Financial and Managerial Accounting - Product Costing - Essay Example

Product Costing Name Course Institution Date Abstract The purpose of this paper is to explore the subject of product costing in depth so as to identify ways that it can be used as a meaningful tool in the production process. The paper shall start with a definition of the topic, and then delve into a short history of the evolution of the process. the paper shall then explore the usefulness of the process for companies, define and explain activity based costing, explore the practice of product costing in service operations, define job and process costing and outline the differences between the two and identify areas that they can be applied, identify ways that product costing can be used to enhance customer profitability, and finish with an analysis of activity based management in the production process. Contents Contents 3 Introduction 4 Discussion 4 Evolution of Product Costing 4 Usefulness of Product Costing 6 Activity-Based Costing 7 Product Costing in Service Operations 8 Job and Process Costing 9 Customer Profitability 10 Activity-Based Management 12 Conclusion 12 Recommendations 13 Introduction Product costing is an important component of the accounting process, which is associated with the task of providing managers and other company heads with operational support. As such, product costing is a managerial form of accounting that contributes to the overall results of the accounting process in an organization. The purpose of product costing is to help a company to effectively and accurately determine the true cost of the product and or items that it produces. At times, the unit to be cost accounted may be a service, which is subjected to the same amount of analysis as products. The practice and activity of cost accounting is motivated by the need for the company to obtain an accurate and representative final cost of the items or services under production. This practice should incorporate all of the contributing streams to the manufacturing process so that the pricing of the product or service reflects the true cost of producing the product or offering the service (Smith & Smith, 2000). Product costing may, on the other hand, be motivated by the need for companies to identify the areas in the production process that take up most of the cost so that they can have the chance to rectify these areas and as such, reduce the cost associated with the production of the product or offering the service. This has the benefit of widening the company’s profit margins and reducing the burden of the consumers having to pay more for the products or services in efforts to compensate for the high production costs. This process, therefore, serves to facilitate processes such as redesigning, reengineering, retooling, and repackaging of the product so that it meets the requirements for cost reduction. Discussion Evolution of Product Costing The practice of product costing can be traced back to the times in the 20th century, when the global market was experiencing mass production as a result of industrial revolution. During this time, companies and their managers in the developed countries were seeking ways that they could optimize the production process using traditional methods and practices of accounting. In efforts by these companies to determine the amount of profitability they were incurring, they found it necessary to track the production process in the amount of raw materials they used, the cost of labor they engaged in the production process and the amount of productivity that this labor yielded, the expenses of the tools and equipment that were used, the cost of energy used, and other overhead costs that the companies might have had to incur in the production process (Stark, 2006). They, therefore, put all these costs together to determine the production costs of certain commodities. The major aim of product costing, as earlier identified, is to facilitate appropriate pricing of the various products and services as offered by the companies. In order for these companies to offer effective prices, it would be important that the companies have a distinction in the costs of producing various commodities so that they can offer differential costing that was appropriate to the various products. The costing of composite products, for instance, requires that the company used to manufacture the product. While the parts used in the production of such products may be definite, the operations on each of the components may differ, so that it requires the company to go down and investigate each individual operation in its cost in order to determine the appropriate cost for the product. Some differences in the operations in the various components may include the requirement for more strength or heavier forgings, which might require that the company provides additional machinery to facilitate the work being done. An effective costing process, therefore, would involve accompany to measure the amount of time required in each process of every component, a systematic analysis of the manner in which the product under scrutiny came to be, the inputs that were used in the production of the product, and the operations that were performed on these inputs to facilitate the being of the products. The company would then estimate the cost of these processes and items so that it can produce a final cost for the resultant item or product or service. Of this cost, the company should deduct the amount it makes from the sale of the scrap incurred during the production and manufacturing process, so that it can get the net cost of the production process. From this point, the practice of product costing moved on to include an appropriate percentage of a company’s total overhead as well as measuring and determining the additional costs that it might have to incur in the presentation of the product to the consumer. These additional costs include costs of packaging, warehousing, and the costs of delivering the finished product to the consumer at designated points of sale. Eventually, all these costs were included in the overall cost of production and they were used to determine the pricing of various goods and services. Usefulness of Product Costing The detailed information that is often sought in the process of product costing has made the practice of product costing a routine in companies that are significantly sized. One use of product costing to a company is that it acts as a mechanism of feedback designers. It is through the true cost of the designing and manufacturing of a product that designers are able to determine whether the product met the required specifications as required by the company and determined by the needs of the consumers. The designers then assess this feedback and work to modify and adjust the product or service they designed to meet the required cost so that it can be sold at a given process depending on the market segment that the company might have identified as its target market. Another use of product costing is to enable a company to identify the ideal and most appropriate direction of work flow in the production process. Through product costing, a company is able to identify the ways and areas that take up most of the costs in the production process. With this knowledge, the company can look for ways that it can reduce the costs incurred in these specific areas so that the total production costs can also reduce. This means that the companies will rearrange the various modes of production in ways that will yield the least possible costs. Product costing is also useful in informing and influencing the types and kinds of tools to be purchased. Through the assessment of the ways that the company can reduce the costs of production, it will identify tools and equipment that may help in reducing this cost such as machinery that will be able to perform heavy duty tasks so that the company does not have to increase the number of men working at these tasks, hence cutting on labor costs. Activity-Based Costing The practice of product costing has led to the invention of activity-based costing (ABC). This practice is based and enshrined in the notion that various costs arise in various areas and points in the production process. the paradigm of ABC is based on the principle in production that it is not the products per se that generate the costs that are incurred in the production process, but rather the activities that are involved in the production process. These activities include the planning process, the procuring of the various items and equipment that are used in the manufacture of the products, and the process of producing the products and services under production. It is, therefore, the resources that are required to support these activities that are performed during the course of the business that lead to the costs that are incurred in the production process. According to the ABC principle, the true costs of the products being produced, therefore, must come after an analysis of the extent to which each of the product or service under production makes use of the activities that have been identified above. Products, therefore, consume the activities associated with their production, while the activities involved in the production of these products also consume the costs incurred in the production process. The ABC model is quite effective in capturing the inputs that are required in a number of operations in the production processes, including overhead functions like design and engineering. Product Costing in Service Operations Product costing usually occurs in advance of activities in the production process before the process gets accomplished. The difference between the company making a profit or a loss lies in the effectiveness of its estimation of the cost of producing the product or service. In both the production of products and services, the process of product and or service costing are similar and produce results that are quite similar and related. The pricing of the services will be done upon the subdivision of the work being undertaken in the delivery of the service into many and various categories. The process will then entail that the company measure the amount of time take in the offering of the service, the cost of the materials that are purchased and used in the delivery of the service, and the services that are done in efforts to deliver the intended service. Just like in the production process where some resulting products are rejected for faults and waste is incurred, so is in the services process where time gets wasted, workers experience false starts, and other experiential problems that may impede the service delivery as intended in effectiveness. In both the products and service production processes, it is important that companies identify and are able to quantify overhead costs incurred. These must be accurately applied to the value of the service being offered in the right proportion. A major difference between products and services in the product and service costing process is the fact that services and the process of offering these services cannot be fully duplicated. This means that a company cannot be apply the same precision and expect the same results as it achieved in previous tasks in its endeavors to compare the estimate and actual costs in the service delivery. Job and Process Costing Product costing includes the costing of the job and processes involved in the production of the items or services. The process of job costing includes a detailed process of accumulating the production costs incurred in the manufacture of certain units or groups of units. In the production of a custom-made piece of furniture, for instance, a company may identify all the costs of labor incurred, which would be recorded on a time sheet before it is compiled in the cost sheet for the particular job. Materials and equipment used in the production process such as wood would then be charged into the production job that is then linked to the piece of furniture identified. The combined information from such recording will then be used to determine the price that the customer should pay for the piece of furniture. This information can also be used to the extent to which the company makes profits in the production of the piece of furniture. Process costing, on the other hand, involves the process by the company to accumulate costs for productions that are lengthy and include products and or services that cannot be distinguished from one another. In the production of 1000 gallons for instance, a company would require that all of the oil that is used in the process and all of the labor used in the production of the oil in the refinery is accumulated into a cost account. This cost will then be divided by the number of units of oil that will be produced in order for the company to arrive at the cost per unit of production for the oil (Hansen, 2005). For most companies, such costs are often accumulated at the departmental level, which are tasked with the mandate of calculating the unit cost of such production to determine the price of the units produced. Job costing and process costing, therefore, differ in the manner that they are achieved and realized in the production process in a number of ways. The first difference between the two is in the uniqueness of the resulting product. Job costing is used for products that are unique, while process costing is used for products whose production is standardized so that they are all similar. The other difference is that of the size of the job being undertaken. While job costing is used for tasks that require small production runs, process costing is applied in large production runs. Record keeping differentiates between these two processes in that job costing requires a lot of record keeping, while process costing requires less record keeping because it aggregates the costs incurred in the production process. Lastly, job costing is preferably used for billings to customers as it includes the exact details of the costs that are incurred by particular projects than process costing. A hybrid of these two processes is used in companies that practice mixed production. In such situations, the company may produce certain products or services in large scale hence use process costing, and when the company customizes the produced products into a finer and more detailed product, it uses job costing. The two costing processes can be used in both computerized and or manual environments, making them highly suitable for use in many companies. Customer Profitability In order for a company to thrive, it is important that it identifies and responds to the market needs of the product as presented by consumers in the manner that the product is designed, produced, marketed, and sold to the consumers. Companies, however, fail to determine the profitability of their customers through the products that they offer them, which leads to customers making incorrect decisions and estimations regarding the allocation of the production process, the pricing of the products, the packaging of the products, as well as the marketing and compensation plans. In order to achieve profitability for the customer, it is important that companies bear in mind the following requirements and that they adjust their product costing procedures and processes to meet the following criteria. The first requirement is that the company must make effort to validate its final products to meet the specifications of customers. The company can also use unlimited cost categories so as to capture all of the costs that are incurred in the production process to determine the most effective and appropriate pricing strategy. The company should track all costs of packaging, ingredients, fixed and variable overhead costs, as well as process costs. It should also differentiate between actual and standard costs and automatically calculate the post variances for these costs. Companies must be able to track the cost of the promotional activities they engage in and in the end, ensure that they increase customer satisfaction through accurate and effective invoicing. Because customers require value for their money, it would be important that companies use the product costing process not only to inform them of the most appropriate price for the products, but also to enable them identify the areas that may be incurring the highest costs in the production process. This way, they should address these areas so that they can cut these costs and as such, cut on the prices they attach to these products. Activity-Based Management Activity based management is one of the methodologies that are used in the management of businesses. It is the method by which a company is able to manage its activities related to the production process in efforts to improve the operational excellence of the company in the production process as well as the value that the product manufactured offers its users, who are the company’s consumers. ABM is arrived at by calculating the production costs using the ABC tool, then analyzing the data and devise ways that the company can improve the performance of the business through effective and efficient production. ABM is a strategic tool that companies can use in the production process to make decisions about production or by department heads to enable them manage their portfolio of the products and customers for the business. It can also be used to inform the company of the processes that it needs to improve in order to achieve efficiency for the company. Strategic ABM is important to a company in the manner that it enables the company to make strategic decisions about the addition or retiring of products depending on the profitability of the products to the company (Jackson & Greg, 2006).). In product costing, strategic ABM can be used to inform the company of what procedures need to be improved in order to achieve increased profitability by cutting production costs. Operational ABM can be used in the product costing process to determine what process or procedure needs to be improved for the same purpose of cutting costs in order to achieve higher profitability. Conclusion The process of product costing is faced with a number of problems and factors that hamper the achievement of effective costing. The process of product costing lays too much emphasis on capturing all costs, including those that do not emerge immediately, a need that can be hardly met by the process. The process of determining the cost associated with the production process is quite complex that the costing process falls short in achieving its needs. It is, for instance, quite difficult for one to assign the capital costs of equipment used in the production process to individual units produced. It is also difficult to measure the qualitative aspect of transactions such as the efforts put by the company to develop good relationships with suppliers. The area of warranty is another complex issue to the process of product costing because of the fact that it is handled much later into the product life, when all major calculations on the cost of the product have been made (Baxendale, 2001). The process of product costing is quite costly, and the benefits of the same depend on the use that the results will be put. Recommendations In order for companies to realize the benefits of product costing, it is important that they develop internal mechanisms that will be consistent in capturing and calculating the costs of production for various products at all levels. The benefits of such a strategy are that it will reduce the efforts and time needed to calculate such costs. Another recommendation would be that companies use the results of the costing process effectively in ways that will enable the company increase its profitability. It can achieve this by using the data to inform it of the ways it can improve efficient and cut on costs and waste. This way, it will be able to realize the benefits of the process and increase customer satisfaction. Reference List Baxendale, S. J. (2001). "Activity-based Costing for the Small Business: A Primer." Business Horizons. January. Hansen, D. R. (2005). Management Accounting. Thomson South-Western. Jackson, S., & Greg, J. (2006). Managerial Accounting: A Focus on Decision Making. Thomson South-Western. Smith, R. & Smith, J. (2000) Entrepreneurial Finance. John Wiley, 2000. Stark, J. (2006). A Few Words About Activity Based Costing. http://www.johnstark.com/fwabc.html. Read More