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A PROJECT ON Strategic Management Turnaround Management Richardson and cruddas (1870).

MASTERS OF COMMERCE BANKING AND INSURANCE SEMESTER - 2012-2013 Submitted by SIMRANJEET KAUR SACHDEV Roll No- 47 Under the guidance of T.Ramraj

GURU NANAK COLLEGE OF ARTS , SCIENCE COMMERCE MUMBAI, MAHARASHTRA 400037 A PROJECT ON Process Costing SEMESTER I 2012-2013 Submitted In partial fulfillment of the requirements for the THE AWARD of the Degree of Masters of commerce SIMRANJEET KAUR SACHDEV Roll No- 47 Under the guidance of

GURU NANAK COLLEGE OF ARTS , SCIENCE COMMERCE MUMBAI, MAHARASHTRA 400037 CERTIFICATE I Professor . hereby certify that MISS. SIMRANJEET KAUR SACHDEV studying M.COM ( ACCOUNTANCY ) IN GURU NANAK COLLEGE OF ARTS , SCIENCE COMMERCE Project on (1870). under my guidance I further certify that information presented in this Project is true & original to the best of my knowledge Course coordinator _ Principal Project guide /internal examiner _ External examiner _

DECLARATION I SIMRANJEET KAUR SACHDEV studying in third year of M.COM (ACCOUNTANCY ) course at GURU NANAK COLLEGE OF ARTS , SCIENCE &COMMERCE , I have completed a project on For academic year 2012-2013 in fulfillment of the course completion requirement at the University Of Mumbai. I further declare that information presented in this project is true and original to the best of my knowledge Simranjeet Kaur Sachdev Roll No- 47

Process Costing Systems 1. Process Costing Systems - What is it and when is it used? Illustrating process costing 2. Three cases 2.1 Case 1: Process Costing with no beginning or ending work - in - process inventory 2.2 Case 2: Process costing with no beginning but an ending work - in - Process Inventory 2.3 Case 3: Process costing with both beginning and ending work - in - process inventory 3. Weighted-average method 4. First-In, First-out Method 5. Transferred-in costs in process costing 5.1 Transferred-in Costs and the weigthed-average method 5.2 Transferred-in Costs and the FIFO-Method 6. Common Mistakes with Transferred-in Costs 7. Mention of sources used

1. Process Costing Systems - What is it and when is it used? A process-costing system is a costing system in which the cost of a product or service is obtained by assigning costs to masses of like or similar units. Unit costs are then computed on an average basis. Process-costing systems are used in industries that produce like or similar units which are often mass produced. In these industries, products are manufactured in a very similar way. The companies usually use the same amount of direct materials, direct manufacturing labor costs and manufacturing overhead costs. Industries that use process costing systems are for example: chemical processing, oil refining, pharmaceuticals, plastics, brick and tile manufacturing, semiconductor chips, beverages and breakfast cereals. The difference between job costing and process costing is the extent of averaging used to compute unit costs of product and services. The cost object in job costing is a job that constitutes a distinctly identifiable product or service. The quantity of manufacturing resources is different in any job. It would be incorrect to cost each job at the same average manufacturing cost. So, when like or similar units are mass produced, process costing averages manufacturing costs over all units produced. The costs of a product are important for inventory calculations, pricing decisions and product profitability analysis. It's also important for measuring how well the management is done and if costs are reduced effectively.

The importance of process costing Costing is an important process that many companies engage in to keep track of where their money is being spent in the production and distribution processes. Understanding these costs is the first step in being able to control them. It is very important that a company chooses the appropriate type of costing system for their product type and industry. One type of costing system that is used in certain industries is process costing that varies from other types of costing (such as job costing) in some ways. In Process costing unit costs are more like averages, the process-costing system requires less bookkeeping than does a job-order costing system. So, a lot of companies prefer to use process-costing system. A process costing system is a technique used within the manufacturing industry to determine the total production cost of a unit of merchandise. It is particularly used in environments where production passes through multiple cost centers. For example, production within a large corporation may require that product move through more than one department, such as procurement, manufacturing, quality assurance and distribution. Each of these departments has its own budget. As a result, a process costing system must be in place to compile the respective costs undertaken by each group. The implementation of a process costing system comes with many advantages. Cost Containment A business that implements a process costing system can better contain manufacturing expenses. Under this system, each department is assigned a cost center. A cost center is a number or code that identifies the purchases made by a single department. As financial expenditures, such as the acquisition of supplies and employee salaries, are made throughout the production process, each group creates a report highlighting purchases that have been made under its respective cost center. These reports are compiled and reviewed by senior management. This data allows them to identify inefficiencies within the supply chain. For example, a cost center report may indicate that 50 percent of production costs come from the procurement department. Management can then dictate steps that the procurement team must take to minimize costs. Inventory Control The Internal Revenue Service requires all businesses that maintain an inventory to meticulously track and report its supply. The IRS uses this information to accurately value the business so that tax estimates can be made. Tracking inventory can be a cumbersome task for very large corporations. This process can be simplified, however, through the implementation of a process costing system. Throughout the manufacturing process, each department documents any materials purchased. In addition, each good is valued and added to the cost center report. Management includes this information on the companys income tax returns. Uniformity Many organizations allow each of their departments to operate autonomously. For example, the procurement department will have policies and procedure that are completely unique and independent of those of the supply chain group. This can be an incredibly ineffective way for a business to operate. Each department, in this scenario, may have its own jargon, making interdepartmental communication difficult. Furthermore, maintaining separate systems and policies means that additional money and time must be spent to cross-train employees.

When process costing is applied? Process costing is appropriate for companies that produce a continuous mass of like units through series of operations or process. Also, when one order does not affect the production process and a standardization of the process and product exists. However, if there are significant differences among the costs of various products, a process costing system would not provide adequate product-cost information. Costing is generally used in such industries such as petroleum, coal mining, chemicals, textiles, paper, plastic, glass, and food

Reasons for use Companies need to allocate total product costs to units of product for the following reasons:

A company may manufacture thousands or millions of units of product in a given period of time. Products are manufactured in large quantities, but products may be sold in small quantities, sometimes one at a time (automobiles, loaves of bread), a dozen or two at a time (eggs, cookies), etc. Product costs must be transferred from Finished Goods to Cost of Goods Sold as sales are made. This requires a correct and accurate accounting of product costs per unit, to have a proper matching of product costs against related sales revenue. Managers need to maintain cost control over the manufacturing process. Process costing provides managers with feedback that can be used to compare similar product costs from one month to the next, keeping costs in line with projected manufacturing budgets. A fraction-of-a-cent cost change can represent a large dollar change in overall profitability, when selling millions of units of product a month. Managers must carefully watch per unit costs on a daily basis through the production process, while at the same time dealing with materials and output in huge quantities. Materials part way through a process (e.g. chemicals) might need to be given a value, process costing allows for this. By determining what cost the part processed material has incurred such as labor or overhead an "equivalent unit" relative to the value of a finished process can be calculated.

Process cost procedures There are four basic steps in accounting for Process cost:

Summarize the flow of physical units of output. Compute output in terms of equivalent units. Summarize total costs to account for and Compute equivalent unit costs. Assign total costs to units completed and to units in ending work in process inventory.

Operation cost in batch manufacturing Batch costing is a modification of job costing. When production is repetitive nature and consists of a definite number of articles, batch is used. In batch costing, the most important problem is to determine the optimum size of the batch that follows the fact that production of two elements of costs:

Set up costs which are generally fixed per batch. Carrying costs which vadetermination of batch quantity requires considerations of some factors: setting up costs per batch. cost of manufacturing such as (direct materials cost + direct wages + direct overhead) per piece. cost of storage. rate of interest on the capital invested in product and rate of demand for product.

Illustrating process costing The best way to show how process costing works, is by example: Global Defense, Inc, manufactures thousands of components for missiles and military equipment. One of these is called DG-19. The product-costing system for DG-19 has a single direct-cost strategy (direct materials) and a single indirect-cost category (conversion costs). Each unit passes through two departments: the Assembly Department and the Testing Department. Every effort is made to make sure that all DG-19 products are identical. Direct materials are added at the beginning of the process in Assembly. Additional direct materials are added at the end of processing in the Testing Department. Conversion costs are added evenly during both processes. They include manufacturing labor, indirect materials, energy, plant depreciation and so on. After leaving the Testing Department, the DG-19 component is transferred to Finished Goods. 1. Process Costing Systems - What is it and when is it used? A process-costing system is a costing system in which the cost of a product or service is obtained by assigning costs to masses of like or similar units. Unit costs are then computed on an average basis. Process-costing systems are used in industries that produce like or similar units which are often mass produced. In these industries, products are manufactured in a very similar way. The companies usually use the same amount of direct materials, direct manufacturing labor costs and manufacturing overhead costs. Industries that use process costing systems are for example: chemical processing, oil refining, pharmaceuticals, plastics, brick and tile manufacturing, semiconductor chips, beverages and breakfast cereals. The difference between job costing and process costing is the extent of averaging used to compute unit costs of product and services. The cost object in job costing is a job that constitutes a distinctly identifiable product or service. The quantity of manufacturing resources is different in any job. It would be incorrect to cost each job at the same average manufacturing cost. So, when like or similar units are mass produced, process costing averages manufacturing costs over all units produced. The costs of a product are important for inventory calculations, pricing decisions and product profitability analysis. It's also important for measuring how well the management is done and if costs are reduced effectively.

Illustrating process costing The best way to show how process costing works, is by example: Global Defense, Inc, manufactures thousands of components for missiles and military equipment. One of these is called DG-19. The product-costing system for DG-19 has a single direct-cost strategy (direct materials) and a single indirect-cost category (conversion costs). Each unit passes through two departments: the Assembly Department and the Testing Department. Every effort is made to make sure that all DG-19 products are identical. Direct materials are added at the beginning of the process in Assembly. Additional direct materials are added at the end of processing in the Testing Department. Conversion costs are added evenly during both processes. They include manufacturing labor, indirect materials, energy, plant depreciation and so on. After leaving the Testing Department, the DG-19 component is transferred to Finished Goods. 2.2 Case 2: Process costing with no beginning but an ending work - in - Process Inventory There is no beginning inventory in February, because all 400 units produced in January had been fully completed. Due to customer delays in placing orders, it was only possible to produce 175 units in February. The 225 partially assembled units as of February 28 were fully processed with respect to direct materials, because all direct materials in the Assembly Department are added at the beginning of the assembly process. Conversion costs are added evenly during the assembly process. Based on the work completed relative to the total work required to be done, an Assembly Department supervisor estimates that the partially assembled units were, on average, 60 % complete as to conversion costs. Total costs for February: Direct materials costs in February $ 32.000 Conversion costs February $ 18.600 _______ Total Assembly Departments costs $ 50.600 Problem: How should Global Defense calculate the cost of fully assembled units and the cost of the partially assembled units still in process? The following four steps help us to find the answer: Step 1: Summarize the flow of physical unit of output Step 2: Compute output in terms of equivalent units Step 3: Compute equivalent unit costs Step 4: Summarize total costs to account for and assign these cost to units completed and to units in ending work in process

Step 1 tracks the physical unit of output. It shows, where they come from and how many units are there to account for, and where they go and how they are accounted for. Step 2 measures the output in equivalent units, not in physical units, because not all units had been completed. The 400 units are complete in terms of equivalent units of direct materials, because all direct materials are added in the Assembly Department at the initial stage of the process. So you count all 400 units in equivalent direct costs. The 175 fully assembled units are completely processed with respect to conversion costs. The partially assembled units in ending process are 60 % complete (on average). Therefore, the conversion costs in 225 partially assembled units is equivalent to conversion costs in 135 (60% of 225) fully assembled units. So, 310 equivalent units of conversion costs are assembled and transferred out and 135 equivalent units are in ending work - in - process inventory. In step 3, equivalent unit costs are computed by dividing direct materials and conversion costs added during February by the related quantity of equivalent units of work done in February: Direct costs Conversion costs Costs added during February: $ 32.000 $ 18.600 Divide by equivalent units work done in February: / 400 / 300 ________ _________ Cost per equivalent unit of work done in February: $ 80 $ 60 In Step 4, total costs to account for are summarized and assigned to units completed and transferred out and to units still in process at the end of February. Since the beginning balance of the work - in process is zero, total costs to account for consist of the costs added during February: direct materials $ 32.000 and conversion costs $ 18.600. Direct material costs are 225 times $80 (=$18.000) + Conversion costs: 135 times $60 (=$8.100). Total costs are therefore: $18.000 + $8.100 = $26.100.

2.3 Case 3: Process costing with both beginning and ending work - in - process inventory In march, Global Defense has 225 partially assembled units in the Assembly Department. During march, Global Defense placed another 275 units into production. Step 1 traces the physical units of production. In march, 400 units are completed and transferred out, 100units are in ending inventory. Step 2 computes the output in terms of equivalent units: 275 equivalent units of direct materials and 315 equivalent units of conversion costs. Step 3 computes equivalent unit costs. Direct materials: $ 80; conversion materials: $ 60 Step 4 summarizes total costs to account for and assigns these costs to units completed and to units in ending work in progress. The costs that get assigned to each of these categories depend, as in all inventory accounting, on the specific assumptions regarding the flow of costs. Next are described to alternative methods, the weighted-average method and the first-in, first-out method. 3. Weighted-average method The weighted-average process-costing method assigns the average equivalent unit cost of all work done to date (regardless of when it was done) to equivalent units completed and transferred out, and to equivalent units in ending inventory. The weighted-average cost is simply the average of various equivalent unit costs entering the work in process account. 4. First-In, First-out Method The First-in, first-out (FIFO) process-costing method assigns the cost of the earliest equivalent units available (starting with the equivalent units in beginning work-in-process inventory. This method assumes that the earliest equivalent units in work in process - Assembly account are completed first. 5. Transferred-in costs in process costing

Transferred-in costs (or previous department costs) are costs incurred in a previous department that are carried forward as part of the product's cost as it moves to a subsequent department. That means, costs move with the units when they are transferred to a new department. So, computations of Testing costs must include transferred-in costs, additional direct materials costs and conversion costs added in Testing. The four -step procedure is used to account for the costs of a subsequent department that has transferred-in costs. Units are fully completed as to transferred-in costs because these costs are just carried forward from the previous process. Direct materials costs have a zero degree of completion in both beginning and ending work-in-process inventories, because in Testing, direct materials are introduced at the end of the process. That completes steps 1 and 2.

5.1 Transferred-in Costs and the weighted-average method In step 3, the equivalent unit costs are computed. In step 4, the total costs to account for are summarized, that is the total debits to Work in Process under the weighted-average method. After that, these costs are assigned to units completed and to units in ending work-in-process inventory. Beginning work in process and work done in the current period are totaled and merged together for purposes of computing weighted-average costs. A company may split the Work in Process account into Work in Process - Testing, Transferred-in Costs, Work in Process - Testing, Direct Materials and Work in Process - Testing, Conversion costs. The journal entries would contain this detail, though the underlying reasoning and techniques would be unaffected.

5.2 Transferred-in Costs and the FIFO-Method The costs transferred-in from the Assembly Department are different when the weighted-average rather than the FIFO method is used in step 3. In step 4, the total costs to account for are summarized, consisting of the beginning inventory plus costs added during the current period, under the FIFO-method. These costs differ from the total debits to Work on Process under the weighted-average method, because of the different costs of completed units transferred-in from the Assembly Department under the weighted-average and FIFO methods. When assigning costs, the FIFO method keeps the beginning inventory separate and distinct from the work done during the current period. Each department in interdepartmental transfers is regarded as being separate and distinct for accounting purposes. All costs transferred in during a given accounting period are carried at one unit cost figure, regardless of whether previous departments used the weighted-average or the FIFO method.

6. Common Mistakes with Transferred-in Costs Here are some common pitfalls to avoid when accounting for transferred-in costs: Remember to include transferred-in costs from previous departments in your calculations. Such costs should be treated as if they were another kind of direct material added at the beginning of the process. In other words, when successive departments are involved, transferred units from one department become all or a part of the direct materials of the next department; however, they are called transferred-in costs, not direct materials costs. In calculating costs to be transferred on a FIFO basis, do not overlook the costs assigned at the beginning of the period to units that were in process but are now included in the units transferred. Unit costs may fluctuate between periods. Therefore, transferred units may contain batches accumulated at different unit costs. Units may be measured in different terms in different departments. Consider each department separately. Unit costs could be based on kilograms in the first department and liters in the second , so as units are received by the second department, their measurements must be converted to liters.

PROCESS COSTING PRACTICE PROBLEM ADVANCED TECHNOLOGIES Solution STEP 1: Determine the units to be assigned costs. Beginning Work in Process Inventory Units Started and Completed During the Month (3,500 500) Ending Work in Process Inventory Total 3,000 500 3,600 100

STEP 2: Calculate equivalent units of production. Materials equivalent units: Whole Units 100 3,000 500 % Materials Added in April 0 100% 100% Equivalent Units 0 3,000 500 3,500 Conversion equivalent units: Whole Units % Conversion Added in April Equivalent Units

Beginning WIP Inventory Units Started and Completed Ending WIP Inventory

Beginning WIP Inventory Units Started and Completed Ending WIP Inventory

100 3,000 500

60% 100% 20%

60 3,000 100 3,160

STEP 3:

Determine the cost per equivalent unit. $1,288,000

Materials Cost/Equivalent Unit

= $368 3,500 equiv. units $158,000

Conversion Cost/Equivalent Unit = 50 3,160 equiv. units

PROCESS COSTING PRACTICE PROBLEM ADVANCED TECHNOLOGIES Solution STEP 4: Allocate costs to transferred and partially completed units. Cost assigned to the units in beginning work in process: Direct Materials Beginning WIP Balance Cost to Complete: Equivalent Units for April Cost per Equivalent Unit Total Cost Transferred to the Testing Department $368 0 Conversion Cost Total Cost $40,000 0 60 $50 $ 3,000 3,000 $43,000

PROCESS COSTING PRACTICE PROBLEM ADVANCED TECHNOLOGIES Solution Cost assigned to the units that were started and completed: Direct Conversion Materials Cost Started and Completed: Equivalent Units Cost per Equivalent Unit Total Cost Transferred to the Testing Department 3,000 $368 3,000 $50 $1,254,000 Total Cost

$1,104,000

$150,000

Cost assigned to units in ending work in process inventory: Direct Materials Ending WIP Inventory: Equivalent Units 500 Conversion Cost 100 Total Cost

Cost per Equivalent Unit Total Cost of Ending WIP

$368 $184,000

$50 $5,000

$189,000

COST OF PRODUCTION REPORT Advanced Technologies Cost of Product ReportAssembly Department For the Month Ended April 30 UNITS Units charged to production: Inventory in process, April 1 ...... Received from materials storeroom ................................. Total units accounted for by Assembly............................. Units to be assigned costs: Inventory in process, April 1 ...... Started and completed in April .. Transferred to Testing Department............................... Inventory in process, April 30 .... Total units to be assigned cost.. WHOLE UNITS 800 3,000 3,800 800 2,700 3,500 300 3,800 2,700 2,700 300 3,000 0 200 2,700 2,900 200 3,100 (Continued) EQUIVALENT UNITS Direct Materials Conversion

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Transparency Master 2-13 COST OF PRODUCTION REPORT (Concluded) COSTS Conversion Units costs: Total costs for April in Assembly ........................ Total equivalent units ........................................... Cost per equivalent unit ....................................... Costs charged to production: Inventory in process, April 1 ................................ Costs incurred in April ......................................... 1,157,000 Total costs accounted for in Assembly............... $1,385,000 Costs allocated to completed and partially completed units: Inventory in process, April 1balance ............... To complete inventory in process, April 1 .......... Started and completed in April ............................ Transferred to Testing Dept. in April................... Inventory in process, April 30 .............................. Total costs assigned by Assembly...................... $ 567,000 63,000 0 $ 34,000 459,000 34,000 $630,000$527,000 3,000 $210 COSTS Direct Materials Total Costs

3,100 $170 $ 228,000

$ 228,000 34,000 1,026,000 $1,288,000 97,000 $1,385,000

5 6

Decision Making Using Process Cost Data Solution Materials Cost per Pound By Shift Average $6.13 7.13 $6.65

Line 1 Shift 1 Shift 2 By Line Average $6.00 7.00 $6.52

Line 2 $6.00 7.00 $6.52

Line 3 $6.50 7.50 $7.02

Line 4 $6.00 7.00 $6.52

It is clear from the table above that increasing the speed of the machines has a very negative impact on materials consumption. The materials cost per pound on Shift 2 averages a full $1.00 per pound greater than on Shift 1. What makes Shift 1 different from Shift 2? The speeds, the employees, the supervisors, and the time of day. Which of these is likely the cause of our problems? Line 3 gives us some additional clues. Line 3 has the highest average machine speed and the highest average materials cost per pound. Thus, the cost differences appear to be related to the machine speed issue. Apparently, headquarters management is expecting Bundys plant to perform up to the standard of some of the plants with newer equipment. Bundys plant appears to be unable to operate at the higher speeds without some major process engineering work.

PROCESS COSTING Process accounting is a security method in which an administrator may keep track of system resources used, their allocation among users, provide for system monitoring, and minimally track a user's commands. This indeed has its own positive and negative points. One of the positives is that an intrusion may be narrowed down to the point of entry. A negative is the amount of logs generated by process accounting, and the disk space they may require. This section will walk an administrator through the basics of process accounting. Process costing is an accounting methodology that traces and accumulates direct costs, and allocates indirect costs of a manufacturing process. Costs are assigned to products, usually in a large batch, which might include an entire month's production. Eventually, costs have to be allocated to individual units of product. It assigns average costs to each unit, and is the opposite extreme of Job costing which attempts to measure individual costs of production of each unit. Process costing is usually a significant chapter. Process costing is a type of operation costing which is used to ascertain the cost of a product at each process or stage of manufacture. CIMA defines process costing as "The costing method applicable where goods or services result from a sequence of continuous or repetitive operations or processes. Costs are averaged over the units produced during the period". Process costing is suitable for industries producing homogeneous products and where production is a continuous flow. A process can be referred to as the sub-unit of an organization specifically defined for cost collection purpose. Is used by manufactures who mass produce large quantities of identical units in a continuous flow.

PROCESS COSTING Is used by manufacturers w ho mass produce large quantities of Identical units in a continuous flow .

System

determine a product cost by measuring the amount of direct materials and direct labor used and allocating over- head costs. allocate overhead using a predetermined overhead rate(s).

In Process costing systems

In Process costing systems

maintain perpetual inventory records with

subsidiary ledgers for materials, work in process, and finished goods.

Process Costing: Costs are accumulated by department for a time period (for example, one month). Unit One Department = Departments Cost Cost to Make One for the Month in No. of Units Produced during the Month

To find the total unit cost, add the unit costs in- curred in each department.

FLOW OF COSTS IN A PROCESS COST SYSTEM Assume that Advanced Technologies, a computer manufacturer, makes its product in three departments: Assembly, Testing, and Pack- ing. Materials and component parts are added in the Assembly De- partment. Packing materials are added in the Packing Department. Materials Cost of materials purchased Materials used in assembly Materials used in packing Materials Direct Labor Overhead (applied) WIPAssembly Cost of units transferred to testing

WIPTesting Costs from Cost of units assembly transferred Direct Labor to packing Overhead (applied)

WIPPacking Costs from Cost of testingcompleted Materials units Direct Labor Overhead (applied) Finished Goods Cost of Cost of completed units sold units Transparency Master 2-5 Cost of Goods Sold Cost of units sold

INTRODUCTION
Today's competitive environment requires manufacturers to know their costs for competing globally. A top notch costing system is one of the most powerful information tools a management can have; especially which provide a clear picture of the activities that are driving costs and the ways individual products and processes consumes resource. We can use costs in distinct ways. Product costing is used for strategic decision making.

PRODUCT COSTING
Product costing system is a set of procedures that accounts for an organization's product costs and provides timely and accurate unit cost information for pricing, planning and control, inventory valuation and financial statement preparation. An organization should be concerned about product costing and their firm's product costing system. Use of an appropriate product costing system helps allocation of indirect costs and helps to use resources in a productive way. It is used to determine the market profit margins and also focus on sales function, customers markets and setting prices.

The most common systems of product costing are: Job order costing

Job order costing allocates costs to products that are readily identified by individual units or batches of which requires varying degrees of attention and skill. It is extensively used in service industries, hospitals, law firms, movie studio, accounting firms, etc.

It is more complex when companies sell many different products and services.

Process costing

Process costing allocates costs to products by averaging costs over large number of nearly identical products. Since every unit is essentially the same, each unit receives the same manufacturing input as every other unit. Refineries, paper mills and food processing companies use process costing.

A complication arising in process costing is that manufacturing of not all units may be completed at the balance sheet date.

B - Strengths of Product Costing

Useful for making judgments about management related profitability and performance, which often leads to decisions about resource allocation, shifting money from unrewarding activities to profitable activities and improve products' cost performance.

Helps for valuation of inventories for financial reporting purposes. Stock can be valued at the lower of cost or net realizable value under the prudence principle and the problems of allocating overheads to products for financial reporting do not arise.

Plays an important role in complex pricing decision process and cost control. Cost based pricing is particularly true for customized products which do not have readily available market price.

Managers often use product cost for planning and controlling the costs. For this purpose managers mainly focus on the product cost, although the scope of the analysis can be extended to include product costs from other areas of the value chain.

Helps the organizations to find out the cost associated to each product .That enables to selling profitable products.

This will help to avoid the use of non profitable products, and maximize profits. It gives an understanding of each product's contribution to the bottom line.

Weaknesses of Product Costing

There are few limitations faced by the organizations by using the product costing systems they are:

This costing system was developed during a period when 80% cost were related to labour, so it focused on direct labour cost.

It is related to the benefits of a change in process or method reduction in direct labour. Only limited service organizations used full product costs for pricing decisions. In service organizations inventory valuation is not a major issue because there is not much to store.

Planning and controlling of service organizations done through responsibility centers linked to functional activities rather than product or services.

It assumed that the factory is an isolated entity and provide no indication of the impact of change in the factory on the rest of the organization.

Conventional costing
Conventional costing produces inventory values which consist of variable costs and such fixed costs which commensurate with the level of production at which the inventories are produced. Conventional cost can aid in controlling cost as efficiently as direct costing. When conventional cost is employed on the books, the variable and fixed costs must be assembled and arranged to fit the analysis made out side the records. A limitation for conventional system is that conventional costs develop under absorbed or over absorbed manufacturing expenses which are not understood by management. (Convertibility of Direct and Conventional Costing; Joseph A. Mauriello; National Association of Cost Accountants. NACA Bulletin (pre-1986); Mar 1954; 35.7)

Traditional Costing
Traditional costing is among the oldest used methods of costing systems. In traditional costing, the manager or the management assigns direct labour, direct material and overheads to each unit of production. In this case, the overheads are not broken down by activity but based on certain volume related factors such as direct machine hours, direct labour hour etc. (At what overhead level does activity based costing pay off? Robert J Vokurka; Rhonda R Lummus Production and Inventory Management Journal; First Quarter 2001; 42, 1; ABI/INFORM Global pg. 40)

A - Going against the odds


Although the introduction of ABC was supposed to be the remedy for the short-comings of Traditional Costing, the Japanese managers still use traditional costing measures and are able to reduce costs and increase their market share. Traditional costing uses a very powerful set of tools and methods and may be much mightier than written deficient by the simplistic textbooks. (Why the Japanese can do without ABC Patel, Ashok, Russell, David. Certified Accountant. Cork: Nov 1994. pg. 64)

B - Advantages of Traditional costing system


Easy to understand and it is widely used In a firm with only one product line, the final cost will be the same as if ABC were used It is a convenient base for the assignment of manufacturing overheads (with direct labour as a significant portion of the product cost)

Easy to depict a diagram representing the flow of product cost (ABC: Revisiting the Basics)

C - Disadvantages of Traditional Costing

In most of today's business scenario, the information that a management needs for decision making are not being satisfactorily provided

The averaging of the overall costs to the entire product line may result in some products carrying a major proportion of the overheads than it actually should. This in turn will affect the decision making related the product such as marketing emphasis, pricing, cost control etc

Since being a volume driven cost allocation, the entire process of costing is based on the manufacturing cost while the other factors of costs (performance driven) such as Research and Development, marketing etc are averaged across all the products.

(ABC: Revisiting the Basics)

Activity Based Costing


Activity-based costing was introduced about 15 years ago and implemented initially by large manufacturing companies since it is proven to show as more beneficial in larger firms that have a diverse mix of products or services. ABC is a system for assigning costs to products based on the activities they require. These activities are those regular actions performed inside a company. Eg: asking a customer invoice related questions. In this way an organization can establish the true cost of its individual products and services for the purposes of identifying and eliminating those which are unprofitable and lowering the prices of those which are overpriced. It is generally used as a tool for understanding product and customer cost and profitability. As such, ABC has predominantly been used to support strategic decisions such as pricing, outsourcing and identification and measurement of process improvement initiatives. Cost centre, cost allocation, fixed cost, variable cost, cost drivers are the methodologies used in activity based costing.

Strengths

It helps to identify costs of individual activities, based on their use of resources Identify most and least profitable customers, products and channels through its methodologies.

It helps to control the cost at individual level as well as on departmental levels. The cost of all activities associated with a product or service can be accurately determined before it is launched, so it helps in pricing, future product planning etc.

Expands the cost of producing and selling a product so that better decision making information is available.

Uses the technologies available to track costs in today's manufacturing environment.

Limitations

Some overhead cost is difficult to assign to products and customers, such as the chief executive's salary.

ABC is time consuming, if all activities are to be costed. It may be difficult to set up and establish ABC if an organization is using more traditional accounting methodologies.

ABC identifies product costing better in the long run, but may not be too helpful in day-to-day decision-making.

Conclusion
Product costing suffers from some set backs but overall it is an effective tool that helps organization in predicting and minimising costs involved in manufacturing a product as well as in providing management with relevant information for strategic decision making process that have a long term impact on the profitability of the firm. And though many experts suggest the use of marginal costing in decision making the modern organization concentrate on product costs. Traditional costing systems fail to meet the management's decision making requirements in the modern organization. But the introduction of ABC had taken out this shortcoming to a minimum level and has made it much easier for the cost control and help managers take wise decisions based on their numbers. This is where product costing systems make an impact and prove to be useful and more importantly a necessity.