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Case study Pedro Nuts! The use of absorption costing has allowed Knock to explain to Pedro the full costing's of the production of his peanut venture and resulted in him estimating a selling price which includes a sufficient margin of profit

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Introduction

Pedro : "Nuts!" PART A In order to build up a selling price of a product, it is important that costs are communicated in the best way possible; this can be easily done by effectively making use of management accountant's role whereby they are able to distinguish what costs are used for a product through cost classification and assigning them to cost objects. Product costs are described by Drury as cost which are "associated with goods purchases or produced for resale", this is shown in the case of Pedro as the manufacturing costs of the peanuts that he is selling. In terms of costs assigned to cost object, it is clear that indirect costing has been used which are described as costs which cannot specifically be involved with a product. According to the extract we can identify that fixed production overheads include the rent of the restaurant, heating and lighting, weekly cleaning and wages of the cook and waitress. In relation to the extract it is clear that Hugh Knock has based his thinking on the costing procedure known as absorption costing. CIMA (2005) has defined Absorption costing as "as cost accounting method which assigns direct costs or a proportionate part of overheads to cost units by use of one or more absorption rate". Within absorption costing there are four techniques which you are required to undertake, these are to identify indirect cost, absorb the indirect costs, once absorbed it is necessary to apportion the costs fairly and then allocate them to the costs of the peanuts to establish a sufficient selling price and stock valuation. ...read more.

Middle

A marginal costing technique which is subsequently useful and not included in absorption costing is the concept of contribution which is sales revenue less variable costs incurred, this acts as basis in identifying the profitability of a product or service. Unlike absorption costing marginal costing values inventory at variable cost and essentially means that unfinished or finish stocks will be accounted for within the calculation this proves to be a limitation as it does not comply with the SSAP9 legislation of stock valuation because of the element of fixed production costs not being absorbed in stock. Also marginal costing can lead to under-pricing at the margin especially if the level of contribution is low. Therefore, although it is clear that Pedro is at currently looking as his peanut venture costs from an old fashioned perspective, it is clear that he still needs to focus his enterprise on absorption costing, however as Pedro stated "I started a plan to gets some more money to go and see Momma or the super reds, Barnsley, Barnsley" , this suggests that Pedro intentions to pursue trading in the nut industry was on a short term profit plan , just to gather funds to go abroad or to attend a football match. Therefore, Knock should have opted to use a marginal costing procedure as it does not include use of an overhead absorption rate and dismisses fixed costs which ultimately would have been easier and quicker for Pedro during his short term decision making process. In terms of whether Knock should be applying those accounting policies and procedures, it is clear that marginal costing would be the best suited option for ...read more.

Conclusion

Tochers four conditions of control as stated by J.Joyce are to state objectives which in the case of Pedro could be to make a short term profit from his new venture, Pedro's ability to measure progress towards the objective would be to weekly break even on his peanut sales, a predictive model that's can be undertaken is to ask Hugh Knock to for assistance in making informed judgements for the business and the ability to take control is to ensure that he seeks Hugh's attention early in his decision making process. To conclude, the statement by Hugh Knock "The sole purpose of accounting is to ensure that all costs have been covered, the business made a profit and that shareholders know about" is incorrect due to his generalised view that there is only one type of accounting, this has resulted in his hypothesis being unbalanced. It is important to understand that there are many different types of accountants within business of which there roles differ in accordance to an organisation. Since management accountants act as internal decision makers within an organisation ultimately they will want to ensure costs are classified and fully covered to allow businesses to operate efficiently, however, it is necessary not to dismiss that it requires information from financial accountants to assist with its key decision. Whereas both management and financial accountants essentially aim for an organisation to make a profit, it is more important for financial accountants to inform shareholders of the financial position of an organisation as they need to ensure whether they will get a return on there investment they opted in after purchasing shares on the stock exchange, these returns are in the form of dividend payments which can be made annually or on a quarterly basis. ...read more.

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