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Perfect Wood works Ltd the manufacture, supplier and installer of factory made joinery such as quality woods, Door, Staircase. The vast majority of the work done by the business is strictly to order and made to suit the specific requirement of the customer. The company monthly turns over £5billion, it has 500 employees country wide and produces 10 products per day. Also with their share capital and share holders are running positively in the competitive market. An average market share is £45 and has a good reputation in the share market. Company has announced revenue of £10billion for the quarter which ended in July 2010. There had been growth of 6% over revenue 2b for the same period in the prior year. The Company has achieved their target and is running successfully because of their proper cost management. As a management accountant, I briefly provide the cost information for budgeting and forecasting purposes in the management of business.
Now we will look at the company cost management briefly.
Full of Costing
The total amount sacrificed to achieve a particular object. It includes all amounts sacrificed. So, if the objective was to supply a customer with a product or service, all cost relating to the production of the product or provision of the service would be included as part of the full cost. To provide full cost information there should be a systematic approach to accumulating costs and then, assigning these costs to particular units of product or services.
Use of full costs
Output exercising control
Elements of cost
The cost elements are Materials, Labor and Expenses which are contributed in a production. According to these elements cost can be divided in to two main categories:
1. Direct Cost
2. Indirect Cost
A cost that is directly related to Product or service.The direct cost is identifying the specific cost units. The effect of the cost can be measured in respect of each particular unit of output. This cost is known as prime cost.
EX: According to perfect wood makers the direct cost is as follows:
Direct material - Wood for tables.
Direct Labor - Wages for production line employees.
Direct Expenses - Royalties Payable of the designer of a product.
A cost is not directly related to the product or service related to all the other costs. It is not directly measured in respect of each particular unit of output. This cost is known as overheads.
EX: According to Perfect wood makers indirect cost as follows:
Indirect materiel - Grease, Cleaning materials.
Indirect labor - salaries for supervisors
Indirect expenses - Rent, Telephone, Lighting, Heating
Total cost of a unit is total of direct cost and Indirect cost. Total Cost = Prime cost+ overheads
Nature (Cost and the behavior of the cost)
Cost represents the resources that have to be sacrificed to achieve a business objective. The cost incurred by a business may be classified in various ways and an important way is how the cost behaves in relation to changes in volume of activity. This is cost valuable according to the volume.
According to Atrill,P.and Mclaney,E.(2009)When changes occurs the volume of the activity changes but cost will remain same. This can be considered as short term in business. This cost is time based not volume activity based.
Volume of the Activity
EX: Perfect wood makers Rent, Insurance, Cleaning cost, staff salary.
The particular cost is not changed by the volume of activity. Even though fixed cost can be variable under inflation, only the cost gets high not the output.
This cost is different with the volume of the activity.
Volume of the activity
Ex: Perfect wood Makers direct material such as woods, direct labor wages for production employees. This cost changes according to the volume of the activity.
Step fixed cost
As the volume of the activity increases from zero the fixed cost is unaffected, at a particular point the volume of the activity cannot be changed without an additional space. The additional space will cause a step in the fixed cost.
Volume of the activity
Ex: Perfects Wood makers Water Bills for every month.
Semi Fixed Cost
In some cases cost has an element of both fixed and variable cost. This is known as Semi fixed cost.
Ex: Perfects wood makers Telephone bills with fixed monthly rental and charges per unit.
Function of cost
Cost can be classified by these functions:
2. Selling and distribution
5. Research and Development.
Ex: Perfects wood makers training programs cost for staff.
Cost Relevance and controllability
Cost classification helps to plan, control and to make decision in business. All cost units have cost centers according to various departments.
Ex: Perfects wood makers Assembly department, finishing department, Training department, Administration department. According to these departments cost code can vary and cost centre identify the different cost for each department and they plan and control the cost in every department through this company, and take a decision for effective cost management.
1.2 Job Costing
According to Atrill,P. and Mclaney,E.(2009) Is used to describe the way in which we identify the full cost per unit of output (job) where the unit of output differs. To cost a particular unit of output first should identify the direct of the job. Basically the job done is as per the requirement of the customer. This relates one unique at a time. The main purpose is to establish the profit or loss on each completed job.
Full cost of the unit
Fair share of the indirect costs
Direct cost of the unit
Ex: Perfects wood makers table production cost per unique time.
Transport vehicle repair
The Batch Costing
The production of many types of goods and services involve producing a batch of identical or nearly identical units of output, but each batch is distantly different from other batches. After completion of production, divided the total cost by number of units produced.
Ex: Perfect wood makers table cost for particular production =£10000
Numbers of units produced = 100
Batch costing for Table = £100
This cost basically includes the job cost and the batch cost. If the cost is taken more than one Accounting period it is known as contract cost. This includes chargers for a particular contract.
Ex: Perfects wood makers contract fitting cost = £500 for new buildings (which take more than one Accounting period)
Appropriate where the product follows a series of sequential, frequently automatic processes.
EX: Perfects wood makers Painting cost for the product. Average of particular painting cost use it as input cost of the next painting process.
This product cannot be seen, or touched it is a service not a tangible product. The product and the conception should be at the same time.
Ex: Perfects wood makers training programs cost for staff.
1.3 Costing Techniques
To cost a product there are two main techniques available:
1. Absorption method
This is a full cost method. It includes variable cost and fixed cost of a particular product. Under this method all cost of a production must be taken into consideration that brings the product, or services at it's actual location or condition.
2. Marginal method
This costing method includes only the variable cost of a product. The fixed cost is treated as a period cost. This will remain the same even when the activity changes in a particular period.
Ex: Perfects wood makers Table production costing under marginal technique:
Numbers of units produced (table) -10000
Numbers of units sold -8000
Selling price per unit -£25
Variable cost - Direct material-£3,Direct Labor-£5,Variable overhead-£2=£10
Fixed Product Cost -£50000 (Which is a period cost will remain same)
According to marginal costing:
Sales -8000units x £25 = 200000
Variable cost -8000 x £10 = (80000)
Contribution = 120000
Fixed Cost = (50000)
According to above marginal costing the number of units sold was £8000 and the selling price is £25 for each. Therefore the total sales are £200000. The variable cost for each unit is £10 (which includes direct material + direct labor + variable overhead) x units 8000 =£80000. Total fixed cost given is £50000. Out of the total sales volume by reducing the total variable cost + total fixed cost the marginal costing which is £70000 is calculated above.
The cost data collection for perfects wood makers to identify the total cost of a particular product is as follows:
TPC =Material cost+ Labor Cost + Expenditures
The sales department can identify the customer requirements, through that they decide the production units of a particular product. Ex: Table requirements: 1000 units according to this information, the sales department inform the purchasing department to purchase the material to identify the material cost. Then, the production department gives the production data (1000 units) to the HRM department to identify the labor cost, and gives the data to the finance department to identify the other expenses.
Perfects Wood makers Total Product Cost for 1000 units according to above department is £10000.
TPC = Total material cost + Total Labor Cost + Total Expenditures
= £2 per unit x 1000 units + £6 per labor hour x 1000units + £2 per x 1000units
£10000 = £2000 £6000 + £2000
According to the above example, the purchase department identified material cost for each unit as £2 x 1000 units =£2000. The HRM department analyzed how many laborers are needed for the production and calculated how many hours are needed for each product. According to that Total labor cost is £6000 as shown above. Financial department calculated all the other expenditures (Administrative expenses) as shown above £2000. After all the departments data collection was analyzed the total cost is £10000 for a particular table production.
Perfects wood maker's data collection diagram.
Production department HRM Department Finance Department
EX: Perfects wood maker's Overhead analysis as follows:
Machine Value -£50000
A - £25000
B - £15000
C - £10000
Depreciation Value- £12000
Wages - £15000
Total Employees worked 15 in each department 5 of them.
Perfect Wood makers' Over head Analysis sheet
Based on operational area
Number of employees
Depreciation machine value
Value of the machine
Value of machine
Rent and Rates
1. Salaries - Total Amount of Salary
Total Numbers of Employees
£15000 = £1000per employee
According to 5 employees in each department 5x1000=£5000 as shown above.
2. Dipriciation value: 12000 x 100 = 24%
A - 25000 x 24 = £6000
B - 15000 x 24 = £3600
C- 10000 x 24 = £2400
3. Insurance : 900 x 100 = 1.8%
A -25000 x 1.8% = £450
B - 15000 x 1.8% = £225
C - 10000 x 1.8% = £150
4. Rent A - 7210 x300 = £3090
B- 7210 x 150 =£1545
C- 7210 x 250 =£2575
Although The Company is growing, in some productions they fail to achieve the budget.
EX: Dressing table production cost
Budgeted cost Actual Cost
TPC =DM + DL + Expenditures TPC = DM + DL +Expenditures
£100 =£25 + £50 + £25 £120 = £30 + £60 + £30
Production Units = 1000 Total production = 1000
Total cost =£10000 Total cost =£12000
According to the above example the budgeted cost for each unit is £100 but actual cost is £120. This is due to the following reasons:
3. The actual material cost is £30 but the budgeted one is £25. An extra £5 is spent for material, due to inflation of a particular month and increased price in materials. It is poor management from purchasing department managers. Alternatively they may try to avoid the above extra cost by bulk purchasing the materials.
2. Actual labor cost is £60 but budgeted one is £50, because the company has recruited highly skilled workers who are charged more for their work. But on the other hand due to highly skilled staff they used the material more effectively to avoid wastage. But still HRM department can motivate staff by using a training program to work effectively to avoid extra hours to reduce the cost. On the other hand HRM department should consider about discretion cost to avoid extra expenses.
3. Financial department cost is high compared to the budgeted cost as is shown above(Expenditures). This is due to administrative cost being high because of more staff, transportation, and raised shipping cost due to inflation. But still it is the particular department manager's responsibility to reduce the cost apart from inflation.
Over all it is each department managers responsibility to maintain the cost within each department's budget to cooperate the main budget of the organization.
The money allocated for the particular month and keeping track on expenditure and income of all financial activity is known as budget.
Objective of the budget
The accountancy system of the organization provides information on what has happened in the past and help managers to keep track of whether or not their meeting their current budgets. Also manager needs information to provide expectation for the future.
Purpose of budget
The decision make every day in a business affect the profitability of the business. Make effect decisions and coordinate the decision and action of various departments a business need to have budgeting.
In budgeting Planning it needs the following:
In organization manager in every department justify the resources they need to achieve their goals. Communicate between manager and the superiors helps a firm their mutual commitment to company goal. In addition different department and units must be communicating with each other the budget process to coordinate their plans and effects.
Different unit in the company must also coordinate the many different tasks to perform.
EX: The number of product to be marketed must be coordinate with the purchasing and manufacturing departments to ensure good use available.
A budget is ultimately the plan for the operation of an organization for a period of time. Old Planed and process are questioned as well as new plan process.
Once the budget is finalized it is the plan for the operation of the organization. Actual revenues and expenditures are monitored constantly for variation and to determine whether the organization in target.
Behavioral aspects of budgeting
To maintain supportive and cooperative relationship with the staff. In management theory participation in decision making such as budget setting is useful seen as bringing advantage of organization. It is allowed information gathered from many sources, increasing the chance that all factors have been considered.
Requires appropriate knowledge, skill and expectant
May involve selfish motives
To maintain supportive and cooperative staff
Participation in the budgeting process tends to result increased productivity and satisfaction.
Different method of preparing a Budget
A business will prepare more than one budget for a particular period. Each budget relates to specific aspect of business. The sale budget is prepared first and other budget will follow:
Benefit to the business preparing regular cash budget.
1. Budget tends to promote forward thinking and the possible identification of short term problems. Because it shows shortage of production capacity can be identified.
2. Budget can help coordinate various section of business. Activities of the various departments and the section of the business are linked because of different type of budget.
3. Can motivate managers to better performance having all information can motivate staff, manager of their performance.
4. It is possible to control current performance with previous performance.
Budget can provide a system of authorization for managers to spend up to particular limit.