Key Reasons for the Current Costing System at KF
The study aims to address the specific requirement from the owner Fred Ferrous of Kilbirnie Fabrications (KF). The main aspects of the study will be conducive in discussing the various types of key reasons which the costing system produces pertaining to information for management. The main aspects of the report will consider explaining the general issues associated with the costing system at KF. The study will also address areas which shows that the current costing system at KF is outdated. The second section will show the complete job cost per unit along with the quoted price for basic and complex fabrication jobs. This statement will further include the breakdown of the various costs such as “direct labour costs per unit, direct materials per unit, overhead costs per unit, full cost per unit, and quoted price per unit”. The third section of the report has been further able to suggest about the rationale for the adoption of alternative job costing approach which will be able to provide an accurate job costs and provide appropriate quote for the customer of KF. The discourse of the study has also differentiated on the previous and alternative job costing approach. The final section of the report has been able to suggest on the appropriate method which KF will use along with reason for the same (Weygandt, Kimmel & Kieso, 2015).
The general problems related to the costing system at KF needs to be identified in terms of using absorption costing. The main problem with the use of such an approach may lead to company’s profit level appear better than the actual accounting period. This is also seen due to the reason of fixed cost not deducted from the revenues unless the company has sold all the products which are manufactured(Ibarrondo-Dávila et al., 2015). Moreover, increasing profit and loss statement may also mislead the investors and management of the company.In this case the fixed costs are seen to be particularly large pertaining to the total production costs then it is difficult to ascertain the variations in the costs occurring at a different level of production. This makes it difficult for the management in making efficient decision to increase the operational efficiency. Therefore, it can be inferred that as per the present costing system followed by Kilbirnie Fabrications (KF), there can be no logical relationship found among the direct materials cost of a product and factory overhead(Appelbaum et al., 2017).
Comparison of Basic and Complex Fabrication Jobs
At present, in each economy, there is a fluctuating trend in the material prices. This is related to pose an additional threat pertaining to the high or low overhead costs in case there is no change in the overhead costs. In most situations, the overhead expenses are seen to vary with time and they are accrued as per time basis instead of the materials consumed. However, the use of direct materials cost approach ignores the time factor which is an essential characteristic to be considered during allocation of the overhead (Butler & Ghosh, 2015).
As per the annual budget of KF the direct labour cost for Expert fitters was $ 170000 and for Junior fitter was $ 153000. In addition to this, the direct labour costsare discerned with $ 323000. The overhead results may be discerned with Welding equipment cost of $ 425000, Administrative and establishment cost of $ 85000. It may be also discerned that total amount of chargeable fabrication work was estimated as3400 hours for Expert fitters, 5100 hours for Junior fitters and total chargeable direct labour hours 8500 hours (Ghose, 2017).The breakdown of the direct cost per unit may be inferred with $ 50 for Expert fitters and $ 30 for Junior fitters. The per unit direct cost for total direct labour costs may be inferred with $ 38. The breakdown of the quoted price per unit is stated with 3 complex hours for Expert fitters (including time spent using welding equipment). The basic hours are seen with 2 hours for Junior fitters and complex Junior hour of 1 hour.In addition to this, the total direct labour cost may be considered with basic hours of 2 hours and complex hours of 4 hours. The data on the typical fabrication cost has also revealed that the use of welding equipment (welding hours)for complex hours is 2 hours (Said, 2016).
The main reason for choosing variable costing approach can be seen with reason of fixed cost not deducted from the revenues unless the company has sold all the products which are manufactured. Moreover, increasing profit and loss statement may also mislead the investors and management of the company. This approach of costing acts as a good measurement for providing an appropriate analysis for the cost and volume. As per the present costing system followed by Kilbirnie Fabrications (KF), there can be no logical relationship found among the direct materials cost of a product and factory overhead (Krstevski & Mancheski, 2016).
Advantages of Variable Costing over Absorption Costing
The alternative job costing approach may be inferred with following a variable costing approach. Thesuitability of such an approach may be considered as the company has decided to sell all the products during the same accounting period. The variable cost approach will be also useful for the company as it will be able to provide the company with the opportunity to compare the potential profitability as per different product lines such as Expert fitters and Junior fitters.The present method is not seen to be suitable in providing an appropriate analysis for the cost and volume like variable costing. In case the fixed costs are high a portion of the total production costs will face difficulty in determining the variations in the production levels. This is further seen to be contribute to the operational efficiency (Otley, 2016). Therefore, the significant advantages of the variable costing may be clearly seen with the consideration of the actual incremental costs related to a certain product. This is also seen to be essential in providing the rationale for accurate representation of the financial statement as per the consideration of cost of production. In addition to this, the various proponents of the variable costing method will be able to identify the accurate cost constraints which are seento berelated with accurately representing the fixed manufacturing overhead irrespective of the volume of production. This will be further helpful in making suitable product related decisions. Henceforth, the variable costing will allow the users of the financial statement to represent the actual inputs of a product. The manufacturing overhead is also important as it will be able to consider the cost which will not be able to contribute directly to the creation of a product (Keller, 2015).
In the given study the two main techniques related to costing may be inferred with the use of variable coting and absorption costing. The main form of the difference between the two methods may be taken into account with treatment for fixed manufacturing overhead costs. As per the application of absorption costing for KF the various types of cost including the fixed cost are associated to the production (Horngren & Harrison, 2015). On the other hand, the various types of the cost considerations as per the variable costing taken into account the costs which are directly related to the production. The adoption of the alternative costing method such as variable costing has allowed KF to segregate cost considerations as per fixed cost for the operating expenses and cost of production (Calderon, 2019).
Recommendations for Pricing Strategy
The different nature of the direct costs related to the manufacturing activity of a production can be further inferred in terms of including wages from the workers and physical manufacturing of the product. The manufacturing activities are included with raw materials used in producing a product and inputs required for running a machinery. The differences of the variable and absorption costing system are inferred with components in budget which has not shown any changes in the level of production (Malmi, 2016). As per the implementation of Absorption costing (full costing), the company has the opportunity to allocate the fixed overhead cost resulting to all units which are produced during a particular period.The variable costing will be able to combine the fixed overhead cost into one expense group and reporting the same under single line item in a balance sheet taken as per net income. On the other hand, absorption costing will result in two categories of fixed overhead costs which will applicable with the cost of goods sold and values attributable to the inventory.The full costing method will be also beneficial in allocating both variable and fixed manufacturing overhead applied with each product (Eker &Aytaç, 2017).
In the present situation it is recommended for Fred to proceed with direct costing method. This is seen to be applicable for all the direct costs and variable manufacturing overhead costs. This particular method will be appropriate for the company in movingthe product through the inventory account until the product has been sold. In addition to this, this method also states on the inventory method which will allow manufacturing overhead to be expenses in a certain period. The adoption of the variable costing method will be ideal for the company in allocating the manufacturing costs and consider the effect of the same as per reporting of the net income (Butterfield, 2016). This will provide Fred with the option to include the direct costs along with variable manufacturing costs. The variable costing will be essential in influencing the inventory values in a different manner. In addition to this, the variable costing will be only able to include the variable production costs. By the adoption of such a method Fred will be able to influence the value od inventory in separate manner. As it was previous stated that the interpretation of the different types of the values pertaining to the variable costing will be able to include the variable costs under the inventory valuation. Therefore, it may be also inferred that variable costing will be more concrete and visible to the managers of the company (Sy, Tinker & Mickhail, 2015).
Conclusion
It needs to be also considered that the selling and administrative expenses include the various aspects of administrative expenses however the adoption of such a technique will ensure that variable and fixed are not charged with the individual products. The adoption variable costing will also ensure that the company will include direct material, direct labour and variable manufacturing overhead. Similarly, the variable selling and administrative overhead will be considered appropriately with the use of variable costing system (Apostolou et al., 2016).
Conclusion
The study has shown that the typical issues associated with KF’s costing system may also mislead the investors and management of the company. This approach of costing acts as a good measurement for providing an appropriate analysis for the cost and volume as variable costing. In this case the fixed costs are seen to be particularly large pertaining to the total production costs then it is difficult to ascertain the variations in the costs occurring at a different level of production. The breakdown of the product cost has shown direct cost per unit may be inferred with $ 50 for Expert fitters and $ 30 for Junior fitters. The per unit direct cost for total direct labour costs may be inferred with $ 38. The adoption of the alternative job costing approach in this case needs to be proceeding with variable costing. This approach will ensure that fixed cost not isdeducted from the revenues unless the company has sold all the products which are manufactured. The suitability of such an approach may be considered as the company has decided to sell all the products during the same accounting period. It will allow the company to compare the potential profitability as per different product lines such as Expert fitters and Junior fitters.
References
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