Question

1) Explain the benefits to be gained from using the following costing systems:

Job costing

Process Costing

Activity based Costing

b) Discuss the ethical issues in the use of costing systems above (Hint: what elements of these systems require judgement or choice by management and therefore leave open the possibility of manipulation)

Answer 1

Answer:-

Benefits to be gained from using the following costing systems:

Job costing -
(a) Profitability of each job can be individually determined.
(b) It provides a basis for estimating the cost of similar jobs which are to be taken in future.
(c) It provides the detailed analysis of the cost of material, labour and overheads for each job as and when required.
(d) Plant efficiency can be controlled by confining attention to costs relating to individual jobs.
(e) Spoilage and defective work can be identified with a specific job and responsibility for the same may be fixed on individuals.
(f) By adopting pre-determined overhead rates in job costing, we can get all advantages of budgetary control.
(g) Job costing is essential for cost-plus contract where contract price is determined directly on the basis of cost.

Process costing -
a. The process costing system does not disclose the weaknesses and inefficiencies of any process. Hence, the accurate cost per unit cannot be calculated.

b. The emergence of joint products may present the problem of apportionment of joint costs.

c. The calculated cost per unit may be a misleading if the apportionment of joint costs is not properly done.

d. Process costing has all the weaknesses of historical costing since it is based on historical costs.

e . The degree of completion of work in progress is taken into account for the calculation of cost per unit. But, there is no standard scale or measurement to access the degree of completion of work in progress. Hence, mere guess work is followed which may lead to inaccurate calculation of cost per unit.

f. The process costing system does not consider the efforts of individual workers or supervisors.
g . The use of excessive materials and labour are not disclosed until the end of the period.

Activity Based Costing -
a . Activity Based Costing helps to reduce costs by providing meaningful information on the opportunities available for reducing costs.

b . Activity Based Costing is working only on the activities. Hence, the management can take the quality decision by knowing the nature of each activity.

c . The activities can be classified into two i.e. value adding activities and non-value adding activities. The Activity Based Costing helps the management on focusing the forces on value adding activities and eliminate non-value adding activities.
d . Some costs are termed as non-manufacturing costs, for example, advertisement. Even though, advertisement is a non-manufacturing cost which constitutes a major portion of the total cost of any product. These non-manufacturing costs can be easily allocated since the relationship between costs and its causes can be properly understood by using Activity Based Costing.

e . The accurate allocation of costs to various products leads to proper pricing policy.

f . The statement of expenditure is prepared on activity-wise and compare the costs of each activity with one another to find the activities which are to be eliminated or improved for better performance.
g . The management can take make or buy decisions by considering the cost of manufacture of a product or sub contract the same with an outside agency through Activity Based Costing analysis.

Ethical issues in the use of costing systems above:-

Job costing
(1) It is expensive to operate as it requires considerable detailed clerical work.

(2) With the increase in the clerical work the chances of errors are increased.

(3) Job order costing cannot be efficiently operated without highly developed production control system. The job costing requires intricate factory organization system.

(4) The costs as ascertained are historical as they compiled after incidence and therefore does not provide control of cost unless it is used with standard costing system.

Process costing
1. The correct treatment of waste and scrap.

2. Accounting for normal loss, abnormal losses and/or abnormal gains in each process separately.

3. Computing the correct value of incomplete units i.e. work in progress at the end of the accounting period.

4. Accounting for joint products and by-products, which may emerge from each process.

5. Accounting for inter process profits.

Activity Based costing

1. Activity Based Costing is not useful to small companies.

2. If the overheads are relatively small, there is no use of Activity Based Costing.

3. Some companies are producing only one product or few products. If so, the Activity Based Costing cannot be applied.

4. Activity Based Costing method should not be used to prepare monthly profit statements.