Principles of Product Costing
Discuss about the Principles Of Product Costing In Perspective Of China And Australia.
Product costing is defined as the accounting process to determine different allied business expenses to create any business product or services. This practice can be instrumental to enable optimum level of quality of any product or service with the reliability and productivity factor at the lowest possible cost. The concept of effective product costing does not mean curtailment of cost. This concept endorses maximum utilization of resources in effective manner to get best possible business return out of it. (Busa, 2011)
In this article, the principles of product costing will be discussed with the practices in perspective of two Asia Pacific countries namely China and Australia. This article will highlight with critical analysis of product costing practices in respect of principles to evaluate the deviations of practices from principles in respect of these two countries.
As per theory, product costs compilation to determine pricing and respective product mix is involved normally by tracking inputs to outputs. Anyway, till the recent development of Activity based Costing or ABC, the theorists defined product costing with own views. There are two types of costs mainly involved in the practice of product costing- fixed and variable costs. These costs are considered in different ways by the critiques. As fixed costs are framed in definite manner, difference of opinion persists in case of determination of variable costs. Basic concepts of fixed costs is defined as those costs which may change as per the output on per unit basis with the quality remained constant in totality irrespective of the quantity in the specific short period as considered. For determination of variable costs, the same is defined as a changing cost, which normally cares with the level of outcome in a short run. To make more practical approach, the practitioners normally used to consider total costs, with the consideration of allocation of all costs to the outputs. Ultimately the measurement of product costs is represented by full variable cost and a logical share of fixed costs as per allocation to the product on the base of respective varieties. The traditional academic logic to justify the fixed cost as provision of basic operating ability prevailed for last 20 years. These costs do not change relating to any future decisions. Hence the theory of conventional variable costs is represented as short run costs and is instrumental for decision-making related to product and pricing mix. (T.J.BrignallL.Fitzgerald R., 1991)
Practices of Product Costing: China
Cooper and Kaplan had evolved Activity-Based Costing or ABC in 1992. This is a new approach to calculate product costs. (Kaplan, 1992) This concept is at par with the concept of Shillinglaw known as Attributable theory. (Burrows, 2013)
ABC is emphasizing to have a better understanding of indirect cost implication. This system is instrumental to discover the causes of overhead costs to be spent with the variance over time and is focused on the issue of the element of generation of costs that differs from the traditional theory of only allocation of costs. In this system, the factors for generation of costs are known as cost drivers and the attitude of costs will be determined by the element of generating costs. Traditional cost systems are mainly based upon volumes with the conception that resources are procured proportionately to the number of produced units. The costs not variable to volume are collaboratively considered as overhead pools. They are subsequently allocated to products on the basis of miscellaneous allocation. System of ABC endorses the concept of collecting costs to the activity cost pools. They are functional followed by subsequent allocation to products through use of individual ABC cost drivers. There are two types of cost drivers considered for tracing the cost of resources, which are consumed for products or services. The first type is connected with unit volume, whereas, the second type is not related to unit volumes; instead it is connected with recognition of activities not related with volume drive costs. Example of first type is allocation of labor overhead by production volume, whereas example of second type is allocation of invoicing costs to the number of executed orders, connected with related batch production. (Ken C. Snead, 2005)
This is the case study of Xu Ji Electric Co Ltd of China. Prior to product costing practices of ABC, the company had followed traditional costing. This practice followed the concept of allocation of albor cost to be charged in two- phased system- first, to allocate in production department and then to finished goods. This practice was followed due to difficulty in allocating direct labor cost to products. Below chart can feature the erstwhile process of cost allocation of the company:
Due to changed market scenario of open economy, huge competition arrived in the Chinese market. The deficiency of traditional costing system had forced Xu Ji to prove its sustainability in the competitive market by introducing more scientific system. Hence the company had opted for ABC system of product costing to ensure better and transparent type of costing system. Main objectives for this adoption are to ensure tracing of direct labor cost to the product and respective clientele contracts, and to ensure allocation of manufacturing overheads on the basis of latest direct labor hours to contracts. After successful implementation of ABC in 2003, some recurring problems were solved with introduction of some new IT related process regarding ABC system. In 2004, the company was refurbished as independent companies with different units. Followed by this restructuring, internal set up of management was changed. This had resulted to non-requirement of some erstwhile cost drivers. Due to continuous change of organizational structure and change of management since 2003, practices of product costing had been upgraded.
Australia
It is proven that practice of ABC system have the ability to work more effectively in an environment which is relatively stable, but it’s worth as costing system may not prove effective in unstable or changing environment. Moreover, major corporate events line acquisition or implementation of ERP can have distinct effect on the commitment of management to enhance the development of ABC with the probable adverse impact of ABC information. For the case of Xu Ji, it is found that ABC system proved unremarkable as they had been able to tackle only direct costs along with manufacturing overheads variable in nature. Application of ABC is featured through following chart for Xu Ji:
Traditional costing system was not able to allocate direct labor cost to output. But the adoption of ABC can prove its worth to ascertain information of product cost. The implementation of ABC in sales activity by Xu Ji management was remarkable effort. It has proven its effectiveness to consider ABC as management tool to ensure more control with desired level of decision making for the company. (Liu & Pan, 2003)
Refer to the case study of an agricultural farm for ABC system, it is found that Activity based costing system had covered all types of operating costs for direct inputs. Then analysis of activity had been done to ensure identification of all activity pools for the purpose of activity model. Through the observation and the interviews of different stakeholders 12 activity pools related the agricultural macro activity had been identified. All these activity pools are related to operation of the farm under normal situation of favorable weather. As this activity is sensitive, some micro activities can be taken care in different manner to combat extreme climatic condition.
Post identification of activity pools, the resources for different activity pools are identified including labor cost. Resource costs are directly allocated to the product while labor and fuel costs are allocated to the respective activities on the basis of labor and machine hours respectively. Implementation of ABC system is influenced by the level of communication between developers of the costing model and the operators. Although the system needs IT support, as the same was absent in case of sample farm, gap between expected and arrived results are found. (Lu, Sridharan, & Tse, 2016)
Product costing is the system to evaluate the product or service manufactured for sale. Practice of product costing is mainly evolved to derive proper price- product mix of any business. To make the practice more systematic, the traditional costing system is gradually replaced by more scientific costing method named Activity-based Costing system. The drawback of earlier system was improper allocation of overhead including labor. The same is being replaced through ABC system with more scientific process of allocation of overheads including labor cost apportionment. (B.B, 2012)
Practices of costing system are being discussed here in perspective of China and Australia. We have considered tow case studies for those countries.
It is observed that the Chinese power generation company had emerged with significant development by implementing ABC from 2003. The company can control and identify the domain of unnecessary costs. Implementation of IT had added value to this effort, and the company proved its worth to perform in more professional way by identifying variable costs.
The Australian agricultural farm has been chosen for a case of ABC implementation. It is found that due to delicate nature of business, the system may not be able to deliver the coveted result, which had been sought for. Moreover, different activity pools are not easy for apportionment of overheads including labor and power. Due to non-availability of IT infrastructure, the application was not as per expectation.
Conclusion
Management accounting is progressing through continuous research. One such research is ABC for product costing. As the same is being followed by different manufacturing and service corporate globally, the effectiveness of same can replace the traditional costing with its scientific and logical approach to enable the management for effective decision making.
References:
B.B, T. (2012). Activity based Costing-An Emerging Foundation for Performance Management. Cost Technology .
Burrows, G. H. (2013). Gordon Shillinglaw: Economist, Consultant,and Management Accounting Scholar. Accounting Horizons , 27 (3), 647-658.
Busa, J. (2011, October 04). Key Principles Of Effective Product Cost Management. Retrieved May 08, 2018, from Manufacturing.net: https://www.manufacturing.net/article/2011/10/key-principles-effective-product-cost-management
Kaplan, R. C. (1992, September). Activity-Based Systems: Measuring the Costs of Resource Usage. Accounting Horizons .
Ken C. Snead, W. A.-A. (2005). Expectancy Theory as the Basis for Activity-Based Costing Systems Implementation by Managers. Advances in Management Accounting , 14.
Liu, D. L., & Pan, P. F. (2003). Activity based Coting in China: A case study of Xu Ji Electric Co Ltd. Chartered Institute of Management Accountant , 7 (13), 2,9.
Lu, C., Sridharan, V., & Tse, M. S. (2016). Implementation of the activity-based costing model for a farm: AN Australian Case. JOURNAL OF APPLIED MANAGEMENT ACCOUNTING RESEARCH , 14 (2).
T.J.BrignallL.Fitzgerald R., J. R. (1991). Product costing in service organizations. Management Accounting Research , 2 (4), 227-248.
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