Cost Accounting Information and Price Determination

Cost Accounting Information and Price Determination

Since the project is dealing with cost which is universally accepted as a measure of value, we shall not demarcate foreign related literature and local related literature as such. And since we are dealing with cost and its effects on pries, we shall review both not so in independently, that is, both cost and price are to be reviewed and analyzed concurrently where possible.

The study “cost Accounting information and price determination’ in a nutshell refer to cost information as an input data which management uses in its pricing policy decision. This task of providing cost information to management according to Allah R. Drabin in his book ‘Managerial accounting, an introduction “consist of the following.

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  1. COST DETERMINATION: What does a component or product cost to produce?

Cost determination is important in financial reporting (inventories, cost of good sold, etc) as well as in management functions. The actual cost data form a basic input to the control process and planning decisions.

  1. COST CONTROL: Whether the increased cost is reasonable for the task performed; cost control goes a step bey and cost determination and considers what cost should be and what corrective action should be taken when costs are excessive.
  2. PERFORMANCE EVALUATION: Where assets used efficiently? Performance evaluation may be the first stop toward controlling costs. In responsibility accounting system, “a person is identified as being responsible for a portion of an operating entity. And costs are accumulated by the areas of responsibility”.

2.1     COSTING METHODS:

          according to T. Lucy in his book “management accounting” (p. 18) costing methods are those methods of costing which are designed to suit the way products are manufactured or processed or the way services are provided. Examples of costing methods are: job costing batch costing, contract costing and process costing it must clearly be understood that whatever costing method used, basic costing principles relating to classification, allocation, apportionment and obsorption, will be used.

Writing on costing methods, Douglas Garbutt, (carter’s Asvanced accounts (p.1506). in addition to the methods listed above, enumerated other costing methods are as follows:

  1. SINGLE OR OUTPUT COSTING: This is used by firms, supplying products of information type examples quarries and breweries.
  2. OPERATING OR WORKING COSTING: Is used by industry or industries which supply a service and do not have a natural unit of output, for example, rail-way motor a natural unit of output, for example, rail-way motor transport undertaking etc.
  3. DEPARTMENTAL COSTING: Which is a system of costing by cost centers.
  4. MULTIPLE COSTING: This merely implies, the use of different classes of costing within the same organization, for example, batch costing with process costing for a rust-resistant treatment for all metal parts.
  5. CLASS COSTING: Where production is on fairly uniform lines, with a few distinquishable classes of product each class is treated differently in recovering oversend.
  6. TEST OR SAMPLE COSTING: Instead of costing all jobs or batches, only test or sample batches are costed, and from these cost a standard cost is established for succeeding batches.
  • THE FLOW OF COST IN A MANUFACTURING FIRM

If a firm is engaged in a manufacturing process, a need arises for several accounts that are not required for a merchandising firm. The management is interested in the cost of the raw materials, the goods in process and the finished goods. These items are effected by the costs of purchased materials, as we as by the various processing costs that incurred in manufacturing. Example of the manufacturing costs generally assigned to inventory are: factory labour, depreciation of factory building, manufacturing supplies, materials, and the costs of various services department. In addition to the cost of the material purchased to make the products, it is necessary to identify the labour cost and the indirect manufacturing costs, such as heat, light, and rent on the factory buildings. All these costs must be incurred to make the product, and the calculation of the product cost were not considered.

Costs are accumulated and identified as to their basic nature and then assigned to products. Cost flow through accounts paralleling the flow of product through manufacturing plant.

The costs associated with goods still in the manufacturing process are recorded in work in process accounts, the number of accounts used will vary. This may be one account but it is more common to have at leas’t three namely.

  1. Direct labour in process
  2. Direct materials in process
  • Manufacturing overhead in process thus, three items are recorded in work in process account.
  1. Direct materials
  2. Direct labour
  3. manufacturing overhead:- Manufacturing cost are assigned to inventory accounts (work – in – process), the costs associated with the manufacture of the goods are not recognized as experses until the goods are sold. The objective is to match the expanses of earning the sales revenues against, revenue to compute the income of the period. The manufacturing over head indirect manufacturing costs) is transferred to work-ing process based on the overhead absorption rate. The direct labour is recorded in work-in-progress as the necessary information is obtained from labour reports. The types of information that has to be known, is:. The department, the job order number, the process or product being worked on, the number of hours and overtime and the hourly rate. The transfer of material to work – in-process is accomplished through a summary of material requiresitions. This summary identifies the materials and gives the number of physical unit price, a total value and the department job process or product that received the material. For example, the products company had the following debit balances in its manufacturing accounts at the end of the accounting period.

Labour                           100,000.00

Material                         50,000.00

Depreciation                  10,000.00

Power cost                     2,000.00

Indirect labour               15,000.00

Entries are           required to recognize the cost of work-in process; over head costs are to be absorbed at a rate of 25 percent of direct labour cost. First, the three elements of indirect cost must be transferred to the manufacturing over head account. This is accomplished by the following entry:-

Manufacturing overhead or Dr.                  27,000.00

Depreciation costs                                      10,000.00

Power cost                                        2,000.00

Indirect labour                                  15,000.00

(to transfer all indirect costs to manufacturing account).next, we can record the #1000.000.00 of direct labour cost we will use one work –in-process account for all cost factors.

Work – in-process                                      #100,000.00

Wages payable                                  #100,000.00

Work-in-process                               #50,000.00

Material inventory                                      #50,000.00

Manufacturing overhead                             #25,000.00

(Being the transfer of manufacturing account balance to work-in-process account)

Note:           Manufacturing over head is transferred at the rate of 25% of direct labour cost, that is #25,000.00 in total.

As a result of these entries, the company now has a balance in work-in-process of #175,000.00. there is also a balance of #2,000.00 remaining in manufacturing overhead account. This is due to the discrepancy between actual overhead cost (#27,000.00) and the estimated amount transferred to inventory through application of a pre-determined overhead rate to the actual direct labour (#25,000.00). this is a case or under absorption of overhead. As the goods are completed and come off product line, they are counted. This gives the amount of goods finishe which because the basis of the entry transferring work in process to finished goods account. It should be noted that the accounting entries follow the physical flow of materials and other costs through the prodution process. For example, assume that the figures for the products company used in the previous example represent the costs of both finished and unfinished products. The cost of the 100,000 units that are finished is #100,000.00 and the cost of units in ending work-in-process inventory is #75,000.00. the cost of each finished unit is #1.00. the following entry is made to transfer the #100,000.00 cost of the finished units from work in process to finished good accounts:

Finished goods inventory #100,000.00

Work – in – process                #100,000.00

(Being the transfer cost of completed goods to finished goods account). After recording this entry, there is a balance of #75,000.00 remaining in the work-in process account. This is the cost of the partially completed units that are still in process. The cost of these units I shown as a separate inventory element.

When the goods are shipped to customers, their costs are transferred from finished goods to cost of goods sold. The basis of this entry is a summary prepared by the shipping department. The relevant information for this entry consists of the units of products shipped, classified by type of product, and the cost of each type of product. There is a temptation to consider all costs incurred in the manufacturing process as expenses.

As the manufacturing costs are incurred they are not considered to be expenses of the period but are costs of making the product. When the goods are physical, the cost factors are considered to be inventeriable from an accounting point of view.

HOW TO DETERMINE THE COST STRUCTURE OR A FIRM FOR PRICING PURPOSES.

          Businessmen have for long been aware that pricing a product is one of the most important and complicated problem and in trying to find some general guidelines by which to establish a sound pricing policy they agree that cost is one of the indispensable factors which must be take into accounts, if any business organization is to survive. Cost as an input to pricing decision which is the major discourse of this research, constitutes what is referred to as the “cost structure of the firm” one useful way of studying costs for pricing decision is to classify each category of cost as to its fixed cost and variable character. Fixed cost are those that do not change with activity level, though some costs are semi-variable in nature, having share of both fixed and variable cost qualifies. A break –even chart aids the breaking up of cost into its fixed and variable components. The general assumptions for break even point are:

  1. Fixed costs must remain fixed irrespective of the level of activity.
  2. Variable cost vary with the level of activity.
  3. Any firm must produce to a level known as break-even units, to cover all its costs and production above this level leads to a positive profit.
  4. another assumption is that, there is only one product mix.
  5. over the activity range being considered, costs and revenue behave in a linear fashion.
  6. that the only factor affecting costs and revenues is volume
  7. that technology, production methods and efficiency remain unchanged.
  8. there is no stocks level changes or that stock are valued at marginal costs only.

From the above chart, production and sales less than x, amounts to irrecoverably of fixed costs while x2, the firm recovers both fixed and variable costs. With respect to pricing strategy generally, it is useful to consider three measures of the cost structure of the firm. The ratio of fixed to variable costs, the economics of scale that may be available to a firm, and the cost of a firm relative to its competitors.

Consider first, the ratio of fixed to variable costs. When a company is operating with very high fixed costs and low variable, costs, such as an oil refinery operating below capacity the incremental cost of additional input is very lows, under such circumstance,s earing may be greatly enhanced if volume is increased even if this is accompanied by some moderate reduction in selling prices. Such industries have been termed volume sensitive. Alternatively, a company may be operating with very high variable costs and very low fixed costs. Since raw material and labour costs are such ahigh percentage of sales, there are not windfall gain to be realized through increseing output particularly if the increased input comes at wealening of prices. Contrarily, earning would be improved most dramatically if selling prices were raised, even if there was some contradiction in the volume output. Such industries have been termed price sensitive.

This article was extracted from a Project Research Work Topic

COST ACCOUNTING INFORMATION AND PRICE DETERMINATION (A CASE STUDY OF NIGERIAN BREWERIES PLC, ENUGU)

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