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ACCT5000 Evaluation of the Formal Product Costing Method Of Busu Pvt Ltd Assignment Answer

You are employed by a Business Consultancy firm providing financial advice to clients. One of the firm’s largest clients is the Business Development Assistance (BDA) section of the Department of Foreign Affairs and Trade. The primary objective of BDA is to manage overseas aid projects on behalf of the Australian government.

You have been tasked with a specific project based in Papua New Guinea (PNG) and you have to provide an initial report to the manager of BDA based on the information below:

BUSU PTY LTD

Busu PTY LTD (Busu) was started by Neil ‘Red’ Williams and Jack Soso in the town of Goroka in the Eastern Highlands Province of Papua New Guinea. Red as he was popularly called by the locals, went to PNG as a Patrol Officer for the Australian government in the 1960s. Jack is a local ‘Big Man’ (usually a traditional chief of the land) in the Eastern Highlands region. The friendship between Red and Jack led to some small business ventures (coffee-buying ) that eventually became successful during times of good coffee prices. 

Buoyed by these initial successes, Busu ventured into other areas of commerce and started the following:

Busu Coffee Factory – buying and processing coffee cherry into green bean (unroasted coffee bean) for sale to coffee exporters

ABOL Electrical – electrical contracting services and sale of electrical components 

Goroka Wreckers – automotive parts and vehicle repairs

Busu Motors – Mazda vehicle dealership, vehicle servicing, and retail fuel stations

Markham Poultry – chicken farm supplying frozen chickens for supermarkets

Goroka Butchers – retail meat supply for Goroka township

‘Accounting records’ consisted of a multi-column cashbook and a notebook containing narratives of non-cash transactions. Having a healthy balance in the bank account was an indication of ‘good’ performance, and during tougher times, very low-interest government-backed loans were easily accessible via the many development banks that were set up to encourage local businesses during that era.

In your review of the information on Busu you have identified two issues that require urgent attention. 

Issue 1:

The financial records have previously been managed by Red Williams who does not have much of record-keeping skills, let alone an accounting background. As such whatever records that were kept were not always complete or timely. 

Red and Jack have no clear idea of what it cost to produce most of the items sold in their various businesses beyond the purchase cost of raw materials. As the growth happened in the ‘good’ times, there was always money in the bank to meet most commitments and finance new projects. 

Red have always been of the opinion that “what has worked, will continue to work, and if something is not broken, why fix it?”  Besides, he was already far too busy to bother with ‘what it cost’ to produce an item or provide a service, so long as it was doing well (indicated by money in the bank). 

He also felt that the same financial reports that were prepared by an external accounting firm for the shareholders and banks should be “more than sufficient”, since they were paying so much money for their preparation, and audit.

In your report to the manager at BDA

  1. Explain why it is so important for a business to have a formal product costing system, and to be able to determine how much it costs to produce a product (you are not required to detail a specific product-costing system but need to provide practical benefits of knowing the cost to produce goods and services). 
  2. Explain why reports prepared by external accountants for shareholders and banks (i.e. financial accounting reports) cannot provide the critical information needed to enable  informed decision-making by a firm’s management team for the future of the business, and why management accounting information is more appropriate for that purpose.

Issue 2:

In the past, decisions regarding new ventures and new products and services have been based on whatever Red and Jack fancied. You are concerned that this approach to decision making, coupled with insufficient understanding of the relationship between business activities and the cost of those activities (cost behaviour) may result in financial ruin.

In your report to your manager at BDA:

  1. Provide an explanation of the benefits arising from having a good understanding of how costs behave, and briefly explain two (2) commonly-used methods to derive a cost function
  2. Discuss in general, the typical difficulties that are encountered in the process of gathering information for meaningful and useful analysis.

You are required to focus your responses on the businesses in this case (or similar types of businesses). Remember that the report is meant to assist Red and Jack to run their businesses in a more informed and profitable manner. 

You must not just provide a textbook summary of the theory and principles. 

You must read the Report Guidelines available on blackboard prior to writing up your report. There are strict requirements as regards page limits, formatting, and layout. 

It is also very important that you be familiar with the Report Marking Guide to ensure you have addressed the necessary components that will award marks for this assessment.

Answer

Introduction 

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. 

Issue 1

(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.

Issue 2

(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:

CostNatureAmount $
Depreciation on processorFixed1,000 per annum
Direct materialVariable 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:

  1. 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.
  2. 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.

Recommendation/ Conclusion 

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. 

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