Importance Of Accurate Product Costing And Activity-based Costing For Beztec Limited

Answer 1: Importance of accurate product costing

Importance of the accurate product costing

While the finance of the company is calculated, the accuracy plays major role in filing the tax as well as for financial statements. each component from the financial statement will have impact on the overall financial position of the company. Inaccurate reports or incorrect computations will lead to legal problems regarding the filling of tax and significant concerns of the auditors. Without proper attention to the cost related information the business will be in a volatile position. It is essential for the business to track the costs carefully which in turn will enable it to compute the profit under each period. Further, the accurate cost data enables the business to analyse the information for making future decisions (Kumar and Reinartz 2018). Accurate costing for the product is important for the following reasons –

• Budget impact – process of the budget depends on the accurate computation of the revenues and expenses which in turn will allow making appropriate forecasts for next accounting year. While the product costs are miscomputed, considerable errors may arise in the process of budget.
• Assets and inventory – calculation of inventories are depended on the accurate reporting of product’s direct cost. If the product cost is not computed correctly the inventory value will also be inaccurate. If the amount of calculation error is big it may have material impact on the reporting (Gertler and Karadi 2015).
• Income statement – income statement reports the cost of product on the basis of accurate calculation. Therefore, if the product cost is not accurate the net profit will be misleading.
• Considerations – while the product cost is calculated, the strategy varies if the product is manufactured as against the product is purchased from the wholesaler.  When the product is manufactured in-house, all the associated costs are considered. Overhead for the manufacturing facility, costs of the parts and payroll for the manufacturing activities are considered under COGS (Simkin, Norman and Rose 2014).

On the other hand, using the traditional method of costing has various problems as follows –

• Rates for overhead recovery like labour hour rate, machine hour rate are used for absorption of the indirect costs that is the overhead. Though this is useful for valuing of closing stocks and reporting it to top management, it is not useful to take decisions as the decisions will have impact on long-term sustainability.
• Splitting the costs into variable and fixed is generally unrealistic. The reason behind that is splitting the cost will lead to inaccurate product costs if the business grows.
• Indirect costs are assigned and re-assigned at the product level after product manufacturing. At the stage of work in progress indirect cost allocation is made arbitrarily. However, with the improvement of technology, completion degree requires accurate cost record for indirect cost. This is not possible as per the traditional cost approach (Hilton and Platt 2013).
• Under the modern technology most of labour work is completed through automation that is mechanization of the manual work. Therefore, the direct costs are automatically reduced and at the same time indirect costs go up. In the same way, cost structure for the product is altered if automation takes place for any product.

Cost driver rates as per Activity-based costing (ABC)

Cost of each model under activity based costing

Profitability analysis through gross profit

Beztec Limited that produces 2 printer models – Lexon and Protox, based on the traditional costing approach is planning to discontinue Lexon model and concentrating on Protox model as its profit per unit is significantly high as compared to Lexon. However, after computing the overheads as per ABC approach, the management accountant of the company Sue Smith is in the view that using ABC approach will change the costas well as profitability of both the products (Dong, Liu and Lin 2014). It is further found that under ABC approach the gross margin profitability for Lexon model was 42.43% whereas the gross margin profitability for Protox model was 11.80%. In view of Steven Kay, the company’s CEO if the ABC approach is used it will increase the complexity as various cost drivers are required to be taken into consideration (Fullerton, Kennedy and Widener 2014). Further, it will have adverse impact on the company’s decision regarding phasing out Lexon model and concentrating on Protox model as under ABC model it is clearly visible that the profitability of Protox model is considerable high as compared to Lexon.

If the costs are altered by Smith as per the suggestion of Kay, it will violate the integrity as per APES 110 on code of ethics. As per section 110, integrity principle requires the member to be honest and straightforward with regard to all the business and professional relationships. It also implies truthfulness and fair dealing. Further, the member knowingly must not get associated with the returns, reports or any kind of communication where he believes that the information –

• Includes misleading or materially false statement
• Includes the information or statement those are recklessly furnished
• Obscures or omits the information those are required to be included as the obscurity or omission will lead to misstatement (Apesb.org.au 2018).

If the member is aware that he is been associated with such kind of information, the member shall disassociate himself from the information. Therefore, if Smith makes any changes as per the suggestion of Kay, it will violate his integrity.

Under allocation or over allocation of overhead costs

Pre determined rates for overheads are used as the actual cost always may not be available until some time elapsed from the job are completed. However, decisions regarding raising a bill to the client for the serviced provided are required to be made immediately. Further, the actual costs may have an impact on the short-run changes under the environment that may deform the procedure of billing (Warren, Reeve and Duchac 2013). Pre-determined rate are affected monthly or weekly fluctuations and thus, it provides stable assignment and comparison for costs through accounting cycle. Overhead costs are the indirect costs required for running the business that includes supplies and other utilities. As they are not traceable directly, overhead rates are predetermined for some of the departments. However, actual cost for that department may be higher or lower as compared to the pre-determination. If the actual cost is lower than pre-determined it will lead to over allocation of overhead (Ren et al. 2014). On the contrary, if the actual cost is higher than pre-determined it will lead to under allocation of overhead.

Disposing the under allocation or over allocation of overhead costs

At the closing of the year, balance in the manufacturing overhead account is disposed-off through various ways. These are as follows –

• Allocating among the WIP, COGS and finished goods – under this approach the amount of the over or under allocation of the overhead is disposed off through allocating the amount among WIP, COGS and finished goods accounts based on the overhead applied for each account during the accounting period. This method is considered as theoretically right (Weygandt, Kimmel and Kieso 2015). Further, in account the journal entry is passed as –

WIP A/c Dr XXX

COGS A/c Dr XXX

Finished goods Dr XXX

Manufacturing overhead XXX

• Transferring entire amount to COGS – as per this approach, entire amount for under or over application of overhead is transferred to the COGS. This method is considered as theoretically right. Further, in account the journal entry is passed as –

COGS A/c Dr XXX

Finished goods Dr XXX

Manufacturing overhead XXX

• Adjusting with allocation rate – another ways of allocating the over allocated or under allocated cost at the closing of the year is to adjust allocation rate on the basis of actual amounts and the amount shall be reallocate the overhead amount to the completed jobs. This method is considered as theoretically right (Drury 2013).

Reference 

Apesb.org.au. 2018. [online] Available at: https://www.apesb.org.au/uploads/standards/apesb_standards/standard1.pdf [Accessed 9 Sep. 2018].

Dong, J., Liu, C. and Lin, Z., 2014. Charging infrastructure planning for promoting battery electric vehicles: An activity-based approach using multiday travel data. Transportation Research Part C: Emerging Technologies, 38, pp.44-55.

Drury, C.M., 2013. Management and cost accounting. Springer.

Fullerton, R.R., Kennedy, F.A. and Widener, S.K., 2014. Lean manufacturing and firm performance: The incremental contribution of lean management accounting practices. Journal of Operations Management, 32(7-8), pp.414-428.

Gertler, M. and Karadi, P., 2015. Monetary policy surprises, credit costs, and economic activity. American Economic Journal: Macroeconomics, 7(1), pp.44-76.

Hilton, R.W. and Platt, D.E., 2013. Managerial accounting: creating value in a dynamic business environment. McGraw-Hill Education.

Kumar, V. and Reinartz, W., 2018. Customer relationship management: Concept, strategy, and tools. Springer.

Ren, J., Boyle, B.D., Ku, G., Weber, S. and Walsh, J.M., 2016. Overhead performance tradeoffs—a resource allocation perspective. IEEE Transactions on Information Theory, 62(6), pp.3243-3269.

Simkin, M.G., Norman, C.S. and Rose, J.M., 2014. Core concepts of accounting information systems. John Wiley & Sons.

Warren, C., 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.

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