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This report is being prepared for Shahin, owner of Essex Bikes Ltd., with the intent of demonstrating practical implications of costing system, particularly those of adopting different costing system when manufacturing more than one model of products. Cost accuracy is a essential part of business activities. However, measurement is only the first step in a process, which is necessary for monitoring, controlling and planning.
Essex Bikes is small manufacturing company, it has currently 18 employees working in the production line, the office receptionist and PA who prepare accounts of the company. Shahin is negotiating a long term contract to produce, supply and maintain the Boris Bikes with the Mayor of London, while continuing producing his standard bikes . He expect that efficient cost system and method may help to obtain costs accuracy, in fact, he plans to manage costs of production efficiently in order to sell bikes at a lower price.
Cox,D. ,Fardon M. (1997) says that costing accounting is used in decision making and in budgeting process. The use of costing information to make decisions is essential to enable entities to maximise their profits and public entities to provide value for money services. Using information provided by costing system managers will be able to assess performance and make decisions that will affect businesses operations in future.
Three main types of cost
Basically, cost may defined as expenses that entities has to pay related to the production of its products. These cost may classified as Fixed Costs, Variable Costs, and Semi-Variable.
According to Atrill, P., McLaney E. (2006) staff salaries and wages are sometimes automatically assumed always to be variable costs. In fact, they tend to be fixed. People are generally not paid according to the volume of activity, and it is not normal to dismiss staff when there is a short-term downturn in activity. If there is a long-term decline, or at least if it looks that way to management, redundancies may occur, with fixed-cost savings. This, however, is true of all costs. If there is seen to be a likely reduction in demand, the business may, for example, decide to move to smaller premises and make rental cost savings. However, fixed does not mean steadiness for all time; it usually means fixed over the short to medium term. Fixed means only that the cost is not altered by changes in the volume of activity. Costs are likely to be affected by inflation. If rent a fixed cost goes up because of inflation, a fixed cost will have increased, but not because of a change in the volume of activity.
According to Atrill, P., McLaney E. (2006) variable costs are costs that vary with the volume of activity. In a manufacturing business, for example, this would include raw materials used. The cost increases as activity increases. In fact, variable cost will normally be the same per unit of activity, irrespective of the volume of activity concerned.
Costs sometimes have an element of both fixed and variable cost. These can be described as semi-variable costs. An example might be the phone bills cost for us. The amount of minutes contracted, this part is probably fixed, at least until the volume of minutes contracted are not exceeded . The other part of the cost will vary from point minutes contracted are exceeded. Usually, it is not obvious how much of each element a particular cost contains. It is normally necessary to look at past experience, because they provide us with an estimate of future costs.
Four main types of Costing System
Cox,D. ,Fardon M. (1997) defines Absorption Costing as method that measure the cost per unit produce by absorbing the total costs of the entire business. Absorption Costing System is widely used, it work where the costs per unit identical. However, Absorption costing use is less appropriated where some of the cost unit differ in quality or models. Sometimes, Absorption Costing may include only production cost, it exclude all others costs, such as selling, distribuition, administration and finance costs.
According to Cox,D. ,Fardon M. (1997) Marginal Costing is a method that measure the production cost of one extra unit of output. It is usually concerned with variable cost, such as direct materials, direct labour, direct expense and variable factory overhead. It enable entityâ€™s management to focus their attention to the sum coming in to the business from sales marginal costs have been paid, once they are paid the remaining money is profit.
Activity Based Costing
For many businesses, pricing their products is essential and generally it is done based in the cost of production. But for some entities knowing the cost of production precisely is not essential because the price of their products may be based in other factors that influence the price such as nature of the product, nature of costumer, market behaviour, competitors strategies, etc. However, most entities price their product based in the production cost which must be calculated with accuracy.
Activity Based Costing is defined for Cox,D. ,Fardon M. (1997) as one of the best tools for refining a costing system which provides better measurement of entities overhead for jobs, products and services. A.B.C. focuses in different activities as the fundamental cost objects such as event, task, unit of work, departments, and etc. Traditionally, this formula has been on the basis of the number of direct labour hours worked on each individual job.Costing Systems