Minimum Product Pricing

Minimum Product Pricing

The minimum price is charged to cover the following cost.

1. Incremental cost of unit produced
2. Opportunity cost of alternative sacrificed, however ,no opportunity cost is charged where there is spare capacity and no scarcity or resources.

Why Minimum Price Charged

There is no concept of charging the minimum price but this concept is used for the two main reason.

1. Know the Minimum Price

The management would like to know the minimum price of the product so that management would be careful in pricing decisions. 

2. Incremental Profit

Minimum price will help to determine the incremental profit would be obtained from setting a certain price.

Imputed interest in Opportunity Costing

Imputed interest in Opportunity Costing

The interest is charged to the resources tied up in a project. The interest charged is equal to the borrowing cost of the entity.

Example of Imputed Interest

A asset is employed at a project costing 1 million and the interest rate is 18% pa. then an amount of $ 180,000 will be charged as imputed interest to the project.

Opportunity Costing

What is Opportunity Costing

Opportunity cost is the value of benefit sacrificed. In opportunity costing system the cost are charged on the bases of benefit sacrificed and not on the bases of cost actually incurred. The opportunity costing has a great use in decision  making.

When Opportunity Cost is Zero

There are two situation where the opportunity cost will be treated as zero.

1. There is no alternative use of resources.

2. There is no scarcity of resources and therefor there is no question of sacrificing.

What are limitation of Opportunity Costing

1. Not Easy Establish Alternative use

It is not easy to determine the alternative use of resources in many cases.

2. Valuation of Alternate use

The valuation of alternate use of resources is also a very challenging task.

Absorption Costing

What is Absorption Costing

Absorption costing takes into account both the direct cost and indirect cost. The direct cost which are directly attributable to the product such as direct labour , direct material and direct over heads. The indirect cost which are not directly attributable to product. The absorption cost also includes the indirect cost in the cost of product by using an appropriate absorption rate.

Typically the indirect costs are apportioned to product cost using appropriate bases like machine hour or labor hour. The great advantage of using absorption costing it is more justified in term of financial reporting. It takes into account the full production cost and therefore inventories are accurately valued at the end of financial year. These inventories values are shown in the financial statement at full cost.

Limitation of Absorption Costing

1.Selection of appropriate absorption rate

it is very difficult to select appropriate absorption rate for consumption of overhead. The using of machine hour or labor hour rate is just a theoretical solution to the problem however in many cases it has no relevance for consumption of overhead.

2.Limited use for Decision Making

The absorption rate is normally decided on the bases of historical information available and therefore it has little role to play in the decision making. And more importantly it takes into cost which is not relevant in many cases and in decision making we only interest in relevant cost. The irrelevant cost has no role to play in decision making process.

Over and under absorbed overheads

As we know that absorption costing use a pre determined rate for absorption therefore the actual amount of expenditure are different from the estimated expenditure. Where the absorbed expenditure using absorption rate is more than actual expenditure it is called over absorbed overhead and where the absorbed overhead are less than actual expenditure it is called under absorbed.

In case of over absorbed expenditure profit is increased or expense is reduced and in case of under absorbed the profit is reduced or expense is increase

Advantages of ABC

Activity based costing based on the concept that it is activity which generates cost and therefore the cost should be allocated to generating activity. The activity based costing approach developed focusing on the fact that now a days there are many other cost involved in the production process and traditional costing concept of product is not relevant.

The activity based costing reduces the limitation of absorption based costing where the overhead are allocated using unfair bases like machine hour and labor hour which sometimes has no relevance with the cost incurred.

In activity based costing the cost driver are defined .in simple words cost driver is determinant of costs. Sometime more than one cost drivers are defined for one activity but such arrangement is not recommended. One activity one cost driver is the best suitable approach.

Advantages of ABC

Detailed information about activities: -

This costing system develops deep understanding about the cost structure in the organization. The critical activities and cost driver are become clearer to the management.

More realistic allocation of cost:- The second advantages is that under Activity based costing system the costs are allocated more rationally and more appropriately.

Disadvantages

How many activities

This is a difficult question to answer that how many activities would be define to server the process . some organization have a lot of activities and therefore the activity based costing is suitable option in that case.

Cost driver Define

The defining of relevant cost driver is also a difficult task and requires huge experience and deep understanding of the business and industry.

All overhead are not activity based

The other limitation that there are a lot overheads which are not activity based and therefore some kind of allocation bases are used for those overhead.

Not easy to implement

The activity based costing require deep understanding of underlying concept and sometime lower tier management find it a difficult and complex process whereas the absorption costing is simple to understand and easy to implement.

Advantages back flush accounting system

The back flush accounting system the cost is allocated to the product at the end of the production process. This is unlike the traditional system where cost is regularly updated during the production process.

The back flush accounting system is only suitable where there is a short process of production and inventory is very low. The back flush accounting system there is no concept of work in progress.

This system basically is not a system because the cost can not allocated to production it is a more like a achievement reporting system.

Advantages back flush accounting system

No detail and complex accounting is required

The biggest advantage of this method that no complicated process of accounting is required. it is to important to remember that accounting for a production process is not an easy task and it vary from industry to industry and sometime organization to organization. Therefore there is no tailor made solution for production process accounting.

There are only two stages where the accounting record is maintained one is at the time of purchase of inventory and other at the time of completion of production. There two points are also know as trigger points in back flush accounting system.

Information about achievement of goal

This system informs management about the achievement of a production goal set by management. Basically this system is goal achieving reporting system and have little role in product costing.

Limitation of back flush accounting system

Only in few cases

This system can be applied only in few circumstances where the production process is very short and the inventory level is negligible.

Management not in a position to control

This system creates no information for the management to monitor the performance and control the activities. So you can say that this system runs automatically and stop automatically and there is no interference is involved from outside.

Types of Costing Techniques

Types of Costing

Costing is very important aspect of management accounting , in fact management accounting is based on different costing techniques and their further implication at different scenarios. Costing techniques provides a bases for management to perform management function. For example standard costing technique provides a bases for preparing budgets that is basically a controlling tool of organization resources.

Types of Costing

There are variety of costing techniques , however, we have mentioned the some important costing techniques.

1. Standard costing
2. Absorption Costing
3. Marginal Costing
4. Activity based Costing
5. Process Costing
6. Job order Costing
7. Batch Costing

Types of Cost

like costing techniques we use different cost concept in management accounting, we have given some important cost concept.

1. Opportunity cost
2. Relevant cost
3. Sunk Cost
4. Fixed Cost
5. Variable cost
6. Step cost
7. Committed cost