A cost accounting system: is the sum of techniques and methods used by businesses in order to allow them to track resources consumed in production and distribution of goods and services to customers. Management use these techniques to evaluate and reward employee's performance, by staff in order to manage recourses efficiently. Moreover, the cost accounting system is used for exterior reporting requirements like income statements and balance sheets. It is planned to meet particular needs of individual companies. There are three main systems businesses apply according to their needs:
- Process costing that is costing system that the costs are accumulated by departments and operations. It used for production of small identical, low-cost items. Process costing averages the costs and can't be directly traced to individual products. for example the Process costing is used by the companies that produce alcoholic beverages, typewriters, breakfast cereals etc. Process costing is also used in public utility services like water and electricity.
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- Job Order costing that is a cost system that is designed to accumulate costs of jobs, orders and contracts. It is used when individual production centres or departments work on a mixture of products during a specific period. The two categories of production costs that monitored with the Job order Costing is the Prime costs and factory overhead costs. For example Job order costing is used for construction projects, luggage etc and accumulating service like (ex. doctors).
- Activity based costing is a costing system that can be used as an inventory valuation method and is used to allocate costs to activities. In other words, costs are traced to activities and then these costs are traced, in a second stage, to the products that use the activities. The Activity based costing method developed to provide more accurate product costs and has become accepted because of the fact that the complexity of businesses keeps rising and so does their need to assign increasingly large indirect costs to the right department or activity. It is a process to assign costs based on the cause and effect relationship among costs and activities that drive costs. In Activity Based Costing systems, an attempt is made to assign all costs to products like engineering, marketing, distribution etc.
- Back flush costing is a cost accumulation method that is used by companies that adopt just-in-time philosophy, which emphasizes simplification and continuously reducing waste in all areas of business activity. One of the goals of these systems is zero ending inventories.
2. What are major objectives of a cost accounting system in a hospitality establishment?
-The major objective of a cost accounting system in a hospitality establishment is to achieve successfully the measuring of various needs of departments and generated revenues.
-Moreover, monitor and control of each department's progress is another object of the cost accounting.
-Continuing with the objectives, department related data gathered is used to evaluate costs and make proper adjustments and corrections in operating procedures.
- Determination of selling price of every item, good or service.
- By knowing the cost of each product a hospitality establishment can achieve both Cost Control and Cost Reduction.
- Assisting management in decision making like establishing standards to check against deviations and highlight capacity utilization and efficiency
3. What are the major objectives of a cost accounting system in a manufacturing company?
The major objectives of a cost accounting system in a manufacturing company are:
- Determining Costs: The main objective of cost accounting is to determine products and services costs to buy them and provide them.
-Control: Another important objective of the cost accounting is to improve efficiency by controlling and reducing expenses.
- Information: The cost accounting systems offer to managers of the company helpful information regarding planning, cost control procedures and determining unit production costs. In most cases manufacturing companies also use a complete job cost sheet which contains Cost Summary and Unit Cost information since manufacturing costs are not immediately recorded as current period expenses. The cost accounting provides information about raw material stock levels, work in progress and the amount of finished goods. Moreover, this information includes total and costs per unit for:
Direct materials, which are the raw materials used in production which costs are directly traceable throughout the product manufacturing process.
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Direct labour, which are the wages and other pay roll costs of employees whose efforts are directly traceable throughout the product manufacturing process.
Manufacturing overhead, is the category including all other manufacturing costs like utilities aside for the above mentioned ones.
- Increasing Efficiencies: The cost accounting system has also as an objective to provide an understanding of the point of efficiency in all areas of manufacturing operations.
-Determine the Selling Price: The details and the information that the cost accounting provides to the managers help them to find the right selling price of the products.
-Operations Management: cost accounting, help managers to find appropriate operations policies in order to increase the profitability.
4. What are the procedures in job order costing, process costing and activity based costing.
Job order costing process is a detailed set of events which will usually occur with each job. Generally the procedures for completing the Job-order costing are as follows:
- The order number or the sales order is received for the batch of products.
-A production order is issued from the sales order and all materials and labour utilized are ordered and tracked for the set of products.
- Overhead, either as a percentage of direct labour or other pre- determined rates will be included in order to arrive at a total cost of operations.
-In fact manufacturing overhead will not affect the work in process account. Instead of that it is changed to a control account.
Direct labour and materials are charged by the accountant to the work in process accounts using the actual quantity acquired. These quantities are all tracked using a job costing sheet which will likely be already a computerized ledger and use used for each job.
-Spoilage which surpasses expected levels based on the job at hand is considered a period cost and is reclassified from work in process account into a separate account so it can be addressed by the management to monitor the efficiency of the operation and provide the necessary information for manufacturing.
Process costing procedures follow specific procedures and while exact procedures may differ between different companies and businesses, but they generally follow these steps.
-While other types of costing are initiated when a sale order is issued, a sale order is not required for process costing as it is a continuous process.
-The work in process accounts are separated departments and are named according to the department they reflect on e.g. Work in process-F&B department.
-The first department in the production process makes the first entry into the work in process account, generally for the raw materials.
-While the products move from department to department entries are made to each work in process account of each department.
-Direct labour costs are recorded at each period.
-Actual overhead costs are recorded; no contra-account in needed because there is no over- or under-applied overhead due to the actual costs being applied.
-Indirect costs are applied to the overhead account in actual amounts.
Activity based costing procedures can be more complicated to set up and operate than other costing systems. The activity based costing procedures are:
-Only if a cost driver can't be recognized a cost can be assigned on an allocative basis.
-Related cost pools are assigned to an overhead rate on costs drivers.
-Cost pools are used to assign costs; the basis depends on the business and industry.
-Costs can be assigned to units, batches or products.
-These pools can be combined to look at facilities, divisions, or other levels of cost classifications.
-Costs can then be evaluated in order to see how and where they are occurring, knowing this the management can discern what cists are controllable and how they arise.
5. Which costing methods (job order costing, process costing and activity costing) are best suited to the following businesses and why:
Old Home Bakery, Inc (a bakery that produces to order): job order costing because it is designed for businesses which work with orders rather than mass production.
Apache Oil and Gas Refinery: the process costing is the appropriate method because the products are similar or identical.
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The Sea View Resort Hotel: the job order costing because it offers services and the method is designed for businesses like that.
Willie Wonker's Chocolate Factory: The process costing method, because the business produces standard items which are identical.
Harris and Harris Law Firm: the job order costing because this business offers services in legal form representation and this method refers to a desired unit which might not be identical to another offered service.
6. Explain and evaluate LIFO, FIFO and AVCO techniques.
A cost flow assumption refers to how costs flow through the inventory accounts, not the flow of work or products on a production line. This distinction is important because the flow of costs is not always the same as the flow of work. The various types of cost flow assumptions include: specific identification, first in, first out and last in, first out.
FIFO is the most frequently used method by the enterprises in order to record the value of their inventory. It is appropriate when dealing with many different batches of similar products. FIFO assumes that the product in the beginning inventory are finished first and transferred to the next department before any of the products that are started during the period. So it assumes that the next item that will be purchased will be placed at the end of the line of to-be-sold items of that kind meaning what was purchased first will be sold first. In an economy of rising prices, it is common for new business to use this method to report the value of merchandise to boost their balance sheet. While the older and cheaper good are sold the new and more expensive goods remain as assets in the business's books, financial statement boosted by FIFO also increase the chances a business has to get a loan.
LIFO is a method that products will be issued with the last-in first-out order. That means that current purchases will be stored recorded and sold before the items that already existed in stock when the purchase was received. LIFO valuation is permitted due to the belief that an ongoing business does not realize an economic profit only from inflation. When prices are increasing they must replace the inventory currently being sold with items on higher prices. Moreover, matches better current cost against current revenue and defers paying taxes on phantom income arising exclusively from inflation. LIFO is preferred by businesses because it delays a major negative effect of inflation; higher taxes.
AVCO (average cost) - Under this method the costs are equally divided among the units of inventory. It is used to establish the value of an inventory by calculating the costs of units. When this method used costs are matched against revenue according to an average of the unit of cost of goods sold. This method os determined by dividing the total cost of the units of each item available for sale during the period by the related number of units of that item.