost Management, ‘THE INNOVATION OF TIME-DRIVEN ACTIVITY-BASED COSTING’ 21(2) 5, retrieved September 20,2009 from world wide web http://proquest.umi.com.elibrary.jcu.edu.au/pqdweb?index=7&did=1253867281&SrchMode=1&sid=10&Fmt=4&VInst=PROD&VType=PQD&RQT=309&VName=PQD&TS=1254224103&clientId=20960
- Wilson, Frank C. “How modern is your company’s costing system?” Textile World, 1991 Retrieved September 25, 2009 from world wide web http://www.answers.com/topic/product-costing
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