KING'S OWN INSTITUTE
ACC707 AUDITING AND ASSURANCE T119
Assessment Type: Case study – 2000 + 10% word report and analysis - Individual Assignment.
Purpose: This assessment is designed to allow students to demonstrate their ability to analyse given financial information relating to a management accounting problem, similar to real world problems, and present their findings and conduct analysis of this information as it applies to accounting concepts. It relates to learning outcomes a, b, c and d.
Value: 20% Due Date: Week 10 – 9.00 am Monday of Week 10
Submission: Students must upload their submission to the Moodle Assignment Link and Turnitin on the KOI Moodle Subject Home Page no later than 9:00 am Monday of Week 10. This is the submission due date and time. A printed copy should also be handed to the Tutor during that Week’s tutorial to assist with marking. All submissions must be accompanied by a signed KOI Assignment Coversheet.
Topic: Management Accounting Problem (Case Study).
Connectta Ltd manufactures furniture for computer work stations. Connectta uses a job costing system. The work in process inventory on 30 November consisted of the following jobs.
On 30 November, the company’s finished goods inventory consisted of four items.
At the end of November, the balance in Connectta’s materials inventory account, which includes both raw materials and purchased parts, was $668 000. Additions to and requisitions from the materials inventory during December included the following.
Connectta applies manufacturing overhead on the basis of machine hours. The company’s manufacturing overhead budget for the year totalled $4 500 000. The company planned to use 900 000 machine hours during this period, which is the firm’s estimated practical capacity. Through the first 11 months of the year, a total of 830 000 machine hours were used, and actual manufacturing overhead amounted to $4 140 000.
During December, machine hours and labour hours consisted of the following:
The jobs completed in December and the unit sales for that month are as follows:
1. Describe when it is appropriate for a company to use a job costing system.
2. Calculate the balance in Connectta’s work in process inventory account as at 31 December.
3. Calculate the cost of the chairs in Connectta’s finished goods inventory as at 31 December.
4. Actual manufacturing overhead incurred in December amounted to $252 000. Calculate Connectta’s overapplied or underapplied overhead for the year.
5. Explain two alternative accounting treatments for overapplied or underapplied overhead balances when using job costing system.
6. Explain how activity-based costing could overcome the deficiencies inherent in the existing costing system.
Task details: Students are to analyse the given information, make calculations where relevant and draw relevant, supported conclusions and make justified recommendations. Responses are to be formatted into a professional report for each part of each question, as would be expected of someone working in a modern accountant’s office. The report should include: title page, executive summary, table of contents, introduction, body, conclusion and reference list.
Research requirements: Students need to support their analyses with references from the text and a minimum of six (6) suitable, reliable and academically acceptable sources. Check with your tutor if you are unsure of the validity of sources. Students seeking Credit or above grades should support their analysis with increased number of reference sources comparable to the grade they are seeking.
This research work undergoes different aspects of the management costing principles especially the job costing system. The work conducted here is based on the Connectta Case Study. Connectta Ltd is a manufacturer of computer stations furniture. It uses the job costing system. The next section provides an introduction about job costing system and when can it be used by companies. The following three sections includes the calculation of the work in process inventory, the chair finished goods inventory and the over or under applied manufacturing overheads. Finally the last two sections deals with accounting treatment of over and under applied manufacturing overheads and the relevance of Activity Based Costing.
Job Costing is a method of costing which is usually being used where the cost of a tailor-made job has to be calculated. A tailor-made job is a specific order made by a customer whereby specific criteria have to be calculated. In that case job costing is an important tool for the company as it allows all the costs incurred on the job to recorded in a job card. The total costs consist of each department’s direct materials, direct labour, direct expenses and a fair amount of production overheads which will be absorbed based on the overhead absorption rate.
Hence each specific task is broken down and the cost is known for each task. According to Kotler and Armstrong (1999), a business sets a price that covers all its expenses including production, selling and distribution costs.
There it is appropriate to use job costing system when the customer requires a tailor-made job and that all details of the production costs have to be reported to the client. In the case of Connectta Ltd, it manufactures furniture for computer work-stations and offered the customer several types of furniture like Computer Caddy, Chairs and Printer Stand. Hence each customer might have their specific design and they can order for customised furniture. If a company orders a large amount of furniture, then the job costing system can be of great use to Connectta Ltd for its pricing policy. The job costing system will allow Connectta Ltd to break down the cost of each part of the production process of each furniture. Therefore, the job costing system can be used to determine the profit margin and the selling price of the furniture.
ACCA Global (2011) defines work in process as the goods that are not yet completely manufactured at the end of an accounting period. Therefore, the goods are in between production materials and the finished goods in the manufacturing process.
Work in Process Inventory at 31 Dec = Opening Work in Process at 1 Dec + Cost of Raw Materials + Cost of Labour – Cost of Good Manufactured
|Cost per Machine Hour||4,500,000 / 900,000|
|Total Machine Hour Used in December||49,900|
|Total Overheads||$ 249,500|
|Cost of Goods Manufactured||$ 4,140,000|
|Opening balance of Work in Process||$ 581,000|
|Cost of Raw Materials and Purchased Parts||$ 668,000|
|Overhead Costs||$ 840,500|
|Closing Work in Process||$ 2,050,500|
Opening Inventory of Chairs + Cost of Chairs Manufactured – Sales of Chairs
|Qty||Unit Cost||Total Cost|
|Opening Inventory of Chairs||19400||$ 35||$ 679,000|
|Cost of Chairs Manufactured||15000||$ 35||$ 525,000|
|Chairs Sold||21000||$ 35||$ 735,000|
|Closing Inventory of Chairs||13400||$ 35||$ 469,000|
If the budgeted manufacturing overhead is not accurate, there will be a case of over applied or under applied manufacturing overhead. In other words, over applied or under applied manufacturing overhead is the difference derived from the actual overheads and the budgeted overheads. The predetermined absorption rate is normally use din job costing and it gives rise to difference in the actual and budgeted manufacturing overhead.
Actual Overhead is greater than Budgeted Overhead then overhead is under applied.
Actual Overhead is less than Budgeted Overhead, then overhead is over applied.
|Actual Overhead||$ 4,731,000|
|Budgeted Overhead||$ 4,500,000|
|Under applied Manufacturing Overhead||$ 231,000|
The manufacturing overheads include all the production costs that are not allocated to a specific job. Under the job costing system, the estimation of manufacturing overheads is performed based on a predetermined overhead rate. Therefore, an inaccurate overhead rate might cause the overhead to be over applied or under applied.
If actual overhead is greater than budgeted overhead, then the manufacturing cost is under applied, while if the actual overheads is less than the budgeted overheads, then the manufacturing cost is over applied.
One way to treat the over applied or under applied overheads is through the income statement. Hence if there is a case of under applied overheads, then it can add it to the cost of sales. In that case the cost of sales will increase resulting in a reduction in profit (Accounting for Management). On the other hand, if overheads are over applied then it should be deducted from the cost of sales resulting in higher profits. Hence the accounting treatment will be as follows:
When overhead is under applied:
Debit Cost of Sales and Credit Manufacturing Overhead
When overhead is over applied:
Debit Manufacturing Overhead and Credit Cost of Sales.
In the case of Connectta Ltd the manufacturing cost has been found to be underapplied by $231,000. To record and balance the books, there will be a debit of $231,000 in the Manufacturing Overhead account and a credit to the Cost of sales by the same amount.
However, many accountants do not use this method as it is not considered to be accurate.
Another accounting treatment that can be performed is to dispose the amount in the work in process, finished goods and cost of goods sold. Therefore, the journal entry required here is as follows:
If overhead is under applied:
Debit: Work in Process, Finished Goods and Cost of Goods Sold
Credit: Manufacturing Overhead
If overhead is over applied:
Debit: Manufacturing Overhead
Credit: Work in Process, Finished Goods and Cost of Goods Sold
Accountants consider this method as a more accurate one than the first one.
In the case of Connectta Ltd, the $231,000 of under applied overhead could have been allocated to the work in process, finished goods and cost of goods sold based on their ratios.
Traditional cost allocation and absorption are often based on volume such as number of products manufactured, number of direct labour hours and number of machine hours. These elements increase as the output increases. In the past, businesses were producing only one product, or a few simple similar products and production overheads consisted of only a small proportion of the total costs. Therefore, the traditional methods were mainly based on averages. However, with evolution production has become more complex and these traditional methods only provide a rough estimate of the production overhead per unit. As rightly said by Glad and Becker (1996), Absorption costing could provide an inaccurate estimation of the production overhead per unit as overheads are allocated proportionally to direct costs. Some of the limitations of traditional costing approach could be the way into which labour and technology are allocated. For instance, labor as a basis for assigning manufacturing overhead could be incorrect if some of the overheads do not require labour hours. Kim and Ballard (2002) argued that cost distortion could hinder the profit level and there could be little attention related to activities of workers.
The emergence of Activity Based Costing (ABC) corrects these inaccuracies which are often found when using traditional cost methods. Drury explained that the Activity Based Costing identifies costs with activities that consume resources and assign resource cost to cost objects (products and services) based on the activities performed for the cost objects. The principle of this costing method is that a firm’s products or services are the results of activities and these activities use resources which incur costs (Popesko, 2009). Costs of activities are attributed to the activity centres and the cost of activity centres are then assigned to cost objects using cost drivers.
Therefore, applying ABC bring many advantages to an organisation as it considers all the necessary aspects that have to be taken into consideration the process. It allows for a better and more comprehensive understanding of overheads and what causes them to occur. Additionally, it provides a more accurate method of costing of products ad services and therefore provides a more realistic cost per unit. ABC also helps in improvement of pricing, sales strategy, performance management and decision making by providing detailed and reliable information about product cost. ABC costing works effectively for manufacturing businesses as well as services businesses.
However, ABC has some limitations. First it can be difficult and time consuming to collect data about activities and cost drivers. Certain costs will still be allocated arbitrarily since it is impossible to allocate all overheads to specific activities.
The Activity-Based Costing system, whose fundamental principles have been explained in this paper, is central to Activity-Based Cost Management. Information provided by this system boasts wider areas of application compared to that of traditional costing systems. Besides the more valuable quantification of costs allocated to cost objects and the detection of relations between cost consumption and operation, the existence of different types of cost objects also allows costs to be analyzed at differing levels of managerial decisions.
Activity-Based Management methods have a broad range of uses, permitting the empowering utilization of ABC information for a wide variety of company functions and operations such as process analysis, strategy support and time-based accounting, monitoring wastage, as well as quality and productivity management. In addition to information outputs, which could dramatically improve the quality of the decision making process, it is also necessary to define any disadvantages of the ABC/M system. Applying this method requires higher costs and difficulties could arise during its use due to the various activities that can appear. The implementation of ABC/M is a collective process and brings with it new cost calculation rules whilst presupposing a change of attitude and behavior.