Unit 9 Management Accounting:Costing and Budgeting

Unit 9 Management Accounting:Costing and Budgeting


I. Identify and classify different types of cost incurred in Foxwood Company with an appropriate cost classification There are many concepts of cost in an organization. Costs also are used in different business applications, such as financial accounting, cost accounting, budgeting, capital budgeting, and valuation. Consequently, there are different ways of categorizing costs according to their relationship to output as well as according to the context in which they are used. Following this summary of the different types of costs are some examples of how costs are used in different business applications. The two basic types of costs incurred by businesses are fixed and variable costs. Variable costs and fixed costs represent the total amount of costs for the company. This is important to know because the variable costs are going to determine how much we spend to make our company work as opposed to fixed costs which we have to pay anyway. * Fixed costs: are costs that will be the same no matter what else changes with the company. Examples of fixed costs would be rent, property tax, insurance and interest expense, depreciation, operation costs, etc. These fixed costs remain constant in spite of changes in output. According to the scenario, fixed costs are as below:

* Plant-leasing costs: they are costs that company has to spend monthly or quarterly, regardless to the company could make profit or not. * Depreciation-plant equipment: It is cost that company has to be incurred despite company are producing or not. * Property taxes on plant equipment: the amount that company has to pay as prescribed by law. * Fire insurance on plant equipment: whether company is being operated or not, this is the amount that are paid to prevent the loss of plant equipment when fire happens. So that it is not affected by the volume of product units. * Operation costs – Marketing promotions, Marketing salaries, Distribution costs and Customer-service costs: they are costs that do not depend on the numbers of products produced.

* Variable costs: on the other hand, variable costs fluctuate in direct proportion to changes in output. Labor and material costs are typical variable costs that increase as the volume of production increases. It takes more labor and material to produce more output, so the cost of labor and material varies in direct proportion to the volume of output. In scenario, we have variable costs as below:

* These costs increase when the number of product increases and vice versa. These costs increase when the number of product increases and vice versa. Sandpaper
* Materials-handling costs
* Lubricants and coolants
* Miscellaneous indirect manufacturing labor
* Direct manufacturing labor: the more products are produced, the more cost that company has to spend to hire workers and vice versa. * Direct materials inventory: the cost that is paid for inventory increases when the materials used in direct manufacturing increase. * Work-in-process inventory.

* Direct materials purchased: the more direct materials bought, the more cost that company will pay for.

Fixed costs| Variable costs|
Plant-leasing costsDepreciation-plant equipmentProperty taxes on plant equipmentFire insurance on plant equipmentMarketing promotionMarketing salariesDistribution costsCustomer-service costs| SandpaperMaterials-handling costsLubricants and coolantsMiscellaneous indirect manufacturing laborDirect manufacturing laborDirect materials inventoryWork-in-process inventoryDirect materials purchased|

Besides, according to type, some costs are considered as direct and indirect costs. * Direct costs: are similar to variable costs. They can be directly attributed to the production of output. Only those costs that vary directly with the volume of production are charged to products as they are manufactured. The system of valuing inventories called direct costing is also known as variable costing. The value of inventory is the sum of direct material, direct labor, and all variable manufacturing costs.

* Indirect costs, in contrast, are similar to fixed costs. They are not directly related to the volume of output. Indirect costs in a manufacturing plant may include supervisors' salaries, indirect labor, factory supplies used, taxes, utilities, depreciation on building and equipment, factory rent, tools expense. These indirect costs are sometimes referred to as manufacturing overhead.

Direct costs| Indirect costs|
SandpaperMaterials-handling costsLubricants and coolantsMiscellaneous indirect manufacturing laborDirect manufacturing laborDirect materials inventoryWork-in-process inventoryDirect materials purchased| Plant-leasing costsDepreciation-plant equipmentProperty taxes on plant equipmentFire insurance on plant equipmentMarketing promotionMarketing salariesDistribution costsCustomer-service costs|

II. Explain the need for, and operation of, different costing methods on the information given the above scenario. Different industries follow different methods of costing because of the differences in the nature of their work. The various methods of costing are as follows: 1. Job costing: is concerned with the finding of the cost of each job or work order. This method is applied where work is undertaken on receiving customers’ special requirements and each order is of comparatively short duration. 2. Contract costing is applied for contract work like construction of dam building civil engineering contract etc. each contract or job is treated as separate cost unit for the cost ascertainment and control. 3. Batch costing: A batch may represent a number of small orders passed through the factory in batch. Each batch here is treated as a unit of cost and thus separately costed. Here cost per unit is determined by dividing the cost of the batch by the number of units produced in the batch. 4. Service costing: This method is used in those industries which rendered services instead of producing goods. It is used in the case of concerns rendering services like transport, supply of water, retail trade etc. 5. Process costing: is used in industries where production is carried on through different stages or processes before becoming a finished product. Costs are determined separately for each process. The main feature of process costing is that output of one process becomes the raw materials of another process until final product is obtained.

Each industry, company has its own different method of costing. As the five costing methods that I presented above, I think that batch costing should be applied for Foxwood Company. As can be seen in the scenario, Foxwood is a metal and woodcutting manufacturer, selling products to the home construction market which is specializing in production of hacksaw frames in different forms and sizes. As we know, hacksaws are manufactured in batch. It means hacksaws are produced in a set amount of goods. This includes all fixed and variable costs for producing the batch. The unit cost of a batch of goods can be calculated by dividing the batch cost by the number of units produced. In addition, Foxwood uses its high-technology equipment it is producing millions of pieces annually. Foxwoods sales traditionally are able to ship all bandsaw blade orders within 24 hours. Thereby, dependent upon what shipping form customer/client choose. All those products may be being made for a single customer, or are being made all at the same time; thus, it is much easily to calculate the costs for each identical product in batch costing, rather than applying job costing or contract costing – calculating costs separately for each job or contract. III. Calculate costs using appropriate techniques for the product bandsaw blades There are many appropriate techniques to calculate the costs. However, I have just applied two common techniques: absorption costing and marginal costing for the product bandsaw blades. * Marginal costing: it is a technique of presenting cost data wherein variable costs and fixed costs are shown separately for managerial decision-making. It should be clearly understood that marginal costing is not a method of costing like batch costing or job costing. Rather it is simply a technique of the analysis of cost information for management to find out an effect on profit due to changes in the volume of output. Following are the advantages of marginal costing: * It is simple to understand and easy to calculate and hence anybody can understand it easily. * By not charging fixed overhead to production cost, the effect of varying charges per unit is avoided. * The effects sales will be evaluated so the decision taken can achieve the maximum return of business. * It helps manager in cost control by showing variable and fixed cost separately. * Comparing the profitability and performance between two or more products. Nevertheless, besides the advantages mentioned above, marginal costing also has its disadvantages: * It is very difficult to segregate all costs into fixed and variable costs very clearly, and sometimes gives misleading results. * The sale price, fixed cost and variable cost per unit are charged follow the quantity. Sometimes the assumptions basic theory of marginal costing becomes unrealistic. * Stock and work in process are not described accurately. * The financial affair of company may be not transparent as a consequence of exclusion of fixed costs from inventory.

June July
$$
Fixed production overhead 9900099000
Fixed selling expenses1400014000
Fixed administration expenses2600026000
Variable selling expenses6400055000
Total budgeted overhead203000194000

| June| July|
Opening stock| 0| 1200|
Closing stock| 1200| 400|

Profit statement for Marginal Costing
June July
$$$$
Sales revenue 640000550000
Opening stock030000
Variable production cost350000255000350000285000 Less value of closing stock3000010000 Variable cost of sales320000275000
Contribution 320000275000
Less fixed cost203000194000
Profit/ (loss)11700081000
Profit/ (loss) per unit9.1406257.363636
Contribution per unit2525

* Absorption costing: in contrast with marginal costing, absorption costing technique calculates the unit cost of an item taking into account all costs, fixed and variable, direct and overhead. Fixed/overhead costs are allocated to or absorbed by the product made. The key advantages of absorption costing include:

* It identifies the importance of fixed costs involved in production. * This method is always used for preparing financial accounts. * Identifies the profitability of different products and services. * It is cost into the stock value hence distorting stock valuation. * Shows less fluctuation in net profits in case of constant production but fluctuating sales. Disadvantages:

* Complex, time consuming and expensive.
* Absorption costing emphasizes on total cost namely both variable and fixed, it is not so useful for management to use to make decision, planning and control. As a result, manager will depend on his intuition to make the decision.

* Absorption rate: = = 9
* Actual fixed cost overhead = 99000
* Absorbed fixed production overhead = Production x Absorption rate

June July
Absorbed fixed production overhead12600091800
Over /under absorption of overhead(27000)7200

Direct material18
Direct wages4
Variable production overhead 3
Variable cost25
Production overhead 9
Full cost34

June July
$$
Fixed production overhead 9900099000
Fixed selling expenses1400014000
Fixed administration expenses2600026000
Variable selling expenses6400055000
Non production costs 203000194000

* Full production cost = Full cost x Production unit

Profit statement for Absorption Costing
June July
$$$$
Sales revenue640,000550,000
Opening stock040,800
Full production cost476,000346,800
Closing stock 40,80013,600
Production cost of sales435,200374,000
Adjustment for over-absorbed overhead(27,000)7,200
Total production cost408,200381,200
Gross profit231,800168,800
Non production cost104,000 95,000
Net profit 127,800 73,800

Reconciliation of profit between two methods
JuneJuly
$$
Marginal costing 11700081000
Absorption costing12780073800
(10800)7200

The difference between absorption costing and marginal costing is based on the recovery of fixed overheads. The difference in valuation of inventory under the two techniques is a consequence of such treatment.

In case of absorption costing, both fixed and variable overheads are charged to production costing and inventory valuation. Conversely, in marginal costing only variable overheads are charged to production and inventory valuation, while fixed overheads are transferred in full to the profit and loss account.

Under marginal costing, there is a different treatment of fixed overhead. Fixed cost is considered as period cost, it means this sort of cost does not include the expenses in the value of stock held. On the other hand, under absorption costing system, the fixed cost is charged to cost of production.

In marginal costing, the unit cost of production does not get affected by the difference in the magnitude of opening stock and closing stock. Whereas, under absorption costing, opening stock and closing stock are incurred the absorbed fixed overhead, so that the costs will be carried over the next month.

The number from reconciliation table demonstrates the difference between the absorption costing and the marginal costing production profit with 117000 and 127800 respectively caused by the difference of sales and production follow the fixed manufacturing overhead. * In June, finished goods stock increased 1200 units x fixed manufacturing overhead absorption rate, $9 per unit = $10800, difference in profit. * In July, finished goods stock increased 800 units x fixed manufacturing overhead absorption rate, $9 per unit = $7200, difference in profit.

Moreover, the absorption costing production profit is lower than the marginal costing production profit in July as more goods are taken out of stock than are going into stock (closing stock in June is an opening stock in July with 1200 units, greater than closing stock in July with 400 units).

From the analysis above, the under mentioned points should be considered: * The results under both the methods will be same in situations where sales & production coincide i.e., there is neither opening stock nor closing stock. * Profit under absorption costing will be more than the profit under marginal costing, when closing stock is more than the opening stock. The reason behind this is that, under absorption costing, a portion of fixed overhead, instead of being charged to the current period, is charged to the closing stock & carried over to the next period. * Profit shown under absorption costing will be lower than the profit shown under marginal costing, when closing stock is less than the opening stock. The reason behind this is that, under absorption costing, to the current period, a portion of fixed cost related to previous month is charged.

IV. Present analysis in graphical format such as histogram or other format which is appropriate as well as prepare and analyze routine cost reports.

1. Marginal costing:

This chart represents the Variable production cost and Variable cost of sales information in June and July under Marginal costing. As we can see, the Variable production cost dropped out from $350000 in June to $255000 in July. This is caused by reducing the number of products. However, having a look at the opening stock, we can easily recognize that it also has effect on variable production cost. Since there were no stock in June, so company needs to produce more products to satisfy the demand of customers. Nevertheless, by the end of June, company was not able to sell all of their products, resulting in having opening stock in the beginning of July. Consequently, they would reduce the number of producing product in July. In addition, the opening stock also had effect on the variable cost of sales. This cost would increase if the closing stock went down. With marginal costing, regardless of the number of products were producing, the fixed expenses, (including fixed production overhead, fixed selling expense, fixed administrative expense) would be constancy at $139.000 in both months, June and July. Nevertheless, the variable selling expense would depend on 10% of sales value. Therefore the revenue is $640.000, we will have $64.000 for variable selling, and $55.000 for $550.000.

The column chart represents the proportion of profit and expenses in amount of revenue. As can be seen, the percentage of variable cost of sales in both months is similar to each other, with is accounted for 50% of the total value. Besides, the variable selling expense also the same with 10% because they are incurred 10% of sales products. There are two figures charged from June to July – profit and fixed expense. In fact, in number, fixed expenses are the same with $139,000, but in the percentages of revenue, they are absolutely different with 22% and 25% respectively. It points out that they went up from June to July. Thanks to this type of figure we can see that company did not use the expense effectively. Furthermore, the profit also decreased from 18% to 15%. It is obvious as the revenue went down following the profit was decreased.

As we can see from the chart, the revenue fell down from June to July. In reality, for constraining the increasing of stock, we can prevent the reducing of revenue. The declining of revenue made the contribution went down as well, from $320,000 to $275,000. Apparently! Then the profit in July would be lower than the one in June. In fact, we can see that, profit can be higher if the stock goes down. It means that, company needs to predict the demand of customers for effective producing. It will help company reduce the inventory cost as well as minimize the lost.

2. Absorption costing

According to the chart above, we can see easily that the sales revenue fell down in July. As the result, it made the gross profit and net profit decreased as well. * In July, the sales revenue declined approximately 14.1% in comparison with the previous month. The falling of revenue affected strongly to the net profit and gross profit. Although the other costs also reduced, they could not push the Net and Gross profit up. * In addition, the revenue went down with 14.1%, the gross profit and net profit fell to 27.2% and 42.3% respectively, compared to the previous month. It means that the cost of inventory in the foregoing period also affected on the profit.

The chart figures out that the fluctuation of costs and expenses in absorption costing is similar to marginal costing. The full production cost dropped down from $476,000 in June to $346,800 in July since the closing stock in June was higher than the one in July ($40,800 and $13,600 respectively). Fixed expenses in absorption costing were calculated differently from marginal costing; thus in this method, fixed expenses were the same in both months. Nevertheless, variable selling expense did not change in calculating, it also depended on sales revenue.

3. Comparison profit between Marginal costing and Absorption costing

Through the illustration above, we can see that with two different techniques, we have different profits. In June, the marginal costing gave the lower profit than the absorption costing did with $117,000 and $127,800 respectively. On the other hand, in the next month, it was definitely different; the marginal costing had higher profit than absorption costing did with $81,000 and $73,000 respectively. Different calculations, different profits. Depend on company’s situation and purpose; we will have appropriate technique to make good sides for organization

Statement showing total cost on 31th June 2010 (output 14000 units)| Details| | Amount| Cost per unit|
Revenue (12800 units)Less Full production cost of sales (12800 units)Direct materialDirect wagesVariable production overheadPrime costFixed production overhead at $9 per unit (14000 units)Add: Opening StockFull production cost (14000 units)Less: closing stock of finished goods (1200 units)Gross profitLess selling and administration expenseFixed administration expenseFixed selling expenseVariable selling expenseAdd: over/(under) absorption fixedNet profitCost of goods sold (Revenue – Net profit)| | 640,000.00435,200.00204,800.00104,000.00100,800.0027,000.00127,800.00512,200.00| 50.0018.004.003.009.0016.002.031.095.007.872.119.9840.02| | 252,000.0056,000.0042,000.00| | |

| 350,000.00126,000.000.00| | |
| 476,000.0040,800.00| | |
| 26,000.0014,000.0064,000.00| | | | | | |

Statement showing total cost on 31th July 2010 (output 10200 units)| Details| | Amount| Cost per unit|
Revenue (11000 units)Less Full production cost of sales (11000 units)Direct materialDirect wagesVariable production overheadPrime costFixed production overhead at $34 per unit (10200 units)Add: Opening Stock at $34 per unit (1200 units)Full production cost (11400 units)Less: closing stock of finished goods (400 units)Gross profitLess selling and administration expenseFixed administration expenseFixed selling expenseVariable selling expenseAdd: over/(under) absorption fixedNet profitCost of goods sold (Revenue – Net profit)| | 550,000.00374,000.00176,000.0095,000.0081,000.00(7,200.00)73,800.00476,000.00| 50.0018.004.003.009.0016.002.361.275.007.36(0.65)6.7143.29| | 183,600.0040,800.0030,600.00| | |

| 255,000.0091,800.0040,800.00| | |
| 387,600.0013,600.00| | |
| 26,000.0014,000.0055,000.00| | | | | | |

According to June and July cost report, we can see that the gross profit of both months was different from each other but the Gross profit per unit of them was the same with $16. It is because the unchanged production costs per unit. In contrast, when the revenue was decreased, the amount of non-production seemly not to change but actually when we charged them to cost per unit we can see they went up. Let’s take the selling and administration expense per unit for example. It was $2.03 and $1.09 respectively with 12,800 units in June, but falling to 11,000 units in July made the selling and administration expense rise up to $2.36 and $1.27 respectively.

Furthermore, the cost of over/or under absorbed fixed made effect on the Net profit as well. When our capacity was over the normal capacity, the absorbed fixed will add to the Net profit, thus it would be higher and vice versa. As can be seen from the table above, when we had over absorbed overhead with 3000 units at $9, the Net profit per unit would have additionally $2.11. However, when the product was under the normal capacity with 800 units at $9, we would have under absorbed overhead. It resulted in the profit lost $0.65.

V. Calculate and evaluate indicators of productivity, efficiency and effectiveness.
In this section, we will calculate and evaluate the productivity, efficiency and effectiveness for before of implementation of Quality Management Program (QMP). Then, base on this information we can identify the figures for after implementation QMP. 1) Productivity: to calculate and evaluate the productivity, we need to identify which elements can affect on the productivity. Afterwards, we can estimate the total product which has to produce for orders. * Company gets order of 5000 units.

* The estimate that there will have 5% of total products will have mistake during delivering to customer (so they have to replace it without addition money). After implementing QMP, it reduced to 2.5%

Before QMP: 5% of 5000 units = 250 units
After QMP: 2.5% of 5000 units = 125 units

Before QMP (Unit)| After QMP (Unit)|
-Requirements: 5000 units-Specification failure: 250 units * Total: 5250 units| -Requirements: 5000 units-Specification failure: 125 units * Total: 5125 units|

* During final inspection stage, we will lose 12.5% of total finished products. After QMP, it cut down 7.5%

Before QMP:
Downgrading = 5250 x = 750 units

After QMP:
Downgrading = 5125 x = 416 units

The total products we need to produce follow the table below:
Productivity
Before QPMAfter QPM
Unit Unit
Total sales requirement 50005000
Specification failure (5%, 2.5%) 250 125
52505125
Downgrading for inspection 750 416
60005541

2) Efficiency: it is calculated and valuated basically on the purchasing of material, processing loss and scrapped. * Before and after QMP we produce 6000 units and 5541 units respectively at 8sq. maters.

Before QMP: 6000 x 8 = 48000 sq. meter
After QMP: 5541 x 8 = 44328 sq. meter
* During processing we waste 4% of material A, but after QMP decrease 2.5%. So waste of material A in processing is:
Before QMP: 48000 x 4% = 2000 sq. meter
After QMP: 44328 x 2.5% = 1137 sq. meter

Before QMP (sq. meter)| After QMP (sq. meter)| -Purchasing of material: 48000-Processing waste: 2000 * Total: 50000| -Requirements: 44328-Processing waste: 1137 * Total: 45465|

* While receiving the materials from supplier, company also has scrapped with 5% of incoming material and went down to after conducting QMP.
Before QMP:
Scrapped = 50000 x = 2632 sq. meters

After QMP:
Scrapped = 45465 x = 1406 sq. meters

Total material:
Efficiency
Before QMPAfter QMP
Square meterSquare meter
Purchasing of material48,000.044,328.0
Processing loss 2,000.0 1,137.0
50,000.045,465.0
Scrapped 2,632.0 1,406.0
52,632.046,871.0

3) Effectiveness: We can depend on gross machine hours and idle time to calculate and evaluate the effectiveness. * Gross machine hour: 01 unit is produced, we need to use .06 running hour of machine. But after QMP, we only need 0.5 running hour of machine.

Before QMP: 0.6 x 6000 = 3600 hours
After QMP: 0.5 x 5541 = 2771 hours
* Idle time: it is 20% of Gross machine hour used (running hour = 20% of gross hour). Then it went down to 12.5% after QMP.
Before QMP:
Idle time = 3600 x = 900 hours
After QMP:
Idle time = 2771 x = 396 hours

Effectiveness
Before QMPAfter QMP
HourHour
Effectiveness3,600.02,771.0
Idle time900.0396.0
4,500.03,167.0

VI. The principle of quality and value and identify potential improvement
After conducting the QMP, we need to make profit and loss account to calculate and evaluate the profit or loss of company as well as the effectiveness of process after implementing QMP.
Profit and Loss account
Before QMPAfter QMP
$ $
Sales revenue5,000,000.05,000.000.0
Downgrade 525,000.0 291,200.0Note 1
5,525,000.05,291,200.0
Cost and Expenses
Total material Purchasing costs2,105,280.01,874,842.0 Note 2
Inspection & storage of material A costs 52,632.0 46,871.0 Note 3
Inspection & other costs 250,000.0 150,000.0 Note 4
Liabilities 150,000.0 50,000.0Note 5
Administration & distribution expenses 600,000.0 540,000.0Note 6
Prevention program costs 200,000.0 600,000.0 Note 7
Machine costs 1,800,000.01,266,800.0Note 8
5,157,912.04,528,511.0
Net profit 367,088.0 762,689.0

* Note 1: we have 750 units of downgrade. It is sale to 70% of selling price. 1. Downgrade = Units of downgrade x 70% of selling price
Before QMP:
Downgrade = 750 units x 0.7 x $1000 = $525000
After QMP:
Downgrade = 416 units x 0.7 x $1000 = $291200

* Note 2: costs of material purchasing = total purchase of material A (sq. meter) x $40 per square meter.
Before QMP
Total material purchasing cost = 52632 (sq. meter) x $40 = $2105280
After QMP
Total material purchasing cost = 46871 (sq. meter) x $40 = $1874840 * Note 3: the inspection and storage of material A cost is charged $1 per sq. meter purchased. 2. Inspection and storage of material A cost = total purchase of material A (sq. meter) x $1 per sq. meter.

Before QMP
Inspection and storage of material A cost = 52632 (sq. meter) x $1 = $52632
After QMP
Inspection and storage of material A cost = 46871 (sq. meter) x $1 = $46871 * Note 4: we collect them in scenario
Before QMP:
Inspection and other costs = $250000
After QMP:
Inspection and other costs = reduction of 40% of the existing cost = (100% - 40%) x $250000 = $150000 * Note 5: the liabilities are estimated at 3% of revenue. However, it decreased to 1% after QMP

Before QMP:
Liabilities = $5000000 x 3% = $150000
After QMP:
Liabilities = $5000000 x 1% = $50000
* Note 6: we collect them in scenario
Before QMP:
Administration and distribution expense = $600000
After QMP:
Administration and distribution expense = reduction of 10% of the existing cost = (100% - 10%) x $600000 = $540000. * Note 7: we collect them in scenario
Before QMP:
Prevention program cost = $200000
After QMP:
Prevention program cost = $600000
* Note 8: the machine cost is calculated by total hours we need for producing 5000 units x machine cost per gross hour.
Before QMP:
Machine cost = 4500 (hours) x $400 = $1800000
After QMP:
Machine cost = 3167 (hours) x $400 = $1266800

Potential improvement:
According to the profit and lost account, we can see the costs and expense during fulfilling 5000 product units. It points out that after conducting the QMP, the net profit increased more than 100% from 367088 to 762689. It is really a positive improvement for company. Nevertheless, I believe that improvement will be much better I company applies some systems such as Just in Time or Enterprise resource planning, etc. Applying such systems can help company reduce the cost of storage material more effectively. The enterprise will have material inventory at the lowest level, eventually no material stocks so that there would have no loss during storage. With these useful systems, supplier will know when and how much materials company needs for tomorrow, next three days or next week.

Besides, the company also needs to look for customers who want to buy scraps for reducing the cost of scraps.
Additionally, company should focus on the inspection process because after implementing QMP, company had 7.5% failure. However, when products came to customers, there also were 2.5% of returns because of failure inspection. It shows that the inspection process was not working effectively. Therefore I suggest that company should apply inspection process with comprise X-ray or laser technology. With that system, 99.9% of mistakes in products can be detected immediately in inspection process.

Such potential improvements recommended above, I strongly believe that they will help company to reduce the costs whilst increase more net profit. 

Comments