Selecting a Costing Method

Introduction
The selection of a cost accounting method is a crucial step in managing company finances. The business type often dictates this choice. In this assignment you consider three methods of cost accounting and evaluate which is best for the company described.
Scenario
Imagine that the CIO of Cool Air Inc., a ceiling fan company where you have recently been hired as an accountant, has asked you to recommend and justify an appropriate cost accounting system. This is an important opportunity for you. You recognize that the CIO knows the best method but wants to test your understanding of cost accounting and how you articulate your ideas and positions.
Company Background
There are several specific steps to assembling a ceiling fan (this company produces several models) that require machinery, labor, and support from multiple departments. Activities include:
Components:
Blades.
Motor.
Remote control.
Fan housing.
Power switch.
Departments include:
Production scheduling.
Materials receiving.
Research and development.
Machine maintenance.
Product design.
Parts administration.
Final product inspection.
Materials handling.

The CIO identifies three cost accounting method possibilities that you should consider: Activity-based costing (ABC), job costing, and process costing.

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Instructions
Write a 3–4 page recommendation to the CIO justifying the costing system that is most appropriate for the company described in the scenario above. Your recommendation should do the following:

Compare the three costing systems in a way that highlights differences in how they would impact the company’s operations and finances.

Justify your choice of an appropriate costing system for the company that includes an explanation of the criteria that you considered and clear evidence of why it is chosen over the other methods.

Identify then analyze the most significant impact of implementing your costing system choice on company finances.

Analyze the most significant impact of implementing your costing system choice on company operations.

The specific course learning outcome associated with this assignment is:
Justify the choice of a cost accounting system for a business.

 

Sample Answer

 

Selecting a Costing Method for Cool Air Inc.

Cost accounting is an approach to the managerial accounting process that reports and analyzes the costs of producing goods or offering a service1. The cost accounting process entails an assessment of fixed and variable costs. Cost accounting is a critical process in any business organization since the process informs management decisions around strategic planning, cost efficiency, and cost controlling. Most importantly, cost accounting forms the foundation for price determination consideration around the products and services. Cool Air Inc. is a ceiling fan manufacturing company. The paper will analyze the most appropriate cost accounting method for Cool Air.

Comparing Cost Accounting Methods

The section compares three cost accounting methods and then evaluates how each method would impact the operations and finances of Cool Air. The three selected cost accounting methods are activity-based costing, job costing, and process costing.

Activity-based costing

Activity-based costing (ABC) is an approach to costing whereby the various activities in the organization are identified, and costs are allocated to each of the identified activities based on their actual consumption2. Within a business organization, activity refers to any task, unit of work, or event carried out to achieve a specific purpose. ABC allows for classifying various costs into fixed costs, overhead costs, and variable costs. This classification of costs is essential in pinpointing cost drivers, which are the activities that precipitate an increase in expenses.

Implementing ABC will impact Cool Air’s operations and finances. Firstly, ABC will offer a highly accurate approach for the company to determine the product or service costs. Such information will help make precise pricing decisions for the ceiling fans the company makes3. Secondly, using ABC will allow the company to trace indirect costs to specific activities. This will enhance overall managerial accounting regarding costing for utilities, salaries, and depreciation. Thirdly, applying ABC will make it easier for Cool Air to assess product profitability. ABC ensures that the organization can closely monitor all operations, especially the production activities. Furthermore, ABC allows for the assessment of the efficiency of production processes.

Job costing

Job costing is an accounting methodology that tracks the costs of specific jobs and projects. Job costing evaluates the accumulated expenses for a particular product or service job in the organization4. Cost accounting requires direct expenses such as materials and labor associated with each position. Afterward, overhead costs are assigned to the job. Therefore, job costs are usually classified into materials, labor, and overhead. The main feature of job costing is that the cost of each job is assessed separately without consideration for processes. Job costing allows for the computation of the profit or loss from each position. Therefore, job costing is especially appropriate for situations where the work in an organization comprises contract jobs or separate projects.

Applying the job costing method will allow the company to make accurate financial assessments of the profitability of each job. The technique makes it easy to identify unprofitable positions and eliminate or halt those jobs to save on expenses. Job costing will offer an accurate picture of the costs of materials, labor, and overheads to allow the company to make correct pricing decisions for jobs and projects4. Job costing impacts operations by making it easy to understand the control the costs associated with each job.

Process costing

Process costing is an accounting method applied when an organization undertakes mass production of products that share similarities5. In such a situation, the costs of a specific unit of output or producing a product unit are assumed to be the same for each unit. When doing process costing, costs are accumulated within a given period for a given production process, summarized then assigned to all the units produced within that period. Therefore, unlike job costing, process costing does not track the cost of individual items across production.

Applying process costing will impact the company’s finances by improving the ability to determine the costs of each production process6. This benefit enhances decision-making around pricing. Process costing makes it easy to decide on the average costs of homogenous products. Applying process costing improves operations by better understanding costs across the production processes. As such, processes can be modified to minimize expenses. Furthermore, understanding costs provides flexibility across operations since the cost information can be applied to add or remove processes.

Choice of Costing Method

The most appropriate method to apply at Cool Air is ABC. The main factors considered when selecting this method include the type of activities or tasks in production and the nature of the products. Process costing is the most appropriate accounting method for Cool Air. Process costing is suitable for Cool Air since the outputs are repetitive processes5. In this case, ceiling fans are produced from repetitive assembling processes. Secondly, process costing is ideal for Cool Air because the company makes similar or identical items. Process costing is appropriate because it will allow for estimating costs accumulated by the various departments. Process costing was selected over ABC and job costing because it will be more effective for Cool Air to capture the expenses across each process of producing the ceiling fans.

Impact of Process Costing on Cool Air Finances

Process costing will positively impact the finances of Cool Air since the method will allow for more accurate computations of average costs due to the similarities in the ceiling fans produced by the company. Process costing will improve the capacity of Cool Air to determine the average costs of producing unit ceiling fans. Such information will inform managerial decisions on the pricing of the fans to increase the profitability of the company7. The method will enable Cool Air to accurately determine costs for each process to guide the decision on improving process efficiency to save costs and increase profitability. Furthermore, process costing will enhance the ability of Cool Air to determine periodic changes to costs.

Impact of Process Costing on Operations of Cool Air

The application of process costing will allow Cool Air to achieve greater inventory control. Process costing will enable the company to have more accurate tracking of production output for different models of ceiling fans which will inventory management processes7. The process costing method will impact operations at Cool Air by encouraging the company to streamline production processes to enhance the precision of costing8. Process costing will improve operations by better understanding costs across functions. Therefore, management can make informed decisions to alter processes to minimize costs and wastage.

Sources

  1. Bhavana. 2022. Cost accounting. Cleartax. Available at: https://cleartax.in/g/terms/cost-accounting
  2. Will Kenton. 2022. Activity-based costing (ABC). Investopedia. Available at: https://www.investopedia.com/terms/a/abc.asp
  3. Al Hanini, E.A. 2018. The impact of adopting Activity-Based Costing (ABC) on decreasing cost and maximizing profitability in industrial companies listed in Amman Stock Exchange. Academy of Accounting and Financial Studies Journal22(5), pp.1-8.
  4. Joseph Clancey. 2021. Job costing defined: A complete guide. Oracle NetSuite. Available at: https://www.netsuite.com/portal/resource/articles/accounting/job-costing.shtml
  5. ACCA. 2020. Process costing. ACCA Global. https://www.accaglobal.com/ie/en/student/exam-support-resources/fundamentals-exams-study-resources/f2/technical-articles/process-costing.html
  6. Chron. 2020. What are the advantages and disadvantages of process costing? Houston Chronicle. Available at: https://smallbusiness.chron.com/advantages-disadvantages-process-costing-4098.html
  7. Joseph Clancey. 2021. Process costing: What it is and why it’s important. Oracle NetSuite. Available at: https://www.netsuite.com/portal/resource/articles/accounting/process-costing.shtml
  8. Elie Ngandu. 2018. An Analysis of Costing Systems. Available at: https://spark.parkland.edu/cgi/viewcontent.cgi?article=1244&context=ah

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