ACCT5000 Evaluation of the Formal Product Costing Method Of Busu Pvt Ltd Assignment Answer
This report reveals the key understanding on the production cost method used by company to record its business costing. In this report, critical evaluation of the formal product costing method have been discussed. This report reflects the financial aspects of any business and the financial risks faced by company in its books of account.
(a) Formal product costing system and costing to produce a product
The importance of a formal product costing system is discussed below:
- Through a formal product costing system the actual cost behind the production of a product gets visible to the management. Through the available cost, management is able to decide whether the selling price of the product is upto mark to enjoy expected and required profit margins.
- The success of a business can be determined only when the actual costs are available and they are within the targeted costs set by it. When real costs exceed the target, the chances of profiteering are less (Noe, Hollenbeck, Gerhart, & Wright, 2017).
- When business development is sought, several production alternatives are available. A business shall be able to analyse and choose the best possible alternative only when detailed costs related to each alternative is available (Dale, & Plunkett, 2017).
In the given case, Red and Jack are totally unaware of what their production cost to them and are unanimously selling it. There are high chances of lacking the profit margin which could be attained by them. Through a formal product costing system, Red and Jack can know the production costs and set selling price accordingly. The given case illustrate situation of several businesses going altogether. Through formal costing system, Red and Jack can compare the profitability of every business and can make decisions about their expansion or closure.
(b) Usefulness of report prepared by external accountant and management accounting information for company in decision making
The reports prepared by external accountants reflect the financial aspects of any business and the financial risks faced by it. These reports are very limited in nature and correspond only to the financial counterparts and transactions. These reports are meant for the users to understand the financial performance attained by the business during a certain period. However, the information provided by them is not enough from the management perspective to take business decisions (Weetman, 2019).
For sound business decisions it is important to concern both qualitative and quantitative business aspects. Management accounting provides information about both the areas along with predictions for future performance. It is not limited to the past results. The scope of this accounting is wider and provide useful insights into the business functioning. These insights help the management in making strategies and futuristic plans. The reports of management accounting are limited for the use of management and hence confidential business information too comes into management’s notice (Schaltegger, & Burritt, 2017).
In the given case, Red and Jack’s view of just relying on financial reports is completely unacceptable from management decision making grounds. For better knowledge about the direction in which business is moulding itself, it is important for them to switch to management accounting systems. The future of their diversified businesses can be led towards success when they shall focus on preparation of management accounting reports which shall provide versatile financial as well as non-financial information.
(a) Benefits of a good understanding of cost behaviour
The benefits of a good understanding of cost behaviour are as follows:
- The knowledge of assessment of cost change as a result of activity change allows management to ascertain the distinction between the fixed and variable costs of the business. This distinction shall help the management to decide the course of their action. Through this the management shall be able to avoid those actions that directly raise business costs by impacting business activity.
- The effect of over-time and production increments on business costs can be clearly analysed by managers and are able to be controlled significantly without compromising on output (Ciftci, Mashruwala, & Weiss, 2015).
- The business managers also get the knowledge of the mixed business costs. These costs include components of both fixed and variable costs and allow the managers to control the variable components of the mixed costs.
Example: the following table hypothetically shows the fixed as well as variable costs incurred by Red and Jack in Busu Coffee Factory:
|Depreciation on processor||Fixed||1,000 per annum|
|Direct material||Variable||100 per k.g. of coffee cherry processed|
The distinction between these costs is only possible by understanding cost behaviour. Red and Jack could lower the costs by reducing the variable costs alone. The fixed costs shall occur to be expended, even when the processing is zero.
The two commonly used methods to derive cost function are:
- Account analysis method: more of a qualitative perspective is followed by managers while using the account analysis method. Here sub ledgers for cost accounts are formulated by managers which classify the cost accounts. The cost accounts are classified as fixed, mixed and variable using the cost behaviour. On the basis of these classified sub-ledgers, cost functions are derived.
- Conference method: the conference method of estimation of cost function makes analysis of cost drivers which leads to cost occurrence. The analysis is made on the basis of opinion provided by the distinctive business departments being manufacturing, engineering, production etc.
In the given case, the knowledge of cost behaviour shall prevent Red and Jack from spending ideally in business. The manner of taking business decisions anonymously till date had cost the business a lot more than actually required.
(b) Problems faced by businesses for gathering information for meaningful
The problems faced by businesses for gathering information for meaningful and useful analysis are as follows:
- While gathering information the business owners come across a lot of information. Every bit of that information is not useful for the business needs. Resultant, gathering of information is not an issue, but filtering useful and meaningful information out of this is (Sekaran, & Bougie, 2016).
- Businesses operate in a dynamic economic model. Information collected currently can outdate too soon. A continuous scan is required for keeping the business information useful. However, for businesses it at times get complex to continuously scan for useful business information (Tracy, 2019).
- The reliability of information collected is not certain. A sound analysis requires data which can be trusted undoubtedly. However, information collected from secondary sources is subject to tampering and might not be trusted completely.
- Business information collected always is not relevant for the purpose it is gathered. In such a case, the information gathered becomes useless.
- Analysis of business information needs business personnel who are well qualified for that purpose. Analysis of gathered information by personnel not equipped with required skills leads to an analysis which cannot be beneficially put to decision making use (Harding, 2018).
- Sometimes, the source of information required is known to the personnel making analysis, but they lack the authorization to obtain and use the same.
- Information related to a subject is at times inconsistent with another information studied and collected for the same subject in past. This leads to confusion.
It is inferred that in order to maintain the transparency in the books of Account Company needs to set harmonization in its financial costing method and accounting process. A sound analysis requires data which can be trusted undoubtedly while recording the financial data in the books of account of company. It is found that the cost accounts are classified as fixed, mixed and variable using the cost behaviour therefore, proper accounting cost method needs to be deployed after assessing these information. The management accounting information is critical data which helps managers to make decisions than the reports prepared by external auditors, therefore, it is advised that decision makers should rely on these reports.