Costing systems involves the classification and appropriate distribution of recorded expenditure which is critically analyzed to arrive at an optimum selling price and establish where saving is possible in production. The technique is instrumental in management as managers can come at a substantial decision that will facilitate the firm's progress, new product development and forecasting. This paper aims at discussing the objectives, principles, differences, types of costing systems, and trends in costing systems.
Objectives of cost accounting
Cost accounting provides the correct examination of cost using different elements of pricing. Secondly, it helps establish wastage in time, machinery and tools. It is instrumental in maximizing the profitability of a product. Besides, the management can plan on proposed future projects. It also acts as a guideline to management in decision making such as the introduction of a new product or using an alternative method of production. Finally, it facilitates internal auditing hence effective departmental management.
General principles of cost accounting
These are guidelines for cost accounting that ensure precision in the determination of cost. Cause-effect relationship: every item of cost should have a relationship with its value as much as possible, and cost should only be shared by units that have gone through the departments and have incurred such expenses. Secondly, charge of cost after it has been incurred: the price of a unit should not be charged in selling cost while the product is still in the factory. Third, principles of double entry should be followed: this facilitates the reducing chances of error hence proper cost control. Also, past cost should not be used to generate future value: the cost which could not be recovered in the past should not be charged in the future. Finally, exclusion of abnormal costs from costs accounting: expenses incurred because of management or employees mistakes should not be charged on the product as it will lead to inappropriate decisions.
Types of cost accounting systems
There are different types of costing systems namely, historical figure, direct costing, average pricing, marginal pricing, uniform pricing and absorption pricing. The historical figure refers to a process of accrual of cost after analytic incurrence overtime. However, it may be too late to correct because it is a postmortem of the past. Direct costing which involves the use of direct and variable expenses incurred in the manufacture of a product. Average pricing it is predetermined before production providing a ground for control through variance accounting.
In marginal pricing, the price tag is rated as fixed or variable, most of the time it is used in internal decision making. Uniform costing it is the application of same pricing principles and techniques by several units of the same industry providing comparisons between firms, therefore, eliminating inefficiency. Absorption costing it is based on charging expense on the product by evaluating the benefit received from the expenditure. Consequently, it is necessary for firms to choose the type of accounting based on the product critically, units produced, and time used (Johnson et al.,1987).
Manufacturing Cost Verses Non-Manufacturing Cost
Manufacturing cost is incurred in goods that are transformed from raw materials to finished product. They include the cost of raw materials, labor, and factory overhead that is necessary to process the good into a finished product. Raw materials and labor are ranked in direct or indirect depending on the end product. Direct materials are the primary apparatus traced in the finished product while direct labor is the exertion applied by factory employees primarily on the completed product.
Cost behavior, for a company to arrive in a suitable decision, it must evaluate the cost manner at different levels using a high-low method which involves the highest production rated with expense at that level and lowest production and its incurrence. Scatter graph method by plotting the latest normal data observation against the activity. The most efficient technique is the least squares regression method, its famous for its statistical strength but its complexity necessitating the use of software packages can be a limitation.
Comparison between traditional costing and activity-based costing.
There exist significant differences between traditional costing and (ABC) system. Costing systems aid in the determination of product cost associated with profits it yields. Traditional costing assigns manufacturing overhead based on the volume of a cost driver for example level of direct manual labor duration required to make an item. A cost driver is a feature that results in an expense. Activity-based costing (ABC) apportion cost of production based on activities needed to produce them. The advantages and disadvantages of traditional costing are: It allies with generally accepted accounting principles (G.A.A.P), these are globally used standards of accounting. It is easy to implement for firms that make one or two products. However, it is an obsolete technique of accounting since most organizations use computerized methods of production hence one cannot use direct labor hours to evaluate cost. It is not possible to supersede since consecutive labor hours are not the superlative price drivers to apply. It also counteracts other cost drivers of an item which are actively involved in costing system. It excludes absolute non-manufacturing cost this result to biased decision making as some factors are not put into consideration (Cooper et al., 1991). Activity-based accounting (ABC) presents precise information on the cost of production yet most companies use it as a supplemental technique. It evaluates every action related to the creation of an item and distributes outlay on the activity. The cost consigned to products that operation of manufacturing (Horngren et al., 2009).
Pros and cons of Activity-Based Accounting (ABC)
Activity-based accounting has a high precision in cost accounting that results in better decisions and proper management of a product by eliminating the extraneous cost to a product. It is easy to interpret the cost of internal management, the facilitate standardization and higher perceptive of overhead cost. Nevertheless, applying an activity-based costing requires significant, this disadvantages a company with constrained funds. It is also highly misinterpreted by some users this results in poor decision making (Berliner et al., 1988). Companies should use activity-based accounting method traditional method since it is more accurate than the traditional technique.
Most companies in Saudi Arabia use the enterprise resource planning (ERP), for example, the JD Edwards uses an integrated business intelligence tool portfolio. The following are the advantages of (ERP). It is instrumental in defining business processes and ensures they are applied in the supply chain. Secondly, it describes roles in the business and security access. It also assists in planning based on the existing orders and forecast. Ensure high customer service ensuring profitability. Finally, it transforms data into information that aids decision making. Unlike the traditional costing which has the following objection. First, the want of necessity it is believed that costing was not applied in the ancient times and companies still prospered without it. Secondly, traditional methods of costing may not be applicable in some firms due to their system of operation. Third, it has failed in many cases hence failing to achieve desired results concluding that the system is defective. The failure may result due to apathy, inadequate facilities, opposition from workers or indifference from management. Also, it degenerates to norms and rulings with time becoming obsolete. Finally, it may be costly to install, and it should be noted that the cost of installation and maintenance should match the profit gained.
Direct costing involves a chain of dealings that amass the expenditure of materials; labor and overhead it is mainly applied in the manufacture of tailored goods; its advantages are: useful for tracking the accurate cost of each product. It yields accurate results for current job hence useful for monitoring purposes. However, it requires a substantial detailed figures entry which is costly. It may also result in inaccurate data which call for expensive control system minimizes the risk. There may be an inappropriately applied job arising from a significant allotment of overhead cost (Atkinson, 1998).
Often process costing is used in situations where differentiating the cost of a unit is difficult for instance in an oil refinery. The favored method for calculating process cost per unit is to amass all associated production cost during accounting phase and calculate a weighted average per unit cost base on the resulting total and amount of production that was completed. The advantage is a fair degree of precision if the mean of the cost is calculated and assigned to each unit. Nonetheless, estimation is made in establishing total production quantities finished. There exists a possibility of deviation of the final product price, and this method requires more of data collection than job pricing, but data exactness's likewise lower (Berliner et al., 1988).
Standard costing it is used an appendage to both job and process costing system. Advantages are; it creates an average for all labor and material cost incurred by a firm hence outstanding control over company accruals. It is instrumental in budgeting, setting price tags and closing financial books in a swift approach. On the other hand, it consumes much time to situate and sustain standards. A firm that uses a continuous process improvement will have the previous standards set as outmoded. In comparison to the actual cost tend to focus on management attention on labor discrepancy that has been mainly used in cost accounting yet, in reality, they only account for a small proportion of the whole production cost. Finally, it brings about inefficiency if one uses present standard value as a benchmark will have had no credential to set a higher standard than the previous. (Kaplan et al.,1986)
Variable costing complied with the (GAAP) and required for internal review service. This is because a firm has to file tax reports and issue financial statements. Secondly, it takes into consideration fixed operating expenses and cost per unit. Therefore, profit evaluation becomes easy. Conversely, it can make a cooperation profit appear better than the actual since the fixed cost is not deducted from revenues, misleading the management and investors. Absorption costing does not show a precise analysis of cost and volume as the variable cost does making it difficult to make operational efficiency. (Kaplan., 1987)
In conclusion, it is necessary for firms to choose a suitable accounting software that will result to an incremental development in saving time, reduce cost increase customer satisfaction give the company an upper hand to their competitors, the management can be able to plan and ensure efficiency.
Alodadi, A., & Benhin, J. (2014). The main determinants of economic growth and the role of non-oil sectors in oil countries economies: The case of Saudi Arabia. International Journal of Business and Tourism and Applied Sciences, 2(2), 1-6.
Atkinson, A. A. (1998). Advanced management accounting. Pearson College Division.
Berliner, C., & Brimson, J. A. (1988). Cost Management for Todays Advanced Manufacturing. Harvard Business School Press, Boston, Massachusetts.
Cooper, R., & Kaplan, R. S. (1991). The design of cost management systems: text, cases, and readings. Prentice Hall.
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