The Treatment of inventory cost

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In my opinion, costs that ought to be included in KMD's inventory are those costs that are specifically and /or exclusively identifiable under the production of whisky as well as overhead costs associated with the manufacturing. Production cost consists of direct costs and factory overheads. KMD incurs direct-expenses in relation to labor from workers converting grain into whisky, direct materials used in whisky production such as rye and barley malt, and other expenses incurred in the manufacturing process (Bruns, 1997). Similarly, factory overheads used in the manufacturing and not in aging process should be included as well. Aging and distribution costs should be excluded from the cost of inventory to ensure conformity with the GAAP regulations.

A decision to charge barrel cost to inventory and exclude warehousing plus aging-costs will have a material effect on KMD company financials. First, the amount of gross profit reported will be higher. This is because the sales cost will be lowered by possible omission of costs previously included in the cost of sale balance. Similarly, the statement of affairs will be affected. Current assets figure reported will change and thus trigger a corresponding alteration in working capital. Accounts balances that will change includes the cost of sales which would decrease by $1,904,000 (arrived at as $5,731,000-$3,827,000).This will cause a corresponding increase in the gross profit figure by the same amount (Bruns, 1997). Moreover, the decision of cost allocation will change various account balances in the balance sheet. First, the stock figure in the balance sheet will be lower because of the adjustments to exclude aging and warehouse cost from the inventory balance. This decline in KMD stock will also cause a decrease in working capital balance and finally a decrease will also be realized in total current assets figure, and total assets as well.

I will not recommend a method of capitalizing the barrel and writing-off the cost to the number of useful years of the containers. Barrel costs are not capital thus cannot be treated as fixed assets. Similarly, as evidenced from the case study, barrel cases are not reusable. They are disposed after the aging-process. Fixed assets are more permanent and are thus used for a long time in the business thus barrel cannot fall in the category of fixed assets. Additionally, barrel cases are turned-over together with firm's stock at the end of operating cycle thus cannot be treated as fixed asset. Depreciation cannot also be charged on these whisky containers as they form part of revenue and not capital expenditure.

Accounting methods

As part of accounting method suggestion, I would recommend that KMD Company be recording transaction using accrual rather than cash accounting basis. This ensures that only revenue as well as costs specifically attributed to a certain accounting period is included in the financials. Therefore this implies that a deliberate effort is made to record revenue possibly when realized and related expenses when incurred. Production costs charged and included in the cost of sales should also be specifically under factory costs classification. Adoption of these methods will bring a close range between the profits reported in fiscal 1996 and 1995 (Bruns, 1997).

Cost increase and ABC costing system

Increase in distribution, selling and advertising cost for the KMD Company could be explained by the new promotional strategy adopted by the firm. As evidenced from the case study, the company had reorganized its dealings with major distributors. Engagement of consultants, new legal contracts and distributor discussions forums among other reorganizations, has consequently led to increase in distribution costs. Rearrangement of orders placed by distributors has also increased selling costs. This is because ordering costs increase with the possible quantity ordered. Similarly, advertising cost as evidenced by Ralph Harmon (the firm's C.E.O), rose due to higher advertising rates (Bruns, 1997). I would advise the marketing department to perhaps allocate accommodative costs to promotional activities as this will not directly compromise the company's profitability. However the costs should not be too low so as to keep the company inn a competitive edge with other firms in the industry.

Introduction of ABC costing system would greatly improve manufacturing operations of KMD Incl. This is because the method will help in estimating products and/or services costs and thus take corrective measures on those products that have no contribution, and perhaps in the long run increase the company's overall profitability. Employment of ABC method will mainly enable the managers of KMD Incl. to carry out strategic decisions effectively. Such decisions may include pricing and cost allocation procedures. Determination of the number of cost drivers will depend on the number of cost pools in the manufacturing department. Cost pools will be indentified according to the number of activities in manufacturing department.

Company performance and measures to be put in place

Standard number of test is one for every 8 barrels and standard cost is 8 for each test. 23, 200 were carried in 1996 @10 per test. Material variance is calculated as actual quantity*(actual price -standard price). Number of barrels sampled is 8*23200=185,600. Therefore, the variance is given by {(10*185,600)-(185600*8) =371, 200 (Bruns, 1997). The resultant figure is positive, implying an unfavorable variance. Thus in 1996, the laboratory performance was poor because the cost spent was higher than the budgeted figure. As evidenced from the calculation, actual amount spent in carrying out tests is higher than the sum planned for.

Some of the management control problems include difficult in cost allocation. Cost allocation measures adopted by the co mpany are inappropriate thus the noted high expenses especially in sales and marketing department. Accounting department is faced with issues on costs separation. Most trading expenses are included in factory costs. The company is likely to face similar problem probably in the future if effective corrective measures are not taken. This is because any resulting weaknesses are likely to be transferred to upcoming managers who will run the organization in future. I would recommend that the KMD Company employ effective measures of cost allocation, for instance costing based on activities to correctly indentify, ascertain and allocate costs. Similarly, preparation of financial statements should be based on GAAP principles to correct expense classification adopted by the company.

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