Importance of Accurate Product Costing and Problems with Traditional Costing System

This report discusses the importance of accurate product costing and the problems with traditional costing system used by Beztec. It also covers the computation of cost drivers and profitability of individual products and overall business. The report suggests the adoption of ABC costing system and the disposition of under-concerned or over-concerned overhead.

Management accounting

TABLE OF CONTENTS
Introduction................................................................................................................................4
Task 1.........................................................................................................................................4
Importance of accurate product costing.................................................................................4
Problems relating to traditional costing system used by Beztec............................................5
Task 2.........................................................................................................................................6
Task 3.........................................................................................................................................7
Task 4.........................................................................................................................................8
Task 5.........................................................................................................................................8
Task 6.........................................................................................................................................9
Conclusion................................................................................................................................10
References................................................................................................................................11

TABLE OF FIGURES
Figure 1: Comparison of Traditional and ABC Costing............................................................6

INTRODUCTION
Product costing can be referred to as a procedure of assigning a cost to inventory and
production on the basis of expenses occurred during producing or purchasing a product
(Allain and Laurin, 2018). Costing method plays a significant role for manufacturers as well
as for service entities in order to attain variant such as simplicity and accuracy in information
and it is significantly affected by selected method. The decision taken by the manufacturer
relating to the product depends on the data or results attained from the costing method. In the
present report, the main emphasis is done on the importance of accurate product costing.
Further, problems related to traditional costing system which is used by Beztec is discussed
under the report have been discussed. In addition to this, the cost driver rates are also
computed, which are recognized by ABC costing system. Along with this, a comparison of
the cost, gross profit, and gross profit percentage per unit is measured in order to ascertain the
more appropriate method of costing.
TASK 1
Importance of accurate product costing
The term accuracy can be defined as the efficiency of the company regarding the tracing of
its expenditures by product cost as well as to the inventory values. As per assertions of
Schram, (2015), accurate product costing assessment assist company in enhancing the level
of accuracy of cost computation procedure, particularly in the case of variable costing, which
only allocates product units as the variable costs linked with their production and leaves fixed
costs to other expenditures accounts.
 The correct base for budgets: Further, it will assist in implementing the
corresponding principle, fixing cost to the value they generate during the operations
of the company. Accurate product costing provide an appropriate base for developing
a budget which provides a correct estimation of expenditures and incomes in order to
make a sophisticated prediction for the upcoming fiscal year and this is only possible
of the data is accurate (Dale and Plunkett, 2017). Since if production costs are not
computed accurately than in that case significant errors can take place in the process
of the budgeting. For instance, neglecting a part of product cost at the time of
estimation which is equal to $5 per unit can lead to devaluation of product budget of

$500000 per year if a company produces 100000 units per year. The same can result
in significant profligacy against the budget statistics, generate financial strain.
 Impact on Income Statement: Further, the statement of income relies on an
appropriate estimation of the product cost. The cost of every product which is sold by
the company will be subtracted from the total income earned throughout the financial
year in order to determine net income. On the other hand, if production costs are not
estimated appropriately than the real net income figure will be higher or lower than
the figures which are reported.
 Other considerations: The approach of computing the product differs according to
the type of business. For instance manufacturing company has different approach and
wholesalers have a different approach. Thus, according to Eastman, (2018), accurate
costing leads to taking a correct decision relating to purchasing of product or
manufacturing of the product. For instance, if the product is purchased from the
wholesaler than product cost will be simply characterised by the price which is paid
by the consumer to obtain that product. On the other hand, when the company is
producing goods in-house, then it includes all the costs related to the product.
Problems relating to traditional costing system used by Beztec
 As per the study of Henderson, et al. (2015), traditional costing system uses a
blanket overhead rate for example hour rate; labour rate is utilized for the
allocation of indirect costs that are overhead. They are inappropriate for the
assessment of closing stock, and as accounting information, the same has to be
reported to senior executives. At the same time, it is not valuable as the
decisions have the repercussions over 3 to 5 years. Furthermore, some fixed
costs are variable in the long run. Thus, there is no appropriate bifurcation of
fixed costs and variable costs. Due to this, the senior executives of Beztec are
not able of taking appropriate decisions.
 With accordance to Rothaermel (2015), another main problem associated with
traditional costing system is that it provides inappropriate costing information
which can result into taking of a wrong decision by the senior executives in case
it is utilized for the purpose of controlling, setting up selling prices or sending
citations. Further, assigning of indirect costs does not actually reveal the number
of resources which are consumed by the finished goods (Laudon and Laudon,
2016). Thus, in this case, even though maximum resources are allocated to a

particular product, under traditional costing, it might be apportioned with
limited expenses due to other factors. It leads to incorrect costing which
eventually affects the decision relating to ascertainment of the selling price of
the product.
Figure 1: Comparison of Traditional and ABC Costing
(Source: Securing and Goldbach, 2013)
TASK 2
Table 1: Statement showing the computation of cost drivers for identified activities
Activities
Cost
Driver for
identified
activities
Cost Associated
for identified
activities
Total
Number of
activities
Cost/
Activity
Cost
Associated
for
identified
activities /
Total
Number of
activities
1 Soldering Solder
Points $1,165,725 1,766,250.0
0
$1,165,725
/
1,766,250.
00
0.66
2 Shipment Shipments $1,064,250 22,500.00
$1,064,250
/
22,500.00
47.30

3 Quality
Control Inspection $1,534,500 87,188.00
$1,534,500
/
87,188.00
17.60
4 Purchase
Orders
Purchase
Orders $1,176,120.00 213,840.00
$1,176,120
.00
/
213,840.00
5.50
5 Machine
Power
Machine
Hours $71,280.00 216,000.00
$71,280.00
/
216,000.00
0.33
6 Machine
set up
Machine
setups $928,125.00 33,750.00
$928,125.0
0/
33,750.00
27.50
TASK 3
Table 2: Statement showing the total cost of Lexon and Protox
Particulars Lexon Protox
Direct Material $5491,200.00 $3,854,400.00
Direct Labor $475,200.00 $277,200.00
Machine $3,801,600.00 $475,200.00
Production Overhead
Soldering $879,862.50 $285,862.50
Shipment $862,042.50 $202,207.50
Quality Control $1,112,753.62 $421,746.38
Purchase Orders $495,621.50 $680,498.50
Machine Power $65,340.00 $5,940.00
Machine set up $495,000 $433,125.00
Total Cost of Goods Sold $13,678,620.12 $6,636,179.88
Cost of Goods Sold 24,000.00 6,000.00
Cost of Goods sold per Unit
Total Cost of Goods Sold/ Total Production $569.94 $1106.03
Working note
Table 3: Statement showing Production overhead cost of Lexon
Particulars
Number of
Activity
Cost per
Activity Lexon
Soldering 1333125.00 $0.66
1333125.00*0.6
6 $879862.50
Shipment 18225.00 $47.30 18225.00*47.30 $862042.50

Quality
Control 63225.00 $17.60
63225.00*17.60 $1112753.6
2
Purchase
Orders 90113.00 $5.50
90113.00*5.50
$495621.50
Machine
Power 198000.00 $0.33
198000.00*0.33
$65340.00
Machine set up 18000.00 $27.50 18000.00*27.50 $495000
Table 4: Statement showing Production overhead cost of Protox
Particulars
Number of
Activity Cost/ Activity Protox
Soldering 433125.00 $0.66 433125.00*0.66 $285862.50
Shipment 4275.00 $47.30 4275.00*47.30 $202207.50
Quality Control 23963.00 $17.60 23963.00*17.60 $421746.38
Purchase Orders 123727.00 $5.50 123727.00*5.50 $680498.50
Machine Power 18000.00 $0.33 18000.00*0.33 $5940.00
Machine set up 15750.00 $27.50 15750.00*27.50 $433125.00
TASK 4
Table 5: Statement showing the profitability of individual product and overall business
Particulars Lexon Protox Total
Sales 23,760,000 7,524,000 31,284,000.00
Less: Cost of production 13,678,620.12 6,636,179.88 20,314,800.00
Gross profit 10,081,379.88 887,820.12 10,969,200.00
Less: Selling and Admin expenses 6,996,000 1,613700 860,9700.00
Net Income 3,085,379.88 -725,879.88 2,359,500.00
Units sold 24,000 6,000 30,000
Operating Income per unit sold 128.56 -120.98 $7.58
TASK 5
Smith should agree on the suggestion which is given by Kay to him that the system regarding
allocation of costs should be changed and ABC costing should be adopted from now
onwards. Since the existing system of Beztoc is not able in calculating the overhead costs in
an appropriate manner. Hence the new system will compute overhead cost on the basis of
activity which is more ethical in comparison to the existing traditional system. As per APES
code of ethics which is applied by the professional accountant in order to judge the accounts

in an appropriate manner, in order to assess compliance with essential principles, a proficient
accountant might be obliged to solve the conflicts occurring in the application of fundamental
principles by considering :
 Pertinent data
 Engagement of ethical issues
 Essential principles of issue
 Established in-house process
 Substitute courses of activities
Involving these issues in consideration, accountant must find out the accurate course of
activities, i.e. constant with the fundamental principles recognized (Trevino and Nelson,
2016). Thus, in the present case as Smith, the management accountant is aware of the fact
that due to the application of traditional costing cost relating to a product has not been
allocated in an appropriate manner. Moreover, due to the same, the profit which is being
presented in books of accounts relating to the specific product is incorrect. Section 110 of
APES code of ethics specify that a member should not be associated with reports in case he
knows that the information provided in the accounts is materially false or presenting
misleading statement. Further section 130 requires the accountant to comply with the
provision of professional competence and due care. Further, it is stated by Martinov-Bennie
and Mladenovic (2015), that competent professional service required to apply sound
judgment in order to implement professional knowledge as well as skill in such service. Thus,
in the present case, Smith is required to consider the suggestion provided by Kay by applying
professional competence and due care so that the books of accounts of Beztec could represent
fair information relating to the cost of the product.
TASK 6
Disposition of under-concerned or over-concerned overhead relies on the importance of the
amount engaged in same. If the amount is immaterial, it is clogged to product cost. When
overhead is under-concerned, that is debit balance an inadequate amount of overhead was
applied to the creation, and the closing procedure causes product costs to augment (Martinov-
Bennie and Mladenovic, 2015). On the other hand, over-applied overhead that is credit
balance indicates the fact that overhead which is applied to production is in great extent. So
closing over-applied overheads results in product costs to decrease. Conceptually, under-

applied or over-applied operating cost must be assigned on the basis of the amounts of
applied overhead included in every account rather than on total balances of the report. Dale
and Plunkett (2017), specified that application of total account balance leads to distortion as
they involve direct material and direct labour costs that are not associated with real or applied
overhead. Despite this deformation, utilization of total balances is more common in practice.
Further, the reasons behind the same are given below:
 Firstly, the method is difficult as well as it entails scrutiny of account in detail.
 The second reason is that overhead tends to lose its identity subsequent to leaving
work in procedure inventory. Therefore, making more complex, the valuation of the
amount related to overhead in Finished Goods Inventory and Product Costs report
balances.
Methods to dispose of under assigned or over assigned overhead are discussed below:
 Allocation according to the total value of indirect costs assigned prior to allocation in
the ending balances of work in progress, completed products and product costs.
 Allocation according to total ending balances prior to allocation in work in progress,
completed products and product costs.
 Year-end write off to product costs (Dale and Plunkett, 2017).
 The alteration distribution rate approach that restates entries of each overhead
utilizing real indirect cost rates in spite of budgeted indirect cost rates.
CONCLUSION
It can be concluded from the above study that Beztec should adopt the system of ABC
costing in order to allocate costs in an appropriate manner. Since the costs allocation through
using ABC costing system will be accurate. With the assistance of same Beztec will able to
evaluate its cost of the product in an accurate manner and come to know about the actual
position of the company. Further, it will also assist them in resolving the issues which Beztec
is facing due to existing traditional costing for the allocation of cost. The same lead to
inappropriate decisions taken by senior executives regarding setting up the selling price,
sending quotations and so on. Thus, Beztec must change to ABC costing system for
allocation of cost.

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