Role of Cost Accounting for Big and Small Businesses: Analytical Essay

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Role of Cost Accounting for Big and Small Businesses: Analytical Essay

1.0 Introduction

Cost accounting is an accounting method that gain control a company’s costs of production by assessing the input costs of each process of producing the products and fixed cost as well, such as the depreciation of equipment, insurance and interest expense. First of all, cost accounting measures and records all costs individually, then it compares input results or actual results to help company’s management in measuring their financial performance. From this process costing accounting can help the company to make decisions and resolve operational problems.

The cost accounting system is the framework which the firms used to estimate the cost of products for profitability analysis, inventory valuation and cost control. The reports of a costing system are provided to the internal user such as the chief executive officer and different levels of manager. Because of its use, the reports of costing do not need a specific standard like GAAP, so that the costing system has different types to estimate the cost, it can be various in different companies or different departments, which type is used depends on the company’s decision.

According to the function of the cost accounting system, firstly it has two main types of cost accounting systems, which are job order costing and process costing. Job order costing is used to accumulate manufacturing costs for each job individual, and the process costing is used to accumulate manufacturing costs for each process individually. Secondly, the other types of costing system based on cost allocation, so that it has another two types of costing system, which are the traditional costing system or the activity-based costing system. For the traditional costing system, the function of it is using a single overhead rate and applying it to each job or in each department and it often is said to be a volume-based costing system. And another is Activity-based costing, which involves the calculation of activity rate and application of overhead costs to products based on their respective activity usages, considering the fixed manufactured overhead relate to the products as well. At last, the cost accounting system has two variances for analyzing the company’s operations, which are various costing and absorption costing. Variable costing can allocate the variable manufacturing overheads to inventories, and absorption costing usually can allocate both variable and fixed manufacturing overheads to products. So that variable costing is used to calculate the contribution margin, and absorption costing is used to calculate the gross profit.

2.0 Business Background

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In order to easily understand the process of cost accounting, and how the firms’ accountants use the costing systems to estimate the cost of products, we found a business which is food and beverage business named 1 Malaysia Cafe and Restaurant.

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We did an interview through Whatsapp Video Call and created a group with the owner of the restaurant. The restaurant is located in Sarikei, Sarawak which is roughly 357 kilometres from Kuching. The owner is a 29 years old mixed race women name Nurziana Binti Zulmadia also known as Anna George. The restaurant has been operated for 10 years and they serve Sarawak Local Cuisine. Moreover, they also provide event catering at an affordable price. Their main dish is Mee Udang Galah Sepit Biru. For further information, they can be contact by email, 1msiacafesarikei@gmail.com.

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3.0 Costing system currently used

For the business, the owner is using activity-based costing. The costing system used can be treated as more feasible as the price per menu is assigned not only based on the raw materials involved, but also the overhead incurred during the process. The cost incurred for the menu such as raw materials where for this restaurant their main dish is Mee Udang Galah Sepit, labor costs including the cooks, kitchen helpers, waiters and waitresses along with the rental of their premise as overhead cost is taken into consideration when assigning the price of individual menu item. According to Investopedia, activity based costing also known as ABC is an accounting process that recognise and assigns costs to overhead activities and then assigns those costs to products. An activity-based costing (ABC) system recognizes the relationship between costs, manufactured products and overhead activities. Through this connection, it assigns indirect costs to products less randomly than the traditional methods. They used the same costing system in the past and they didn’t change until now. It is good for operating business, which will be easier to compare two different periods costing result.

4.0 Materials and Labor Involved

For food and beverage business, they have many raw materials for food making process. The owner focus more on their most famous Mee Udang so in the owner’s business, their main dish is Mee Udang Galah Sepit Biru. For the dish of Mee Udang, the highest cost is the cost of raw materials which is lobsters used in the dish. For the lobsters, the owner got the supplies from local wholesaler instead of importing from another country. The reason why the owner is doing so is because she believes that local ingredients are cheaper and can have quality as equal as the imported ingredients. The purpose of doing so is also to ensure that the restaurant can get fresh lobsters daily for their dish. Other raw materials for the dish which consist of the noodles that make up big part of the ingredients list is also acquired from local producer which is daily homemade.

On the other hand, for the direct labor, they have the costs of the salaries for cooks, kitchen helpers, waitresses and waiters. For the manufacturing overhead they also have labor cost of salaries for the cashiers, managers and administration. The fixed cost involved such as rental is also taken into account. Although they operated a small business, but they still have the complete management system, and it can support they for a long time.

5.0 Method used to identify and report the production cost

In operating the restaurant, the owner told us that several main activities for producing process are grouped. The main operating activities such as cleaning, preparation, cooking, administrating and serving customers made up the groups. These groups of activities make it clearer for us that ABC costing system is applicable for this restaurant. We report the costing method according to these groups of activities to comply with ABC costing system. The application of ABC to a restaurant involved the assignment of overhead costs into homogeneous cost pools. An example of a first stage cost driver is the number of hours worked by the employees. Three separate cost pools were created–labor, direct operating supplies, and facility sustaining. The next step of an ABC process involved cost drivers by dividing the total costs of each activity center into activity cost driver pools including three stages which are unit-based, batch-related and facility sustaining. The number of employee hours and units of utilities used are examples of unit-based cost driver. Things produced in batches such as purchasing raw materials or ingredients is example of batch cost driver while facility sustaining cost driver category contains costs that sustain the business general processes such as accounting and marketing. According to ABC theory, each of the activity cost driver pools has its cost assigned to products using a second stage cost driver that is unique to each cost pool. A cost driver pool is distributed to products based on the number of cost driver units it consumes. The overhead cost applied to the product is calculated by multiplying the number of cost driver units with the cost pool rates established during the first stage of an ABC process. Finally, ABC costs that were calculated for each entree is incorporated to the price of menu.

6.0 The benefit of using the costing system in allocating the cost

Since the business is using the activity-based costing system, it allows the owner to trace undistributed operating expenses to individual menu items when the product price of an individual menu item are established where usually very little attention is ordinarily paid to undistributed operating expenses during the establishment of the price. This allow the business to maximize their profit in the highly competitive market where the proper pricing measures is critically important as the profit margin diminished.

Secondly, the activity-based costing system examines all major production activities and allows for the identification and reduction of activities that cost more than the business add in value. As an example, the activities that can be either eliminated or conducted more efficiently by the employees. This costing system really help the owner to reduce organizational waste and in eliminating service delays for the guest since achieving the customer’s satisfaction is 1 Malaysia Cafe priority.

Lastly, by using the activity-based costing system, the owner said that the accounting and marketing functions can cooperatively applied in determining the menu prices at the point where total profits are maximized as well as value is created for customers. This means that the activity-based costing system contributes in the decision-making of price that would have a significant impact to their cafe to compete in the highly competitive restaurant industry.

The owner of 1 Malaysia Cafe is glad to consistently using the activity-based costing system in their business since it helps them a lot in determining the menu prices while maximizing the profit of the business in the same time.

7.0 Limitation of current costing system

Despite all the benefit gained from the activity-based costing system, there are still limitations when using the costing system faced by 1 Malaysia Cafe since the activity-based costing is actually not a common costing system in the restaurant industry. In using the activity-based costing system, all activities should be detailed including the value-added and the non-value added. But the owner said that in their business, non-value added activities such as receiving, storing and moving goods and waiting for process are usually ignored which is not a good practice since most of the non-value added activities are also consuming the resources. Supposedly their business should carefully examined such activities in order to minimize cost of their restaurant.

8.0 Challenges and difficulties

Apparently, the business does find a lot of challenges in allocating the cost. The most obvious that she mentioned was some cost are difficult to estimate. The owner had problem in estimating the food and beverage cost when it was first operated such as portioning. For example, their famous Mee Udang has a lot of ingredient and what they did was they had to measure all the ingredients that is needed to satisfy the customer needs. It was a try and error process and it also must consider the pricing too since customers notice pricing more than portioning.

The second challenge that the owner faced is difficult to estimate the cost. The owners had to determine how to allocate individual costs. With modern computer systems, it is usually possible to track evert cost down to the gram of sugar or salt. But, the cost involved with this level of tracking often outweighs the benefit. Either it should be included in their food and beverage cost because the amount of using it just less such as for making their famous Mee Udang. They should consider the information as costless or not.

The third challenge that they are facing is time. We know that tracing and assigning costs efficiently could be crucial. As for this case, the tracing of the costs varies everyday according to the amount of customers that come to their restaurant. As you know, the restaurant hired an accountant to trace all the costs and yet the accountant spends countless of hours attempting to track every cost of the restaurant. So what the accountant do is to allocate the assigning costs to a cost object rather than trace them to their beginning costs. Which bring to them making a guess when accuracy would be impossible without spending a lot of time on studying the cost object relationship.

9.0 Problems in managing the team

Currently, the amount of people they work are not big which consists of three waitresses, two waiters, one cashier and one cook with few helpers. There is at one point that that they have problems such as their previous cook quit the job because she had to take care of her children but thankfully they managed to find new cook as the demand for the job is high. The restaurant accepts part time workers because the demand of it is high such as the waiters and waitresses. They are not permanent because they are usually high school graduates and waiting to enrol in universities. So far, there is no big problems in managing the team as everything runs smoothly. They are not stubborn but sometimes they come to the restaurant late but it is still okay as some of them live quite far from the restaurant. The owner told that they are very keen when it comes to workers welfare because they believe that without them, the restaurant cannot runs smoothly.

10.0 Cost-cutting Strategies

It appears that the owner of the restaurant did a cost-cutting strategies. What they did was to trim their food waste. Lately, they see a lot of food waste which give an impact to the environment which lead to produce a big amount of methane. Cutting the cost starts in the kitchen. The owner of the restaurant provided their cook a prep list which usually just a list of food items and needed quantities for particular day of the week. The prep list is created in Excel by the cook and the owner of the restaurant. Without the prep list, the cooks tend to over prepare which results in food waste.

Another cost-cutting strategy they did is to use local ingredients. Most of the restaurants use import ingredients which is much more expensive. The owner of the restaurant said that the prefer to use local products and ingredients because it much more cheaper compared to imported. The quality of the ingredients usually the same so it is better for them to use local ingredients. Moreover, they are boosting the local economy and it gives a big impact to the local to give more confidence that their local ingredients are on par with the imported ingredients. They owner has their own ingredients supplier which they sell their local ingredients at wholesale prices.

11.0 Ways to improve a regular accounting process

One of the co-founder of the restaurant said that they need to use the right tools to make the accounting process easy such as the accounting software products that can be used to specify all the expenses and profits that they receive. They can go to courses to learn how to use the software or ask for their accountant to teach them how. They believe that for food sales is to keep track of the amount of money that the restaurant earned during each meal period of the day. It is better if it is recorded daily because the is more accurate if compared to weekly and as for beverage sales it is the same as the food sales. Moreover, they also sure to keep track of their inventory as it plays a big role in the restaurants. They suggested that to keep on track all the expenses such as non-perishable items like paper towels, tableware, and cutleries.

12.0 Conclusion

In conclusion, the cost accounting is a critical accounting process for operating a business, which can illustrate the company’s cost in a year or an operation period. Every business needs to prepare the report of cost accounting even if it is running a small business. Furthermore, the costing system is the most effective issue in cost accounting process, which may relate to the cutting of cost, the reports of costing are important to develop a company’s financial situation in current year. In other words, the reason why is all the companies have the same target is cutting the cost and increasing the profit to promote the company’s development.

If the company has prepared the costs and found the right way to reduce the cost of product, it will have more opportunities and be easier to increase the profit from the knowledge of operating the company in current year. It is also the most efficient way to control the financial operation of company. If the owner or the managers want to control the company, the first thing they need to do is understand the facts of company’s costing and how the company operations are working.

During this process, the company can use the accounting software product to simplify the costing process. Firstly, using accounting software can reduce the time and labor then the company can have more resource to focus on other compulsory stuff. Secondly, the technology is improving so the company should keep pace with the times, so that the company will not lose in the competitive market. According to that flexibility in the use of assist tool is another important thing that companies need to consider.

References

Advantages, Disadvantages and Limitations of Activity Based Costing (ABC) System. Retrieved from: http://www.accountingexplanation.com _advantages disadvantages_ and_limitations_of_activity_based_costing.htm
Kenton, W. (2018). Activity-Based Costing (ABC). Retrieved from: https:// www.investopedia.com/terms/a/abc.asp
How to Apply Traditional and Activity Based Costing, Steps, Results Compared (2019). Retrieved from: https://www.business-case-analysis.com/activity-based-costing.html
Activity-Based vs. Traditional Costing, (2018). Retrieved from: https://quickbooks.intuit.com/r/pricing-strategy/activity-based-vs-traditional-costing/