Accounting professionals should be aware of the accounting approaches available and their advantages and disadvantages. Below is a short summary:
The two traditional methods of costing are marginal costing and absorption costing.
Absorption is in line with IFRS and allocates overheads based on the volume of units produced or hours worked.
Marginal costing splits costs strictly between variance and fixed costs. This approach may have the benefits of allowing the analyst to see how the business is likely to behave in certain scenarios such as an increase in certain costs, volume increases or price increases.
There are alternatives, however:
1. Activity Based Costing - a form of absorption costing where the overhead absorption is not based on volumes but instead overheads are allocated to cost pools which are then absorbed based on cost drivers.
2. Target Costing - this is a top-down approach. Whereas the conventional approach is to develop the cost for goods held in inventory based on the cost to produce them and order the inputs, in the target costing approach the company first estimates the market price of the final product and then will subtract the profit margin and take into account investment costs and working capital needs in order to come up with a figure for the true cost.
3. Life Cycle Costing - this is a concept that seeks to track and take into account all the product costs over the lifecycle of the product. For example, an organization that does not take into account lifecycle costing may acquire goods at the lowest possible price but incur subsequently much higher costs later. (e.g. acquire agriculture land cheaper but with certain farming obligations that may have a heavy cost)
4. Total Quality Management (TQM) - this is a structured approach to quality and cost management of an organization focusing on three main elements:
a) Focus on internal systems to prevent faulty products, production failures etc
b) Improvement - management needs to persist improvement of the organization processes and not accept the status quo.
c) Customer orientation - the organization needs to aim to achieve customer needs and expectations and quality should be evaluated from the point of view of the customer.
TQM classifies quality costs under four categories:
I) Prevention costs - costs of any actions by the organization to reduce defective product or failure.
Examples: customer surveys, research of customer needs, quality engineering
II) Appraisal costs - costs associated with checking that the product meets the required quality standards.
Examples: inspection and product testing, product quality audit, process control monitoring
III) Internal failure costs - costs arising from inadequate quality of the organization's processes BEFORE the transfer of ownership to the customer/client actually occurs
E.g. if the plant due to failure produces waste, the cost of getting rid of it and cleaning the facilities can be considered an internal failure cost. Disposal costs of defective products produced is another example.
IV) External failure cost - costs arising when the ownership title for the product is transferred to the customer
E.g. warranty claims, legal claims from the customer for poor quality of service, complaint investigation and processing costs
Prevention and appraisal costs are essentially conformance costs that the organization undertakes to ensure the product meets the requirements and is high quality. The internal and external failure costs on the other hand are non-conformance.
The two traditional methods of costing are marginal costing and absorption costing.
Absorption is in line with IFRS and allocates overheads based on the volume of units produced or hours worked.
Marginal costing splits costs strictly between variance and fixed costs. This approach may have the benefits of allowing the analyst to see how the business is likely to behave in certain scenarios such as an increase in certain costs, volume increases or price increases.
There are alternatives, however:
1. Activity Based Costing - a form of absorption costing where the overhead absorption is not based on volumes but instead overheads are allocated to cost pools which are then absorbed based on cost drivers.
2. Target Costing - this is a top-down approach. Whereas the conventional approach is to develop the cost for goods held in inventory based on the cost to produce them and order the inputs, in the target costing approach the company first estimates the market price of the final product and then will subtract the profit margin and take into account investment costs and working capital needs in order to come up with a figure for the true cost.
3. Life Cycle Costing - this is a concept that seeks to track and take into account all the product costs over the lifecycle of the product. For example, an organization that does not take into account lifecycle costing may acquire goods at the lowest possible price but incur subsequently much higher costs later. (e.g. acquire agriculture land cheaper but with certain farming obligations that may have a heavy cost)
4. Total Quality Management (TQM) - this is a structured approach to quality and cost management of an organization focusing on three main elements:
a) Focus on internal systems to prevent faulty products, production failures etc
b) Improvement - management needs to persist improvement of the organization processes and not accept the status quo.
c) Customer orientation - the organization needs to aim to achieve customer needs and expectations and quality should be evaluated from the point of view of the customer.
TQM classifies quality costs under four categories:
I) Prevention costs - costs of any actions by the organization to reduce defective product or failure.
Examples: customer surveys, research of customer needs, quality engineering
II) Appraisal costs - costs associated with checking that the product meets the required quality standards.
Examples: inspection and product testing, product quality audit, process control monitoring
III) Internal failure costs - costs arising from inadequate quality of the organization's processes BEFORE the transfer of ownership to the customer/client actually occurs
E.g. if the plant due to failure produces waste, the cost of getting rid of it and cleaning the facilities can be considered an internal failure cost. Disposal costs of defective products produced is another example.
IV) External failure cost - costs arising when the ownership title for the product is transferred to the customer
E.g. warranty claims, legal claims from the customer for poor quality of service, complaint investigation and processing costs
Prevention and appraisal costs are essentially conformance costs that the organization undertakes to ensure the product meets the requirements and is high quality. The internal and external failure costs on the other hand are non-conformance.
No comments:
Post a Comment