Direct and Indirect Production Costs in the Accounting System

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Table of Contents

Introduction
Main Body
Conclusion
References

Introduction

The accounting system of resource allocation am familiar with is activity-based coating. Activity based accounting system is an accounting system that is used in resource allocation to various activities in multinational manufacturing firms and is yet to adopted by small firms. The allocation of total general overhead by this system is allocated based on direct labour hours and machine hours in my organization. The activities of production for the company are allocated the total overhead using calculated overhead rates per hour of machine and labour. Then the figure obtained is multiplied per the number of hours each activity is using. The Labour and machine hours are taken as cost drivers for each activity. This method has assisted the company reduce customer complains of over charging in prices.

Activity-based costing system of accounting considers a number of activities that takes place in various production units. It is considered the best method of allocating overhead within production unit. In my organization direct costs are those costs which are directly and easily costs that are attributable to production and indirect costs are those costs which arise during the existence of the business as whole. Indirect cost can not be attributed to any production unit it is only distributed various production units based on activity-based system.

Main Body

The underlying principles, conventions and objects of this method similar to other methods, but the application of that principle and the methods by which the objects are to be achieved must vary with circumstances. This does not mean, however, that the processes and procedures of a business must remain unaffected by the introduction of a system of cost accounts.

This method of costing influences price because they affects supply. The lower the cost of producing a product relative to the price customers pays for it, the greater the quantity of a product the company is willing to supply. Managers who understand the cost of producing their companies’ products set prices that make the products attractive to customers while maximizing their companies’ operating incomes. In computing the relevant costs for a pricing decision the manager must consider relevant costs in all values.

This method is also used in assessing the performance of manager responsible for running production units independently. The best criteria according to my view are the one without the allocation of indirect costs. This is because of manager should be held responsible for the costs that is under their direct control. They are free to make decisions that could increase or decrease the cost of operation of a unit. The efficiency and effectiveness of a manager should be judged from his ability to generate maximum revenue from operation and to keep the cost associated with this revenue at a minimum level. This will present a clearer picture to evaluate the performance of a manager of a unit. Although each unit produce certain amount of indirect costs but these cannot be directly attributed to the unit from which it had originated. So the company devised a formula of allocating this cost to each unit based on unit’s revenue-producing capability. However as said earlier, there is no set criterion to allocate indirect costs to different units and it varies from business to business. This allocation of indirect costs is discretionary and could create distortion in evaluating the performance of a manager. So in order to help manager accountable for results they are evaluated on the basis of operation under their direct control.

The management pricing strategy will reveals company’s view of customers, competitors and cost profitability as well future success. Competitors selling similar commodity have no control over setting prices and must accept the price determined by a market consisting of many participants. Cost information only helps the company decide on the output level that maximizes its operating income. In less competitive, products are differentiated and all three factors affect prices; the value customers, place on a product and the prices charged for competing products affect demand and the costs of producing and delivering the product influence supply. As competition lessens even more, the key factor affecting decisions is the customers’ willingness to pay, not costs or competitors.

Short pricing decisions are responses to short-run demand and supply conditions, but they cannot form the basis of a long-run relationship with customers. Long-run pricing is strategic decision. A stable price reduces the need for continuous monitoring of suppliers’ prices, improves planning, desired long-run buyer-seller relationships.

Conclusion

In normal circumstances, the pricing strategy has effects on the performance of the company; therefore I will advice other companies to select a price which is above the ABC costing method considering the capital requirement and profitability for the firm. This is because the price that is attached to the product influences the utility value and sacrifice value of the customer. The customer has to sacrifice some monetary benefits that will be a clued on consuming another product which is different from the product in question.

References

Ask, U, Ax, C. and Johnson’s (1996); Cost management in Sweden: from modern to post-modern management accounting.

Drury C; (2000); Management and cost Accounting;5^th edition ,business press Thomson Learning,

Wald J (2000) Biggs’s Cost accounting; The English Language Book Society and MacDonald and Evans Ltd London & Plymouth.

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Direct and Indirect Production Costs in the Accounting System

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