Case Study on Cost Accounting
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Case Study on Cost Accounting
TABLE OF CONTENTS
Title page…………………………………………………………………………...1 Acknowledgement………………………………………………………………2 Abstract… …………………………………………………………………………..3 Introduction………………………………………………………………………..4 Case Study………………………………………………………………………… 14 SWOT Analysis…………………………………………………………………..17 Conclusion…………………………………………………………………………19 Suggestions/Recommendations…………………………………………19 References…………………………………………………………………………20
COST ACCOUNTING INFORMATION SYSTEM
The cost accounting information system (CAIS) is one of the most important information systems in any business. It is the key to management’s assessment of the company's efforts to achieve profit. Since it is so important, the CAIS must be carefully designed and properly maintained.It is an accounting information system which determines the costs of products manufactured or services provided and record these costs in the accounting records Small businesses are the backbone of the American economy. They provide, in the aggregate, most of the jobs for "working America.' They account for 38 percent of all sales, 44 percent of assets, and 55 percent of private sector employment.1 Therefore, it is extremely important that these businesses survive and grow. A properly functioning CAIS is an essential ingredient for survival and growth. It keeps management informed by monitoring and reporting the results of operations, and provides information essential for planning, controlling, and other decisionmaking needs of management. Many small businesses are cash poor, especially in the critical early years. Thus, many small business managers feel they are in a very difficult situation--they cannot afford a "good' CAIS, but they can't afford to be without one. This is especially true of managers of small manufacturing concerns operating on a job-cost basis. The cause of this seeming paradox is management's misconception of what constitutes a "good' CAIS. Cost accounting concepts and techniques usually taught in business courses are presented in the context of large companies. Therefore, even those who have some formal accounting education sometimes experience difficulty in applying these concepts and techniques in a small business context. A good (optimal) CAIS is one that provides management with needed information that is (1) Cost/benefit justifiable; (2) Presented in a form that management can work with; and (3) Available when it is needed. To gain a better understanding of how small businesses can utilize conventional managerial accounting concepts and techniques in designing and implementing an effective Job-Order Cost Accounting Information System, the following case example is presented.
Direct Material: The cost of material that are an integral part of the product. Direct Labor: The cost of labor directlyinvolved in converting material into the product. Factory Overhead: Manufacturing costs other than direct material and direct labor
Cost Accounting System Job Order Cost System: Provides a separate record for the cost of each quality of product that passes through the factory. Process cost system: System in which costs are accumulated for each of the departments of process within the factory.
Functions of Cost Accounting Information System (CAIS) Generally the purposes or functions of cost accounting information system fall into four categories. These include providing information for: 1. 2. 3. 4. External financial statements, Planning and controlling activities or processes, Short term strategic decisions and Long term strategic decisions.
These four functions relate to different audiences, emphasize different types of information, require different reporting intervals and involve different types of decisions. CAIS Technology
Input: The input devices commonly associated with CAIS include: standard personal computers or workstations running applications; scanning devices for standardized data entry; electronic communication devices for electronic data interchange (EDI) and ecommerce. In addition, many financial systems come “Web-enabled” to allow devices to connect to the World Wide Web. Process: Basic processing is achieved through computer systems ranging from individual personal computers to large-scale enterprise servers. However, conceptually, the underlying processing model is still the “double-entry” accounting system initially introduced in the fifteenth century. Output: Output devices used include computer displays, impact and non-impact printers, and electronic communication devices for EDI and e-commerce. The output content may encompass almost any type of financial reports from budgets and tax reports to multinational financial statements.
Development of CAIS The development of a CAIS includes five basic phases: planning, analysis, design, implementation, and support. The time period associated with each of these phases can be as short as a few weeks or as long as several years. 1. Planning—project management objectives and techniques: The first phase of systems development is the planning of the project. This entails determination of the scope and objectives of the project, the definition of project responsibilities, control requirements, project phases, project budgets, and project deliverables. 2. Analysis: The analysis phase is used to both determine and document the cost accounting and business processes used by the organization. Such processes are redesigned to take advantage of best practices or of the operating characteristics of modern system solutions. 3. Design: The design phase takes the conceptual results of the analysis phase and develops detailed, specific designs that can be implemented in subsequent phases. It involves the detailed design of all inputs, processing, storage, and outputs of the proposed accounting system. Inputs may be defined using screen layout tools and application generators. Processing can be shown through the use of flowcharts or business process maps that define the system logic, operations, and work flow. Logical data storage designs are identified by modeling the relationships among the organization’s resources, events, and agents through diagrams. Also, entity relationship diagram (ERD) modeling is used to document large-scale database relationships. Output designs are documented through the use of a variety of reporting tools such as report writers, data extraction tools, query tools, and on-line analytical processing tools. In addition, all aspects of the design phase can be performed with software tool sets provided by specific software manufacturers. 4. Implementation: The implementation phase consists of two primary parts: construction and delivery. Construction includes the selection of hardware, software and vendors for the implementation; building and testing the network communication systems; building and testing the databases; writing and testing the new program modifications; and installing and testing the total system from a technical standpoint. Delivery is the process of conducting final system and user acceptance testing; preparing the conversion plan; installing the production database; training the users; and converting all operations to the new system. 5. Support: The support phase has two objectives. The first is to update and maintain the CAIS. This includes fixing problems and updating the system for business and environmental changes. For example, changes in generally accepted accounting principles (GAAP) or tax laws might necessitate changes to conversion or reference tables used for financial reporting. The second objective of support is to continue development by continuously improving the business through adjustments to the CAIS caused by business and environmental changes. These changes might result in future problems, new opportunities, or management or governmental directives requiring additional system modifications.
What Are the Benefits of a Cost Accounting Information System?
A cost accounting information system offers benefits for many companies. Cost accounting is a type of accounting method concerned with the cost of goods manufactured and/or sold. Many factors are taken into consideration when cost accountants analyze business costs. The information determined by these accountants is used for inventory valuation, financial statements and decision making.
Cost accounting offers the benefit of having an accurate inventory valuation of all inventories on hand. This includes all raw products used to make goods, all work-in-process inventories and all finished goods ready for sale. Cost accountants take all costs into consideration and are able to determine the value of all of these inventories on hand. This information is useful for financial statements and for management of the company. Managers use this information to determine selling goals and production needs.
Cost accounting is beneficial to determine the maximum efficiency production amounts. Cost accountants take all costs into consideration when calculating this amount. Manufacturing costs consist of direct labor, materials and manufacturing overhead. These costs are all calculated and added up to find a per-unit cost price for manufactured items. When the cost price is calculated, these accountants begin determining a hypothesis of production rates. Many times cost accountants determine that if production is increased slightly, overhead costs remain the same. If this is the case, increasing production actually results in a lower per-unit cost for production, and the end result is a higher profit.
The information determined by cost accountants is used for decision making for future company needs. Short-term goals and decisions are made as well as long-term strategic decisions. The analysis of cost information is used to compare projected costs to actual costs. This is useful for businesses when budgets are created. Often times, unforeseen costs occur with production, and they are determined in this way. Unforeseen costs are added into the future budgets at rates calculated by cost accountants. Cost accounting also helps companies establish approximate future cash flows. Short-term production goals and marketing decisions are set based on this information. Long-term production plans are also calculated.
THE COMPANY ZTC Sign Company is a small closely-held corporation with the only stockholders being its two managers. The company employs seven people, including the managers. It manufactures metal, plastic, and painted (wood) signs to specifications and provides contract maintenance services (e.g., keeping signs clean, replacing burned-out bulbs, and keeping electrical wiring in good repair). The company has four departmental functions:
(1)Accounting and administrative services; (2)Plastic and metal signs; (3) Painted signs; and (4)Servicecontract work. The major stockholder and president of the company believed that profit margins were not what they should be and that his pricing policy was the major cause. The pricing decisions were made based on “ball-park' estimates of costs. Management failed to explicitly include any overhead costs. In most instances, estimates of total labor hours expended on a job were used because there was no complete accounting for employees' time. Compounding these problems was the fact that prices often had to be quoted before any work was done. Since the owners had no clear idea of overhead and labor costs, there was no way of knowing whether the quoted prices would cover costs and provide a profit. Thus, the president wanted an accounting system that would provide more complete information on the cost of individual jobs. Due to the "job shop' nature of the production process (producing to specification), a Job-Order CAIS was implemented. THE PLANNING PHASE The following plan of action can be followed as a guide when developing a new CAIS with the aid of a knowledgeable consultant. 1. Discuss the company's strategic and operational business objectives with members of the management team. 2. Analyze the decisions made by management and the decision processes, to identify information needs. 3. Analyze the existing CAIS, noting its strengths and weaknesses in filling management's information needs. 4. Identify the characteristics a well-defined job-order cost system should possess. 5. Based on 1 through 4 above, design a system to fill overall information needs. This step necessarily involves making many cost/benefit evaluations, some of them subjective. 6. Review management's response to the proposed system. Identify possible pitfalls and oversights. Try to involve all management personnel who will be affected by the system. In addition, impress upon management the importance of "selling' the system to employees. 7. Make adjustments as required and test the system through hypothetical job runs and pilot runs on actual data.
These procedures provide the methodology for developing the CAIS and are not different from those usually employed in systems design for larger companies. Moreover, this guide facilitates an efficient and effective design process. DESIGN OF THE SYSTEM During the systems analysis phase (1 through 4 above), management and the consultant determined the old system's shortcomings and how it should be changed to meet management's information needs. The results of this analysis provided a basis for establishing the goals of new system. The established goals of the CAIS were: (1) toproduce technical information to facilitate management's assessment of the cost of jobs, and (2) to accomplish this in an accurate, timely, and cost-effective manner. The CAIS was then designed to accomplish these goals. Small business applications of cost accounting concepts and techniques are often subject to organizational constraints, such as the following: 1. ZTC Sign Company's bookkeeper is also a secretary who prepares work orders and records transactions. She has a limited accounting background and management wants the system to be simple enough for her to maintain while performing her secretarial duties. 2. No one in management has an accounting background. 3. The company employs an independent accountant to prepare its financial statements. This service is quite expensive and thus should be held to a minimum. That is, the system should not require input from the independent accountant. These are typical design constraints for small businesses, which must be considered in the design of a new CAIS. First, however, the old system must be reviewed. Original System In ZTC Sign Company's old system, orders for signs were taken over the phone or in person by the secretary. She prepared a three-copied work order (WO) and entered it in a WO ledger. In addition, the job was posted on a bulletin board so that everyone could see what jobs were in process. One copy of the WO was sent to the appropriate department; the second and third copies were filed in temporarywork order file. In the department, the job was completed and shipped to finished goods (if not a service order). Descriptions and quantities of the materials and supplies used were entered on the WO copy by the person(s) whodid the work. The copy was then sent
back to the secretary who drawa line through the entry in the ledger and removed the job number from the board. Copies 2 and 3 were then retrieved from temporary filing and sent, along with copy number 1, to the president (manager). The president then priced the job based on the cost of materials and estimated labor costs, plus some "arbitrary' mark-up to cover overhead costs and provide a profit. If the job was bid or price-quoted, he simply noted the price and allocated the difference between price and identifiable costs to overhead and profit arbitrarily. These allocations were entered on the WO copies and sent back to the secretary for billing and bookkeeping. Upon receipt of the WOs, the secretary /bookkeeper prepared and mailed an invoice (if a service job) or had the invoice delivered to the customer along the completed sign. She then filed WO copies 1 and2 in a permanent WO file. WO copy 3 was temporarily filed in an accounts receivable file, after which the secretary/bookkeeper recorded the transactions; sale, receivables, materials usage, direct labor, etc. Once payment was received and recorded, copy number 3 of the WO was discarded, completing the process. The analysis of this system indicated a number of weaknesses and deficiencies when compared to what is traditionally taught in cost, managerial, and systems design classes. However, when one considers the relatively high costs and low benefits of many of the more conventionalCAIS designs (especially systems control aspects) in a small business context, the deficiencies are not nearly so glaring. Still, management needed more information; and information is not costfree. Additional costs, mainly in terms of employee time and effort, are usually necessary to improve cost accounting systems. Once an analysis of theold system is made, management must make a subjective cost/benefit assessment and decide how to proceed. The New System The major objective of a job-order cost system is to accumulate costs for each job independently. The customer can then be charged price that will recover the costs of the job and provide a reasonable profit. Theoretically, this would require that all of the costs associated with a specific job be charged to that job. However, this can be almost impossible to achieve. The direct materials and labor employed in the processing of a job are usually fairly easily identified. Still, factory overhead costs (indirect costs) must be allocated. Overhead costs (e.g., depreciation, repairs, maintenance, heating, lighting) cannot be pinpointed for specific jobs. Nevertheless, in order for the costs assigned to jobs to be useful for product pricing, income determination, and inventory valuation, overhead costs must be included.
determination, and inventory valuation, overhead costs must be included. Management must be able to compute the costs of jobs as they are completed rather than having to wait until all actual overhead costs for an accounting period have been determined (usually days after the end of the month). One practical way of applying overhead costs is on a predetermined basis. However, often the overhead rate is not computed on a departmental basis even though actual factory overhead may differ significantly among departments. Rather, one factory overhead rate is computed based on annual projections of factory overhead. This method, although not altogether accurate, can be a cost-effective solution for small manufacturers. The primary concern is that total overhead costs be accounted for in the cost of goods manufactured. Thus, actual overhead costs are accumulated separately, and adjustments are made accordingly to the cost-of-goods-sold account, at the end of each reporting period. (The adjustment of the cost-of-goods-sold account, rather than the use of some of the more theoretically sound methods of adjusting factory overhead, is a widely accepted practice, even in large companies, because of its practicality.) As the firm develops better means of predicting overhead costs and labor hours (the base chosen for applying overhead to products), the system can be adjusted. The new system provides more accurate recordkeeping, which allows management to better assess the costs of jobs in a timely and cost-effective manner. It also aids management in estimating both labor andmaterials costs. Note that the system can be adapted to accommodate growth and change. The new system is depicted in exhibit 1. A sample clock sheet for recording labor costs, a sample materials usage ledger sheet, and a sample job-cost sheet are shown in exhibits 2-4. Clock Sheet. Direct labor costs for a given job are accumulated here. Ideally, employees should "clock-in' and “clock-out.' However, this procedure is not cost/benefit justified for this company. Therefore, the clock sheet is maintained by the employee and submitted weekly. All time worked during a week is accounted for. If time is spent working on something other than a job, then a brief description of the activity is written in the job number column. At the end of the week, administrative personnel compute the total number of hours and costs to be charged to each job and enter the total costs on the job-cost sheet. Space is also made available for the computation of gross earnings. Materials Usage Ledger. This ledger is designed to record all materials used. Ideally, one person should be responsible for dispensing all materials (based on properly authorized requisitions) and maintaining this ledger. However,-this is sometimes not practical. In such cases, each individual must provide the desired information (job number, date, description, and quantity) each time that the
materials are drawn from stock. Administrative personnel can then fill in the “unit cost' and "amount' columns. Job Costs Sheets. This is the basic document for accumulating costs for individual jobs. It is to be completed by office personnel. Information from the clock sheets and materials usage ledger is transferred to this sheet periodically. Until the job is completed, this sheet is maintained in a "work-in-process' file. Upon completion of the job, the direct materials and labor costs can be totaled and the factory overhead computed (using the predetermined rate) to arrive at the total cost of the job. The job cost sheet is then filed in a "finished goods' file. Note that all of the above forms should be pre-numbered for control and reference purposes. Clock sheets and the materials usage ledgers should also be filed appropriately and maintained for a specified period as back-up. The new system more closely monitors the three basic categories of costs involved in the manufacturing of any product: direct labor direct materials overhead. Therefore, increased cost accountability and job-cost control are accomplished. Managers need these data to facilitate the making of many decisions, both routine(e.g., costing, inventory, pricing) and no routine (e.g., discontinuing production of a particular product).3 Under the old system, management was forced to use estimates of total labor hours expended on a job. The revised system, through the use of the clock and job-cost sheets, explicitly gathers this information for each job in a timely manner. The new system also provides management with a basis for charging to each job a portion of total manufacturing overhead costs (accumulated on the job-cost sheet).Moreover, the materials usage ledger allows the tracking of materials usage to departments as well as to jobs. Therefore, inventory valuation and income determination will be more reliable for financial reporting as well as management decision-making. Management's ability to properly price products should be enhanced, using the system's well-established cost basis. Also, costs recorded for past jobs can be used as the basis for making bids and quoting prices before work is done. Another important feature of the new system is its flexibility. The weekly clock sheet, materials usage ledger, job-cost sheet, “work-in-process' file, and "finished goods' file can be very easily modified to accommodate the company as it grows. For example, controlled, punched, time cards may be used rather than clock sheets, and departmentalized overhead rates may be easily incorporated.
CONCLUSION Job-order costing can be a relatively expensive proposition because of the detailed recordkeeping required for each job. The amount of information incorporated into the system will depend upon an assessment that weighs management information needed for decision making against the cost of more detailed recordkeeping. Relatively simple, cost-effective systems can be designed for small businesses. In the case described here, the Cost Accounting Information System was designed with flexibility so that it can be modified to accommodate the needs of a growing business. It was tailored to meet the needs of management for more accurate cost information without imposing undue strain on present personnel. Continuous evaluation of management’s decision-making needs and the effectiveness of the system in satisfying those needs is paramount to the successful operation of any business--especially a small one. Most small businesses can adopt effective cost accounting systems through the application of conventional cost accounting information system concepts and techniques.
, costs of products
, COST ACCOUNTING
, working America
, American economy
Description: The cost accounting information system (CAIS) is one of the most important information systems in any business. It is the key to management’s assessment of the company's efforts to achieve profit. Since it is so important, the CAIS must be carefully designed and properly maintained.It is an accounting information system which determines the costs of products manufactured or services provided and record these costs in the accounting records
Small businesses are the backbone of the American economy. They provide, in the aggregate, most of the jobs for "working America.' They account for 38 percent of all sales, 44 percent of assets, and 55 percent of private sector employment.1 Therefore, it is extremely important that these businesses survive and grow. A properly functioning CAIS is an essential ingredient for survival and growth. It keeps management informed by monitoring and reporting the results of operations, and provides information essential for planning, controlling, and other decision-making needs of management.