Importance of Accurate Product Costing in Management Accounting

Management Accounting Techniques 0
Management Accounting

Management Accounting Techniques 1
Question 1
Accuracy is important to manage the finances of business. The financial results of an entity in
a particular year depict its true financial position when all the results are accurately
determined and analysed. From the perspective of preparation of financial statements as well
as tax filing, the correctness of all the financial information regarding the business is of
utmost importance. In a manufacturing concern, product costing is the function of assigning
cost to each individual product on the basis of quantum consumption of various resources
such as time, materials etc. in the production process of such products. In a trading concern,
product costing is the function of adding cost of value addition to the cost of the product
which is purchased from the market (Hilton & Platt, 2013). In service organisation, services
are the products of such concerns as in these organisations information is being provided
which is collected by conducting various interviews, data searches and analysis, discussions
or consultations and so on. The costing of such organisation is undertaken using the
information related to the consumption of time and other resources in provision of such
services to the ultimate client (Maelah & Ibrahim, 2007). The importance of accurate product
costing can be clearly observed in following particular areas:
 Budget Impact: When all the expenses or costs which are going to be incurred in the
budgeted period are not accurately estimated there are possibilities of the situation
when the company has to lose track from the entire budgeted statement in the course
of carrying out of the actual operations. If the product costs are calculated incorrectly,
there are higher chances of errors in the budgeting process which may result in
excessive spending against the budgeted cost, causing financial strain for the entity.
 Income Statement Preparation: To prepare the income statement, it is necessary to
determine the correct amount of cost of goods sold ((Lambert, Leuz & Verrecchia,
2007). The value of Cost of goods sold can only be determined correctly when the

Management Accounting Techniques 2
firm has accurate information of cost of production. If accurate information regarding
the true cost involved in the production process is not available then correct level of
gross profit of the company cannot be determined.
 Assets and Inventory Valuation: The valuation of inventories held by an entity
depends on the accurate reporting of all the direct costs related to the products dealt
by such entity (Edwards, 2013). If product cost is not calculated correctly, the value
of the inventory will also go incorrect and in such cases overstatement or
understatement of profit will occur in the financial statements. if true profitability
position is not depicted by the financial statements, it may lead to incorrect decision
making by the managers.
 Make or buy decisions: Many a times a firm has to decide as to whether the raw
materials requisite for their manufacturing processes shall be internally manufactured
or to be procured from the market. To undertake such decisions a cost benefit analysis
is undertaken by the management accountants of the firm. This analysis can allow the
managers to reach at the appropriate decision when accurate cost information is used
under the cost benefit analysis.
 Product price fixation: Determining the appropriate selling price of the products
manufactured by the company is quite a necessary process. It requires adding a
desirable profit margin to the total cost involved in the production process of the
manufacturing concern. If accurate information regarding the actual cost incurred in
the manufacturing process is not available with the company, it becomes difficult to
set a reasonable price. In absence of such information, the company may have to face
situations of losses or low profits due to low price fixation of the products (Schmidt,
Nakajima, 2013).

Management Accounting Techniques 3
 Product continuance or discontinuation decisions: Many a times, managers have to
decide on the matters like business expansion or termination of a particular product
line because of resource constraints. In such cases, it is important to determine the
profitability potential of the product unit in order to select the appropriate product unit
for the termination. For such purposes availability of accurate cost information is
necessary.
 In the instant case of Beztec Limited is currently employing traditional costing
method to determine the cost of the printers manufactured by it. As a part of
traditional costing, all the overhead costs are allocated to both the printing machines
models i.e. Lexon and Protox on the basis of overhead recovery rate. The said rate is
applied to the actual machine hours consumed in manufacturing both the types of
printers. However, not all the activities that are involved in the manufacturing process
of Beztec Limited relates to the machine hours. Hence, it is not an appropriate
management accounting practice to allocate all the production related overheads of
the machine on the basis of single overhead recovery rate (Granof & Platt &
Vaysman, 2000). Rather, the company must implement the activity based costing
method for the allocation of different overhead costs to both the product lines. ABC
method will allow the reasonable allocation of production overheads to Lexon
Printers and Protox Printers on the basis of activities that are driving the cost of
respective overheads. Under ABC, the overheads related to the soldering activity will
be allocated to both the printer divisions on the basis of number of soldering points
involved in the activity. Further, the shipment cost will be allocated to both the
printers on the basis of number of shipments undertaken in respect of each division.
The quality cost incurred for the inspection of the product quality will be apportioned
to the products on the basis of number of inspections conducted in respect of each