Direct and Indirect Cost
1.Identify and explain the value of the various cost classifications. Illustrate using examples of how three different bases of cost classifications may assist Mr. and Mrs. Long in improving their decision-making processes in Flowers Finesse Co.
2.Conduct some research into costing techniques that Flowers Finesse Co. might find useful. Based on this research and using the detail in the case, choose a specific technique (or set of techniques) that you believe would be most suitable.
3.Please briefly describe why you consider your chosen technique(s) to be superior to other techniques. Using the detail in the case, describe how your chosen method of calculating product cost will be beneficial and relevant for Flowers Finesse Co. specifically.
Cost can be segregated based on the level of traceability of the cost object that is a project, a product and a department into the below mentioned types –
- Direct cost
- Indirect cost
Direct cost
Costs those are easily recognizable or identifiable to the cost objects are called as direct cost. If the project is cost objects, then the direct cost signifies the resources and costs that are traceable or recognizable with the project (Drury, 2013). The direct cost examples are direct labour, direct material and direct overheads.
Indirect cost
Costs that cannot be identified or traced with the cost object are known as indirect costs. For example, in case of Flower Finesse Company costs of administration staff, sales office and salary of the manager will be regarded as indirect cost as these costs are not directly related to the product and related to the production as well as administration and sales (Parambath, Usunier & Grandvalet, 2014).
Classification of cost is crucial as the overhead expenses cannot be identified to the product it creates issues while the cost is analysed and determined. Further the apportionment of the indirect cost needs application of the judgements on account of the cost. The indirect costs are traceable only through allocation in logical manner. Any cost can be indirect or direct based on the circumstances. The segregation of cost also depends on the nature of business.
Three different bases for classification of cost
Various bases are there on which the cost can be classified. The major bases of classifications are mentioned below –
- Nature of the expenses – through nature of the expenses the costs are segregated into variable cost and fixed costs. Cost that changes with the changes in production units are the variable costs and on the contrary the costs that does not change with the changes in production units are known as fixed costs.
- Related to the cost object – traceability – under this the segregation are made in association of the costs elements with cost object. Here the costs are segregated as the indirect cost and direct cost. The segregation here signifies the cause and impact relationship among the cost object and cost element of the costs to the cost object (Jenkins & Farid, 2015).
- Activities or functions – here the costs are classified based on different activities or activities. Common classifications based on this classification are administration, production, selling, distribution, finance, quality check and development and research.
Classification of cost will help Mrs and Mr Long to improve the process of decision making regarding the profit planning, managing cost and computing the break-even analysis, proper absorption of the overhead expenses and budgetary control.
Cost Classification
The costing method that will be most appropriate to the Flowers Finesse Company is Batch Costing. This is the extension for job costing. The batch represents the number of small orders those are passed through factory in batches. Each of the batches is separately valued and treated as the unit cost. Further the unit cost is measured through dividing the batch cost by number of the units produced in one batch. When orders are received from various customers, generally there are common products among the orders and therefore the orders can be issued in batches that may contain predetermined quantity for the product. This method is adopted in case of each of the batches (Cooper, 2017). For example, in case of Flower Finesse Company the cost of growing the flowers, cost of labours and the cost of fertilizers, pesticides, cost of refrigeration as these costs are directly related to the cost of the product that is flower. The direct costs are able to be measured with the high accuracy degree as these costs are directly traceable to the cost object like department or product. Further, it will also help in processing the cost data (Thomas & Gilbert, 2014) and will allow the ascertainment of cost for services or products. It further helps in taking major management decisions related to product mix. The profits are maximized through controlling the costs or increasing the selling price. The batch costing is used generally under the below mentioned 2 situations –
- When the customer orders quantity for identical items or,
- When the order for internal manufacturing is generated for the batch of identical parts.
It will also help them to do the following –
- Selling price fixation – Selling price fixation is an important aspect to maximize the profitability. Batch costing will also allow the management to apply most appropriate policy for fixing the selling price.
- Budgetary control – for preparing the efficient budgetary control and flexible budget the cost determination is pre-requisite. Further, the flexible budget designed to be changed as per the changes with activity level and therefore the behaviour of cost is an important aspect (Bhattacharya, 2014).
- Effective control on cost – profit can be maximised through effective control on cost and reduction of cost. Batch costing will help in controlling the cost efficiently and as the fixed costs are the manageable and controllable costs.
Moreover, batch costing will help Mr and Mrs Long to produce the Economic Batch Quantity. The economic batch quantity (EBQ) is identical to the economic order quantity (EOQ) and the only difference is that EBQ is measured to decide the production level at the minimum cost whereas the EOQ is measured to determine ordering level to purchase the store, spares and raw materials (Eldenburg et al. 2016).
Therefore, the batch costing system requires less involvement of the management as the production will be carried out in batches and the jobs that is carried out is of repetitive type. Further, as the job is of repetitive type the employees do not need special knowledge and regular training. Therefore, the idle time will be lower and the efficiency of the employees will be enhanced. Further, the inventory management will be easier and the company can analyse the stock for issuing to the customers those come through the door and to the regular customers. It will assist them in increase the profitability through ideal issuance of stock. As Flower Finesses Company’s main product is different types of flowers that are mainly sold in batches, adopting the batch costing will improve the company’s profitability.
Batch costing technique will be most appropriate as compared to other techniques for Flowers Finesse Company as the company is facing issues related to sales management with regard to short supply for the products. Moreover, due to shortages the company cannot sale its products to the 1st customers that come to the door for purchase (Black & Al-Kilani, 2013). They are provided with the requirement only after partially satisfying the demand of the regular customers. In this way the company is losing its revenue from the customers those come through the door. Further, the company produces and sells similar type of products that is flowers that can be easily measured with batch costing. The EOQ calculation will assist Mr and Mrs Long to decide about the production volume that will enable them to maximize the profit through selling the product to regular customers and door customers in most profitable way. This can be done through batch costing as the products of Flower Finesse Company require similar kind of production process and raw material. However, the production volume can be determined in advance through application of Economic Batch quantity
References
Bhattacharya, H. (2014). Working capital management: Strategies and techniques. PHI Learning Pvt. Ltd..
Black, G., & Al-Kilani, M. (2013). Accounting and finance for business. Pearson Higher Ed.
Cooper, R. (2017). Target costing and value engineering. Routledge.
DRURY, C. M. (2013). Management and cost accounting. Springer.
Eldenburg, L. G., Wolcott, S. K., Chen, L. H., & Cook, G. (2016). Cost management: Measuring, monitoring, and motivating performance. Wiley Global Education.
Jenkins, M. J., & Farid, S. S. (2015). Human pluripotent stem cell?derived products: Advances towards robust, scalable and cost?effective manufacturing strategies. Biotechnology journal, 10(1), 83-95.
Parambath, S. P., Usunier, N., & Grandvalet, Y. (2014). Optimizing F-measures by cost-sensitive classification. In Advances in Neural Information Processing Systems (pp. 2123-2131).
Thomas, D. S., & Gilbert, S. W. (2014). Costs and cost effectiveness of additive manufacturing. NIST Special Publication, 1176, 12.
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