Costing in an entity USQ UNIVERSITY OF SOUTHERN QUEENSLAND. M B G Wimalarathna (ACA, ACMA, ACIM, SAT, ACPM)(MBA USJ/PIM)

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1 USQ UNIVERSITY OF SOUTHERN QUEENSLAND MBA - ACC5502 Accounting & Financial Management / S1 / 2013 Costing in an entity M B G Wimalarathna (ACA, ACMA, ACIM, SAT, ACPM)(MBA USJ/PIM)

2 Introduction A Cost is a resource, commonly measured in monetary terms, used to achieve a particular objective. Hence, cost either categorized as expenditure (Income statement) or asset (Balance Sheet) in financial accounting. But, key management cannot clearly understand the cost structure and take their decision accordingly since financial accounting itself not provides sufficient (in depth) details. Hence, management expects sound costing system (System used to collect, record, summarize and allocate cost information) which essentially be able to provide answers for the following questions. What level of profitability provides by individual products, services, customers or departments? How efficient are daily operations? Where are the opportunities for cost reduction? How much does it cost to serve a particular customer group? Which products or service should drop? 2

3 Key Terms Cost Object : Is anything for which separate measurement of cost is desired / used. (ex - products / services / customers / departments) Inventoriable Product Cost : Production costs used in financial reporting and only includes in manufacturing accounts. Internal Value Chain : All the activities which are linked and undertaken within the entity from the inception of production of goods to the final delivery to serve customers. Activity Based Costing (ABC) System: Align / Assign all the costs to activities rather than to departments/products directly. 3

4 Full Cost Direct Costs : Costs which are directly linked to the cost object. At any given scenario, there will be a clear positive co-relationship between cost and cost object. DC CO Indirect Costs : Costs which cannot directly linked to one object but to few. Indirect costs also called as overheads. CO - A IDC CO - B Full Cost = DC + IDC CO - C 4

5 Why we Need? In Summary, Cost information assists entities in; Price setting Profitability analysis performance evaluation Cost management 5

6 Cost Allocation Cost allocation refers allocation of indirect costs to identified cost object. Direct cost already allocate to particular cost object as we have discussed / identified above and as such no allocation need. Allocation of costs essential in order to achieve following; To determine full cost of the particular cost object. (DC+IDC) Assist in resources allocation. To allocate cost of shared services. To encourage the use of central resources. Cost element to use as control tool. To comply with AASs. 6

7 Selection of cost drivers It requires to select the appropriate cost driver in order to allocate indirect costs to the cost objects. Cost driver means allocation basis of indirect cost. Cost driver provides a measure of activity that explains the cost object s use of the indirect costs. selection criteria; cause & effect benefits received fairness or equity Behavioural It gives more accurate results when entity use activity drivers (like ABC costing) for the allocation of costs. Activity drivers depend on the activity hierarchy of an entity. Unit level costs. (per unit) Product level costs. (specific products) Batch level costs. (group of products) Facility level costs. (entire entity) 7

8 Process of allocation 01 st : Structure the cost allocation formulae by using - Total indirect costs. - Cost driver. 02 nd : Calculate the indirect cost rate. Total indirect costs Total cost driver usage 03 rd : Allocate costs to the cost object. Indirect cost rate x cost object s use of cost driver 04 th : Determination of full cost. Full cost = Total direct costs + Total indirect costs 8

9 Inventoriable product cost Inventoriable product cost can be seen in the manufacturing entity. This means conversion cost of raw materials to finished goods/products. Note : Any other non - manufacturing costs such as office salaries and administration expenses treated as period costs and not form part of inventoriable product cost. Inventoriable product costs comprised both Direct manufacturing costs and Indirect manufacturing costs. Direct Indirect Ipc Directly can identify Total indirect costs No. of units produced Cost of sales (when sold) Closing stock (retain in the business) Variance : is a different between actual costs and budgeted / estimated costs. Variance could cause to record either over applied overheads or under applied overheads in the financial records. 9

10 Tactical decision making Entities which are operate in highly competitive business environment tend to take various decisions in day today context. Decision generally involves selecting the best alternative solution/option out of all the possible solutions /options. Commonly experienced decisions would be; Make or buy decision. Special order decision. Working on extra shift Shutdown of product/section/factory Following key factors should consider in above decision making. Relevant Income (Incremental) Relevant Costs. (Incremental) Opportunity costs. Available capacity (Idle) Note: To make efficient & effective decision, it is compulsory to consider qualitative characteristics also than only considering quantitative characteristics identified in above. rather 10