Discussion Of Product Costing Accounting Essay

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With the development of market, the business environment has continuous changed, and the business practice of outsourcing has been accepted by most organisations to achieve competitive advantage. By virtue of this development, the cost management of an enterprise is reinvented to adapt this new global condition. The advantages of outsourcing that the virtual organisations could obtain are focus on the core competencies of their company other than providing all organisational services internally. It means that companies can gain effective and efficient products or services by external suppliers, in the meantime, they can receive cost-effective and strength their own competitive advantages in expert area. Based on a survey from Lankford and Parsa (1999), there are 85 percent companies outsourced some or all part of their business function to outside. The most frequent outsourced job is legal work and shipping with 59 percent and 41 percent respectively. Followed by information systems in computer (36 percent) and then production and manufacturing is 31 percent.

Most companies are expanding their business strategy to global area. Production outsourcing is the key element on deepening of international division of labour and improvement of degree of specialisation. Take IKEA as an example, it were regarded as a late entrant into furniture industries, but succeeded in building their own market position through core competence concentration, with outsourcing obtained the key development in lower-cost productivity effectiveness (Leavy 2004). IKEA initially aimed in a simple, elegant, and modern position to attract most young customers. And in comparison with other furniture brand, it prices have well below average. Leavy (2004) has stated that the choice of production outsourcing has been carefully decided as IKEA has clearly defined itself in "production-oriented retailing". For IBM, in particular, it has become not only a user of outsourcing services --- mainly in the manufacturing production area, but also an offer by providing internet integrator ---- primarily in the IT area. Moreover, it shows that the IT outsourcing services provided by IBM is the main source in generating revenues in e-commerce area (Leavy 2004).

Discussion of outsourcing:

When it comes to building relationship with outsourcing provider, there are a series concerns related to signing this relationship. The transferred responsibility in production outsourcing is within risks as those companies heavily relied on suppliers. For virtual organisations to succeed, their partners should acknowledge a shared recognition and goals about the product perception. The measurement should be undertaken to analyse the ability of chosen partners. Product cost is not only the way to manage cost in the production process, but also it is an indicator of prices, performance evaluation and continuous improvement (Corvello & Migliarese 2007). There are two vital procedures before companies enter into contractual relation in outsourcing. Firstly, it is to determine how much spent on a function and whether it is worth this amount. Secondly, if the decision is made, the regular performance check should be taken to monitor the suppliers' capability. To better assist above purposes, the product cost could be an effective way to measure whether they can gain cost-effectiveness benefit of using outsourcing (Gray et.al 2009).

The virtual organisations have evolved in world-class as the expectation from customers on all-aspects development, such as quality of products and services, inventory, and value chain management. However, since the collaborated activities increased, it is hard for managers to study on value adding activities. One of the important roles of cost managers is to recognise and minimize non-value creating activities by achieving to promote valuable activities (Gupta & Gunasekaran 2004). Traditional cost control systems are integrated in an advanced model which is suitable for normal business. Also, it is undeniable that cost measurement can still assist in long term as well as horizontal comparison as a benchmark (Gupta & Gunasekaran 2004). The Activity-Based Costing (ABC) is no longer relevant for new economy environment as those enterprises are normally outsourcing their production. The measurement based on their strategy and operation is more meaningful as the virtual organisations' responsibility distinguished from the other types companies.

Background of product costing:

Product costing is the process based on the characteristics of cost to determine and differentiate it by which the accounting costs incurred from cost objects or related activities (Balakrishnan et.al. 2012).The process to allocate cost is the way to help managers in decision making in relation with product planning and resource planning. Product costing is important in every organisation whether the type is virtual or traditional business. For example, the decision of producing products within the organisation or to outsource this function to outside in achieving cost-effective is mainly depending on the costing methods. Also, it is worth to recognise the total costs savings that the production jobs is undertaken by outsider, and the reengineering costs should be taken into account (Fisher & Krumwiede 2012). As for Dell, contractors are producing all the manufacturing and assembly work whereas the main company focus on the design and marketing. The virtual organisations have enjoyed in Just in Time strategy, and gain benefit on saving the cost of inventory (Balakrishnan 2012).

Although the evolution of outsourcing is inevitable, its adaption should be adjusted for companies' strategy. As Bartkus and Jurevičius (2007) has stated an example of Lithuanian company cooperation with a Swedish company. The company was aimed in integrated production of stone crashing machine all by themselves. Due to the production is technological complexity, the need of high qualification workforce leads to only 10 final units per year. With the demand increased to 50 products per year, the management had decided to improve their capabilities and production. Before they find proper partners, the companies' management has evaluated the highest cost activity based on Activity-Based Costing. And they determined to outsource this function to outside. Finally, the metal structure of mechanism is decided to outsource to expert metal processing company to produce as it is the most material and labour cost activity. From this example, it can be seem that the product costing is beneficial for the virtual organisations to distinguish valuable and non-valuable activities; also it is further assisting in the outsourcing decisions.

Discussion of product costing:

In the virtual organisations, the using of ABC can minimize the unnecessary activities of auditing, checking and control process by changing the ex post facto control in normal costing in control in advance. However, some arguments about the recent management accounting practices are not applicable for virtual organisations and new economy environment (Gupta & Gunasekaran 2004). Companies are continuous changing their fundamental in the organisations except their costing system, such as technology and strategy. The complexity of changing environment in global area of companies leads to increase related cost such as engineering, marketing and distribution which may exceeds direct labour cost (Gunasekaran et.al. 2005). It is a challenge to analyse those cost information in relation with purchasing, logistics, whereas the most valuable activities are undertaken by partners in virtual organisations. In some extent, the analysis on financial and non-financial information is a cruel job for managers or even for hard to gathering useful information in virtual enterprises.

Gupta & Gunasekaran (2004) also defined virtual organisations into many characteristics according to performance measurements; it includes virtual integration of infrastructure and functional areas, domination of indirect costs and capital costs over direct costs and operating costs, knowledge-based operations, informal and flat organizational structure and flexible management controls. They also concluded that as activities are difficult to trace, many costs are hard to measure due to hidden which will results in distorted product cost information (2004). Hence, an identification in business areas of value adding, which is Performance Based Costing (PBC), is in the purpose of estimating accurate cost information. According to above analysis, ABC needs for rich valuable information that activities are normally within companies, but PBC system is relied on the performance rather than activities. (Cunha et.al. 2008). They also suggested in their findings, for a virtual enterprise, the adoption of costing treatments may be more than one types according to companies' performance measurements (2008).

Improved costing system

There are 9 steps in building successful PBC system. For the first three steps, which are the set up steps including define objectives, develop PBC team, recognition of company's issues. Followed is the identification of value creation area (VCA) and critical success factors (CSFs). This is an process to find out what values an organisation can created, with deepen to ensure value added to products and services. Next one is to define CSF drivers. This could be costs or performance that each area is undertaken, and shows how many resources it takes. Then, a CSF pool is used to allocate similar types of CSF cost, the cost can be directly charged if the CSF pool has cost driver. Moreover, once a secondary cost driver has been decided, the assignment of CSF cost to a cost object could be done. Normally, cost object can be product, customer, services, project or other work unit depend on the business type of company. It is also the bottom line of cost assignment in PBC model. After all of those steps are done, it comes to the final part --- implementation (Gunasekaran et.al. 2005).

Take outsourcing as an example,


In conclusion, product costing is important for virtual organisations to analyse their costs no matter they outsource production or not. Outsourcing is inevitable procedure for virtual companies to focus on core competencies, such as global companies like IKEA and IBM. However, it is not to say product costing is unimportant since virtual companies signed contract to outsource their production. The product costing can be a benchmark of performance, and measurement of validate contracts of whether they gain cost-effectiveness through outsourcing (Gupta & Gunasekaran 2004). On the other hand, product costing is fall behind in the adoption as new virtual environment is in complexity components of different aspects. The key element is that the product costing should be adequate changed for companies as they differ in fundamental position in nowadays. Hence, a Performance Based Costing system is provided to help virtual organisation to define clear position, and achieve competitive advantage throughout performance management.