Choosing A Costing System Is Crucial For Effective Financial Management.

Carl Simons sat back in his chair wondering about what he had just done. He accepted a special order from a national supplier of wellness products for 200,000 chocolate bars at a 20 percent discount from the usual price. It is a new type of bar and the company provided the recipe. The company also hinted about a second order for 150,000 bars if the first order was successful. Carl sighed and thought, ‘‘I hope we can make a profit on this order, because we are going to have to increase our capacity big-time to fill it. Wish I knew what the cost will be.’’

Fancy Chocolate (F.C.) is the major product line of Kangaroo Valley Foods, in Berry, NSW. President Carl Simons was burned out by 30 years in the food service industry and decided to sell his business and begin anew. Quite by accident, he received a call asking if his new company Kangaroo Valley Foods would consider selling chocolate bars. Carl’s son Rob was employed by a German company and was frequently flying to Europe and returning with wonderful chocolate as family gifts. Carl wondered how he could produce European-style chocolate (no waxes or preservatives) in Australia. With his son’s help, he found a supplier in Germany who would ship to Australia. Carl purchased a chocolate factory in Berry and began production in August 2005. Tanya Mason, Vice President, oversees the creative arts department and assists Carl in managing the plant. What started with one basic milk chocolate bar has grown to include two milks, two darks, two semi-sweets, one white, one bittersweet, and other adaptations involving various ingredients such as coffee, berries, and fresh mint. The chocolate is wonderful, but the real charm of the product is its custom labelling. For individual snacking, F.C. bars are sold in specialty markets, fine gift stores, and other locations. They are also available for corporate events and celebrations, such as weddings and birthdays.

Now put yourself in Carl Simons’s shoes and think about what type of costing approach will help you determine more accurate products costs for pricing different orders, like the recent big order. In Part A, you will analyse F.C.’s situation, identify its information needs, evaluate the pros and cons of different costing approaches, recommend an approach, and suggest ways to implement it.

Choosing a Costing System

1. What information does F.C. need?

Before recommending a cost system, it is helpful to understand the cost information needs of the company. Conduct some research to explain the value of cost classifications for F.C. and how this may assist Carl in improving their decision-making processes.

2. Which costing approach(es) do you recommend?

Conduct some research into costing techniques that F.C. might find useful.

1. Discuss the pros and cons of the different costing approaches available to F.C., including job order costing, process costing, hybrid costing, and activity-based costing.
2. Based on your analysis of costing approaches, which approach do you recommend F.C. use for direct costs? What about indirect costs? Provide support for your recommendation. Keep in mind it is a small company with limited staff and they do not currently track actual cost information during production. The approach should also be flexible enough to handle high-volume or low-volume months.
3. Discuss how you would handle different types of costs such as special ingredients, stir-ins, or labeling design costs for the new special order from the wellness company. You do not need to state how you would handle each specific ingredient.

3. Using the detail in the case, describe howyour chosen method of calculating product cost will be beneficial within F.C. and have relevance to management.

Product costs Vs period costs

As commented by Chang et al., (2015), cost could be termed as sacrifice of resources in order to gain any specific benefit or other resource. The costs are categorised as follows:

The product costs are those costs apportioned to the production of products and they are realised for financial reporting at the time of sale. Thus, with the help of these costs, Carl would be able to include direct labour, direct materials, factory wages and depreciation. Period costs are those costs through which Fancy Chocolate could be able to track administration and marketing costs to devise budgets accordingly.

Prime costs could be considered as the total of direct costs like direct materials, direct labour and other direct costs (Christ & Burritt, 2015). On the other hand, with the help of conversion costs, FC could be able to obtain an idea of the amount paid to convert raw materials to finished goods.

Fixed costs could be considered as those costs remaining fixed within particular output or sales level. On the other hand, the variable costs are those costs that vary with change in the overall activity level like direct labour and direct materials.

Sunk costs are those costs through which FC could incur or commit the same irreversibly and they could be stated as unrecoverable costs (Cugini & Pilonato, 2013). On the other hand, opportunity costs are those costs arising out of a foregone potential benefit like the cost of going on a picnic is the amount earned during that time.

The various costing approaches that are available to FC along with their pros and cons are discussed as follows:

For both direct and indirect costs, FC could use the activity-based costing system. Even though it has been stated above that activity-based costing system is not suitable for small-sized organisations, since it is expensive to implement. However, it could be stated that in case of small manufacturers, the realisation of direct labour-based plant-wide rate of manufacturing does not depict the individual cost product in an accurate fashion (Sygulla, Götze & Bierer, 2014). In addition, the overall cost-based G&A percentage does not depict the overall administrative effort needed to support any part, customer or both. As a result, the management of FC could assemble a multidisciplinary team for applying the basic ABC concept in developing cost model, which would cost out each part of the organisation accurately.

Special ingredients and stir-ins could be considered as manufacturing costs, which are the significant determinants in the profitability position of an organisation (Tan et al., 2014). These products would be processed into the finished product inventory and their necessity is immense in production. The label design cost could be adjudged as the non-manufacturing costs and this expense play a significant role in the profitability of an organisation and its capability of competing in the market. FC need to keep this cost at a pertinent amount, which would be relative to the profit margin of the organisation and other operational expenditures.

In this case, the activity-based costing system has been chosen to compute the product cost of FC. This is because with the help of this costing system, costs could be traced to the areas like processes, managerial responsibility, departments and customers along with the product costs (Trappey et al., 2013). Along with this, the activity-based costing system is useful in setting the selling prices of products due to the availability of accurate data pertaining to product cost. Furthermore, FC could keep accurate recording of costs and facilitation of cost control by contrasting actual with estimates. Thus, with the help of this costing system, Carl would be able to include direct labour, direct materials, factory wages and depreciation. Period costs are those costs through which Fancy Chocolate could be able to track administration and marketing costs to devise budgets accordingly. Finally, FC could be able to obtain an idea of the amount paid to convert raw materials to finished goods.

References:

Chang, S. H., Chiu, A., Chu, C. L., Wang, T. S., & Hsieh, T. I. (2015). Material Flow Cost Accounting System for Decision Making: The Case of Taiwan SME in the Metal Processing Industry. Asian Journal of Finance & Accounting, 7(1), 117-134.

Christ, K. L., & Burritt, R. L. (2015). Material flow cost accounting: a review and agenda for future research. Journal of Cleaner Production, 108, 1378-1389.

Cugini, A., & Pilonato, S. (2013). The Cost Accounting System in B-to-B Service Companies: Cost Centers or Activity-Based Costing?. GSTF Business Review (GBR), 2(4), 122.

Drury, C. M. (2013). Management and cost accounting. Springer.

Marota, R., Ritchi, H., Khasanah, U., & Abadi, R. F. (2017). Material Flow Cost Accounting Approach for Sustainable Supply Chain Management System. International Journal of Supply Chain Management, 6(2), 33-37.

Rieckhof, R., Bergmann, A., & Guenther, E. (2015). Interrelating material flow cost accounting with management control systems to introduce resource efficiency into strategy. Journal of Cleaner Production, 108, 1262-1278.

Salako, M. A., & Yusuf, S. A. (2016). Cost Accounting: A Pivotal Factor of Entrepreneurial Success.

Sygulla, R., Götze, U., & Bierer, A. (2014). Material flow cost accounting: A tool for designing economically and ecologically sustainable production processes. In Technology and manufacturing process selection (pp. 105-130). Springer London.

Tan, S. S., Geissler, A., Serdén, L., Heurgren, M., Van Ineveld, B. M., Redekop, W. K., & Hakkaart-van Roijen, L. (2014). DRG systems in Europe: variations in cost accounting systems among 12 countries. The European Journal of Public Health, 24(6), 1023-1028.

Trappey, A. J., Yeh, M. F., Wu, S. C. Y., & Kuo, A. Y. (2013, June). ISO14051-based material flow cost accounting system framework for collaborative green manufacturing. In Computer Supported Cooperative Work in Design (CSCWD), 2013 IEEE 17th International Conference on (pp. 639-644). IEEE.