Importance of Accurate Product Costing and Overhead Allocation in Cost Accounting

This article discusses the importance of accurate product costing and overhead allocation in cost accounting. It explains the concept of under or over applied overhead and how to dispose of it. A case study of Beztec Limited is included to illustrate the use of traditional costing and activity-based costing. The article also touches on the ethical considerations of management accountants in providing accurate cost information to the top management of the company.

Cost Accounting 0
Management Accounting

Cost Accounting 1
Question 1
Importance of accurate product costing:
Product costing is an integral function of system of costing. It involves determining of all the
expenses of the business incurred during the production and sales process. Determination of
cost of a particular product is an important function which is usually performed by the
management accountant of the company (Pennanen, Ballard & Haahtela, 2010). To calculate
the overall cost of the product, various techniques of management accounting can be used
such as traditional costing, activity based cost accounting etc. In a manufacturing concern,
product cost information is used by the managers to fix the prices of products produced and
sold by it. The process of price fixation involves adding a certain percentage of profit-margin
to the cost of the production of different items. Also, the accurate cost information also helps
the managers to undertake effective decision making about the business. The managers of
the company can only formulate sound strategies and policies for the effective management
of the business, when they have availability of accurate cost data. Further, the budgetary
function of the business requires the managers to collect all the relevant and correct cost data
from for the estimation of total amount of spending. If in accurate information is used to
prepare the budgets then the management might have to face funds crisis or excessive usage
of funds in unnecessary or unproductive business areas (Hilton & Platt, 2013). Further, the
accuracy of cost information plays vital role in the situation when managers have to
undertake make or buy decisions. Make or buy decisions are those decisions where managers
have to ascertain whether a particular item must be produced or it must be purchased from the
market. For such decisions, contribution margin is required to be calculated. If accurate cost
information is not available with the managers, they might not be able to determine the
correct contribution margin and in such cases it could lead to wrong decision making.
Furthermore, the preparation of income statement also requires the correct calculation of cost

Cost Accounting 2
of goods sold of the business (Kaplan, et, al., 2010). If true cost of production and inventory
items is not available with the business, then the actual profitability of business could not be
ascertained. If incorrect cost information is used by the managers then it could lead to
determination of misleading profitability position of the business. Moreover, cost information
is also helpful in decisions like shutting down of product unit or business unit. If ranking of
multiple projects is undertaken on the basis of contribution margin which has been
determined using inaccurate cost information, then it may lead to incorrect decisions which
could finally result in heavy losses to the business.
Therefore, it is necessary for the management accountants to determine the accurate cost of
the business so as to enable the managers to use correct cost information while making
various decisions (Schulze, Seuring & Ewering, 2012).
Question 2
Overhead Costs Calculations Overhead Rate
Soldering Cost $ 1,165,725.00 $ 0.66
number of solder
points 1766250
Shipment Cost $ 1,064,250.00 $ 47.30
number of shipments 22500
Quality Control $ 1,534,500.00 $ 17.60
number of inspections 87188
Purchase Cost $ 1,176,120.00 $ 5.50
number of orders 213840
Machine Power
Costs $ 71,280.00 $ 0.33
machine-hours 216000
Machine Set up Costs $ 928,125.00 $ 27.50
number of set-ups 33750

Cost Accounting 3
Question 3
Overhead Allocation
Rate Workings Lexon Workings Protox
Soldering Cost 0.66
(1333125*0.
66)
$
879,862.50
(433125*0.
66)
$
285,862.50
Shipment Cost 47.30
(18225*47.3
)
$
862,042.50
(4275*47.3
)
$
202,207.50
Quality Control 17.60
(63225*17.6
)
$
1,112,760.00
(23963*17.
6)
$
421,748.80
Purchase Cost 5.50 (90113*5.5)
$
495,621.50
(123727*5.
5)
$
680,498.50
Machine Power
Costs 0.33
(198000*0.3
3)
$
65,340.00
(18000*0.3
3)
$
5,940.00
Machine Set up
Costs 27.50
(18000*27.5
0)
$
495,000.00
(15750*0.3
3)
$
5,197.50
Total Production
Overheads
$
3,910,626.50
$
1,601,454.80
Question 4
Profitability Analysis:
Sales $ 23,760,000.00 $ 7,524,000.00
Total Cost of Goods
Sold $ 13,678,626.50 $ 6,208,254.80
Gross Profit $ 10,081,373.50 $ 1,315,745.20
Number of units sold 24000 6000
Gross Profit Per unit $ 420.06 $ 219.29
GP % 42% 17%
Workings:
Total Cost of Goods
Sold
Lexon Protox
Direct Material $ 5,491,200.00 $ 3,854,400.00
Direct Labour $ 475,200.00 $ 277,200.00
Machine $ 3,801,600.00 $ 475,200.00
Production Overheads $ 3,910,626.50 $ 1,601,454.80
Total Cost of Goods $ 13,678,626.50 $ 6,208,254.80

Cost Accounting 4
Sold
Sales Lexon Protox
Number of units sold 24000 6000
Selling Price per unit 990 1254
The case study in the present question deals with case of Beztec Limited which is a
manufacturing concern engaged in the business of manufacturing of printers of different
models. The company is presently producing Lexon and Protox model of printers. For the
calculation of overall cost of the business, traditional costing method is being used in Beztec
Limited. The allocation of production related overheads of the business is made by using a
single overhead recovery rate (Hart & Dowell, 2011). The overhead rate is applied to both the
models on the basis of machine hours used in the production of such printers. However, all
the production overheads are not related to the machine hour consumption and hence it is not
feasible to allocate the overhead cost on the basis of a single overhead recovery rate (Sani &
Allahverdizadeh, 2012). The cost per unit as calculated in the present case study of Beztec
Limited is not correctly determined. It could lead to incorrect decision making by the top
management of the company. As the management of the company is using such cost
information to determine as to which printing model is profitable and which is generating the
losses for the business. The results of traditional costing have shown that Lexon Model is
generating lesser profits than Protox Model and top management of the company is of the
view that Lexon must be phased-out of the business. However, before reaching at the final
conclusion as to which product must be phased out, the company must make use of activity
based costing. As the business of Beztec Ltd involves different activities for the production of
printers, the costs related to each activity must be allocated to both the printer models on the
basis of its appropriate cost driver (Ross, 2017). If allocation of different production
overheads of the business is done according to the system of activity based costing, the cost

Cost Accounting 5
allocation will be done appropriately and it will allow the management accountant of the
company to provide accurate cost information to the top management of the company so that
they can undertake correct decision making (Kaplan & Anderson, 2003).
Question 5
From the present case study, it has been observed that Steve Kay, the CEO of Beztec Limited
is earning sizable amount of incentives based on the performance of its both product
divisions. Hence, the CEO is of the view that the company must continue working with the
traditional costing system as it providing favourable results to the top management of the
company. However, Miss Sue Smith has found that traditional costing technique is not
offering the true cost information to the company therefore, activity based costing system
must be adopted by the company. To undertake the feasibility and appropriateness of ABC
technique, management accountant of Beztec Limited has allocated thw production
overheads of the business to both the printing models in the ration of their relevant cost
drivers. The cost allocation on this basic has been proved to be more appropriate due to the
involvement of multiplicity of activities in the production of printing machines (Dale &
Plunkett, 2017). Miss Smith has shown the results of activity based costing method to the
CEO of the company, who in turn, rejected the proposal of Miss Smith by asking him to alter
the results figured out under ABC method because of the fear that there will be a huge
reduction in the bonuses of CEO.
In this case, the management account must now refer to the codes of ethics as prescribed in
APES 110- Code of Ethics for Professional Accountants. This code is meant for all the
individuals who belong to accounting profession and holds the prescribed qualification as
prescribed by the profession. The code requires the accountants to adopt the principles of
integrity, professional competence and skills, objectivity, professional behaviour and

Cost Accounting 6
confidentiality, while performing the professional duties so as to respect the accounting
profession. The profession of accounting has a districting feature of acting in the public
interest. Hence, the management accountant in the current case must not be influenced with
the suggestions of company’s CEO about the alteration of cost results which are calculated
under ABC approach. The management accountant must apply the principle of objectivity by
applying own professional judgement as per the requirements of the situation so as to act in
the interest of the overall company not merely in the favour of company’s CEO. Moreover,
the accountant must apply all his professional knowledge and skills to accurately determine
the true cost of the products in order to avoid negligence towards any of its professional
obligations.
Question 6
In order to understand the concept of disposition of under or over applied overhead, it is
important to understand the meaning of applied overheads. Applied overhead are those
overheads which are determined by applying budgeted overhead recovery rate to the actual
overheads whereas, actual overheads are those overheads which are actually incurred in the
course of production (Andersson, et. al, 2014).
Under-application of overhead is defined as the situation when applied overheads are less
than the actual overheads while overheads are said to be over-applied in the situation when,
applied overheads exceeds the amount of actual overheads.
In both the situations of under-application as well as over-application of overheads, the
balanced overheads have to disposed- off in the following manner:
By adjusting the amount to the cost of goods sold:

Cost Accounting 7
If overheads are under-applied then it means that less amount overheads have been charged to
the products. In such cases, the cost of goods sold account must be debited with the
differential amount of applied overhead and actual overhead. On the other side, in case of
over-application of overheads, the cost of goods sold account must be adjusted by crediting it
with the differential amount of applied overhead and actual overhead.
However, in case when there is a significant difference in the actual overheads and applied
overheads, the disposition off under- applied or over-applied overhead must be done in such a
way that such differential amount must be bifurcated to the three different accounts- work in
progress inventory, finished goods inventory and cost of goods sold. Under this approach, the
closing balances of these accounts will be adjusted for such allocation of differential amount.

Cost Accounting 8
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