Marginal cost;
In product/service costing, a marginal costing system emphasises the behavioural, rather than the functional, characteristics of costs. The focus is on separating costs into variable elements (where the cost per unit remains the same with total cost varying in proportion to activity) and fixed elements (where the total cost remains the same in each period regardless of the level of activity). Whilst this is not easily achieved with accuracy, and is an oversimplification of reality, marginal costing information can be very useful for short-term planning, control and decision-making, especially in a multi-product business.
A controllable cost
This can define as a cost that is reasonably subject to regulation with whose responsibility that cost is being identified. If this condition does not hold then clearly cost should be classified as non-controllable by manager of the responsibility center. However, such non-controllable cost may be controllable at a higher level of responsibility. The controllable cost can be classified into various important categories of expenses, and that the differences between the budgeted and actual result be emphasized. This difference is called the variance.
A non-controllable cost
There are different cost centre used by the cement company these would include the following;
- Limestone, clay, gypsum, quarry cost center
- Transportation cost centre
- Crushing cost center
- Stock hall storage/ issuage of raw materials
- Raw mill (for mixture/slurry) cost centre
- Kiln cost center
- Grinding (cement) cost center
- Packing and storage
- Air compressing
At stage of my work I’ll be identifying the types of cost associated with each cost center and also there cost behaviour
Quarry (Limestone, clay, gypsum); this department is involved with the raw materials the company needs to produce the cement. The limestone, clay and gypsum are all gotten from the place called quarry.
Under this cost center there is what is called the direct departmental cost and indirect departmental cost. For the direct cost they have the following cost
- Explosive,
- Labour
- Salaries
- Employee’s
- Other benefit
- Indirect materials
- Insurances
- Repair and maintenance
- Fuel oil
- Gas
- Depreciation
- Other overheads
And for the indirect cost they have the
- Power and other overheads.
As I have stated above about controllable and non-controllable cost, this department also has its controllable and non-controllable cost that can be identified.
The controllable cost are the cost that the manager in the department can control which can be; employee’s other benefit, labour cost, other overheads, salaries, gas, compressed air and fuel oil.
The non-controllable cost are cost that be controlled which are; Insurance, royalty and duties, repair and maintenances, depreciation and power.
Transportation;
This department involves the transportation of all the raw materials into where they will be made to a product (cement).
In this department they also have what is called Direct Departmental cost and Indirect departmental cost.
For the direct cost they have
- Transportation cost
- Labour cost
- Salaries
- Employee’s other benefit
- Indirect material
- Insurance
- Repair and maintenance of the vehicles
- Greases for lubrication
- Tyres and tubes
- Depreciation of vehicle
- Other overheads
All these are under the direct cost, and the indirect cost will be
- Compressed air
- Power
- Other vehicle expenses
METHODS OF COSTING
There are different ways of calculating how much a product would cost at different levels. Management accountant use different methods to do this. The method chosen depends on the type of production undertaken in the factory. Some of these costs methods are follows;
Contrast costing
This is system of job costing that is applied to relatively large cost units, which normally take a considerable length of time to complete. Building and construction work, civil engineering and shipbuilding are some examples of industries where large contract work is undertaken, and where contract costing appropriate.
All direct costs of the contract are debited to the specific contract and overheads are apportioned in the manner each contract account therefore becomes a small profit and loss account.
Because of the considerable length of the time that is taken to complete the contract, it is necessary to determine the profit to be attributed to each accounting period. The accountant therefore calculates the direct cost associated with the project. The overhead in this case will be added to the direct cost. This is done by how long the place was used to construct the product.
Process costing
This can be applied to organization that produces many units of the same product during a period. A process costing system is used to compute product cost for mass or flow production system where each sequence of operations is dedicated to a single product. With a system of process costing, the allocation of manufacturing cost to a specific order is unnecessary.
Instead, the cost of a single unit can be obtained by merely dividing the cost of production for a period by the number of unit produced in that period. In other words, the cost of an order is assumed to be the average cost per unit of the entire unit that has been produced during the period multiplied by the number of unit order. This is an ongoing affair. Cost accumulation covers overheads at each stage of the product process.
Job costing
This classification is suited to industries that produce specialized or made-to-order output. Examples of such industries include construction, printing, machinery and shipbuilding. Because each customer’s order is normally unique, average costs per unit of output are not suitable.
A job costing system will give a more accurate calculation of product costs because costs are accumulated for each specific order, but the system is expensive in terms of clerical work involved in attaching direct cost to each specific job
Batch costing
This is a type of job costing where a batch of identical products is treated as an individual job with unit cost found by dividing the total batch cost by the number of units produced.
Standard costing
This is most suitable for organisation whose activities consist of a series of common or repetitive operation. It is used in an environment where methods are similar.
Standard costing procedures can be applied to non- manufacturing activities where the operations are repetitive nature, but it cannot easily be applied to activities of non- repetitive nature, since there is no basis for observing repetitive operation consequently standard cannot be set.
A standard costing system can be applied to organisation that produce many different product, as long as production consist of a series of common operation.
When the management accountants use this method they try to find out the cost for making the product are calculated. The different between the actual and the expected is called the “VARIANCE”.
To help the company use standard costing method the department will first conduct a market research what the price of raw material are, before production.
After the standard cost database has completed or created by the different department, the actual production of the product will commence.
All the following are the methods of costing used but which will be used in the cement industry and the advantages and disadvantages of these methods.
Due to the nature of the organisation (Castle Cement Company) and my research the company uses the process costing methods. However some other cement company will be using both the process and standard costing methods. This is because they make other types of cement like the concrete, white cement and the process of production will therefore be different from other normal cement.
The Castle cement company will be using the process costing method due to the following reasons;
- Cement production is a continuous flow process.
- The production is mass types of production.
- The products made are similar in all regards.
The advantages of process costing can be analyzed in the following ways;
This is an example of how the Management accountant would use the process costing method to find the unit cost of cement (i.e. bag of cement).
Example of how the process costing is calculated in the cement factory.
Process A (Quarry) Process B (Transportation) Process C (Crusher)
Material 1000 from process A 3000 from process B 6500
Labour 1000 Labour 2000 Labour 3000
Overheads 1000 Materials 1000 Materials 2500
Total 3000 Overheads 500 Overheads 1000
Total 6500 Total 13000
Process D (stock hall) process E (Raw mill) Process F (kiln)
From process C 13000 from process D 19200 from process E 25000
Labour 4000 Labour 4000 Labour 2000
Materials 1200 Material 1000 Materials 2500
Overheads 1000 Overheads 800 Overheads 950
Total 19200 Total 25000 Total 30450
Process G (Grinding) Process H (packing and storage) Finished goods
From process F 30450 from process G 34750 Transfer from
Labour 2500 Labour 4500 process H 43450
Material 1000 Material 2700
Overheads 800 Overheads 1500
Total 34750 Totals 43450
No of bags = Cost of production
No of bags
Price per bag of cement = 43450
20,000
= 2.1725
The cost accumulation procedure follows this production flow. Control accounts are established for each process and direct costs and manufacturing overheads are allocated to each process. The procedure for direct and labour being charge to the appropriate process, but a process costing system is easier to operate than a job costing system.
As the production moves from one process to process, cost are transferred with it. The costs of process A are transferred to process B; process B costs are then added to this cost and the resulting total cost is transferred to Process C; Process C costs are then added to this cost. Therefore, the cost becomes cumulative as production proceeds and the addition of the costs from the last department’s costs determine the total cost.
THE NEW EQUIPMENT PURCHASE
The Castle Cement Company is confronted with the option of either buying a new machine for the factory or continues to use the existing old machine, which is use for the production of the cement.
At is stage of my work I’ll briefly describe the three methods available to accountant for appraising an investment that will bring in more revenue for the company.
Castle cement activities involve the use of different types of machinery to make products. Production involves the tear and wear of machine, which means that the machine will depreciate years as it is used. As the machine gets old it becomes expensive to maintain.
Castle Cement therefore needs to keep cost low by buying a new machine.
At this stage the management of the company decides to replace the old machines with a new or continue to use the old one. Buying a new machine for production involves spending money this is therefore called investment.
A company does not just decides to buy a new machines, investment in new machine require a careful evaluation. To help the management accountant make a good decision whether to buy a new machine or not, he needs to use certain methods.
As I have stated above there are three main methods which the accountant has to consider to decision is made;
METHODS OF INVESTMENT
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Payback method; this is one of the simplest and most frequently used methods of capital investment appraisal. It is defined as the length of time that is required for a steam of cash proceeds from an investment to recover the original cash outlay required by the investment. If the steam of cash flow from the investment is constant each year, the payback period can be calculated by dividing the total initial cash outlay by the amount of the expected annual cash proceeds. If the steam is not constant from year to year, the payback period is determined by adding up the cash inflows expected in the successive years until the total is equal to the original outlay.
A payback method easily understood by all levels of management and provides an important summary measure.
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Net Present Value Methods; this is the most straightforward way of determining whether a project yields a return in excess of the alternative equal risk investment traded securities is to calculate the above (MPV). This is the present value of the net cash inflow less the project’s initial investment outlay. If then the rate of return in this project is greater than the return from equivalent risk investment in securities traded in the financial market, the MPV will be positive. Alternatively if the rate of return is lower, the NPV will be negative. A positive NPV therefore indicates that an investment should be accepted while a negative indicates that it should be rejected. A zero NVP calculation indicates that the firm should be indifferent whether the project is accepted or rejected.
The Net Present Value can be calculated by using the following Formula
NPV = FV + FV2 +FV3 + FVn -Io
1+K (1+K) 2 (1+K) 3 (1+K) n
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Internal Rate of Return methods; this is an alternative technique for use in making capital investment decision which also takes into accountant the time value of money. The internal rate of return represents the true interest rate earned on an investment over the course of its economic life. This measure is sometimes referred to as the discounted rate of return. The internal rate of return is that interest rate (K) which, when used to discount all cash flows resulting from an investment, will equate the present value of the cash receipts to the present value of the cash outlays. In order words, it is the discount rate which will cause the net present value of an investment to be zero.
The internal rate of return can be calculated by using the following formula
IO = FV1 + FV2 + FV3 + FVn
I have stated the three main types of method available to accountant for appraising an investment, but I will be identifying the two methods that the cement company will be using for investment.
Projected cash flow table for the investment
The investment requires an initial outlay of £60 000 and is expected to produce annual cash inflow of £20 000 per year for five years, the payback period will be £60 000 divided by £20 000, or three year for five year. If the expected proceeds are not constant from year to year, the payback period is determined by adding up the cash inflow expected in successive years until the total is equal to the original outlay.
Two projects A and B, that requires the same initial outlay of £50 000 but that display different time profile of benefits.
This is the cash flow table of the two-project investment.
Project A (£) (£) Project B (£)
Initial 50 000 50 000
Cash inflow
Year 1 10 000 10 000
Year 2 20 000 10 000
Year 3 20 000 10 000
Year 4 20 000 20 000
Year 5 10 000 30 000
Year 6 - 30 000
Year 7 - 80 000 30 000 140 000
NRV AT 10% 105 500 39 460
Project A pays back its initial investment cost in three years, while project B pay back its initial cost in four years. Project B has a higher NPV and the payback method incorrectly ranks project A in preference to project B. This shows that project B would yield a positive NPV for Castle Cement Company.
The second investment method would be the Net Present Value method. This would help to convert the future of net cash flows into present-day values and the project with the largest NPV is the one preferred.
Project A Project B
Year Discount Net cash Present Value Net cash present value
Factor 10% flows flows
£ £ £ £
0 0 (20,000) (20 000) (20 000) (20 000)
1 0.909 1,000 909 14,000 12,726
2 0.826 2,000 1,652 4,000 3,304
3 0.751 2,000 1,502 4,000 3,004
4 0.683 7,000 4,781 2,000 1,366
5 0.621 20,000 12,420 8,000 4,968
Net Present Value 1,264 5,368
From this calculation above the figures shows that Project A has a NPV of £1,264, while Project B gives the higher value of 5,368. Therefore Project B should be chosen. The present value is called NET because the initial outlay has been deducted from the total of the discounted inflows.
The 5,368 from project B is the present value of the ultimate benefit arising from the project if money is borrowed at 10%. The rate of 10% was selected for the discount factor the cost of capital was that amount, but other criteria may be used to determine the discount factor.
Since both projects have a positive NPV, the Castle Cement factory would be getting on investment of more than 10% but if the projects have shown a negative NPV, the return would be less than 10% and would neither worth undertaking.
Before the company makes there final choice of investment, there are some important factor that should e considered which is called the QUALITATIVE FACTORS.
Qualitative factor can be said to be expressed in monetary terms only with much difficulty or imprecision. In many situation it is difficult to quantify in monetary terms all the important clement of a decision. It is therefore essential that qualitative factor are brought to the attention of management during the decision-making process, as otherwise there may be a danger that component internally may be more expensive than purchasing from an outside suppliers.
Castle Cement needs to consider the following factors to help make decision;
MAKE OR BUY IN A PRODUCT
The Castle Cement Factor is once again confronted with the problem of either making a product themselves or buying it from a supplier.
Decision-making in the Cement factor requires the use of different costing methods
In this chapter I will examine a situation, which can confront any manufacturing plant. It is possible that the Cement Company may be faced with a problem with either making new product themselves or having supplied by other firm.
The management accountant would have to compile some figure to support such a decision making process. Decisions of such nature have to be made carefully because of “costing implication”. Bad decision could cost the company a lot of money, because product in best at lower cost to make profit.
At this level I will need to advise the management accountant of Castle Cement on what decision is best to used for the production of Cement. The management accountant therefore has to come up with some method of calculation which is
Relevant Cost
Definition of payback methods; Collin Drury 4th edition.
