The price of the material or materials from which a product is prepared is called direct material. In this task it would include,
Carriage on purchase of basic raw material.
Direct Labor:
That part of the factory wages which is useful in quality and which may be applied straight to the product or to the manufacturing procedure, is called direct labor. In this task the direct labor would include,
Wages of operatives in the cutting department.
Direct expense:
Any other cost or expenditure which is related and which may be charged directly to a work, order or item, is called direct expense charge. In this task the direct expense would include,
Royalty payable on number of units of its final product produced.
Indirect Production Overheads:
All cost related which procedure, other than direct labor and direct materials, are measured production overheads. It is also known as factory overhead or factory burden. In this task the indirect production overhead would include,
Lubricant for sewing machine.
Performing Right Society charge for music broadcast throughout the factory.
Wages of storekeeper in material store.
Wages of fork lift driver who handle raw materials.
Wages of security guard.
Research and Development Cost:
An area where innovative work carryout on a efficient basis in order to increase knowledge, culture or it could be anything. In this task the research and development cost would include,
Developing a new product in the laboratory.
Selling and distribution Cost:
Selling overhead comprise the cost incur in encouraging sales and maintaining consumers. Distribution overheads comprise the cost of the procedure which starts with making the full product available for send off and finishes with making the clean returned empty packages available for reuse. In this task the selling and distribution cost would include,
Market research undertaken prior to a new product launch.
Road tax on delivery vehicles.
Parcel sent to customers.
Cost of advertising products on television.
Cost of painting advertising slogans on delivery vans.
Administration Cost:
Administration cost is usually allocated to product, either as a fraction on production cost or as a fraction on conversion cost. In this task the administration cost would include,
Floppy disks for general office computer.
Telephone rental plus metered calls.
Chief accountant's salary.
Audit fee.
Maintenance contract for general office photocopying machine.
Finance Cost:
Any fee or cost for an addition of credit is called finance cost. In this task the finance cost would include,
Interest on bank overdraft.
ALTERNATIVE METHOD OF PRICING.
There are three methods of pricing, which are FIFO (First-In-First-Out), LIFO 9Last-In-First-Out) and Average Price method.
First-In-First-Out (FIFO) Method:
The item or product purchased first to be sold first, so the closing stock assumed recently purchased.
Purchased
Sold
Balance
Date
Units
Unit Cost £
Total Cost
Units
Unit Cost £
Total Cost
Units
Unit Cost £
Total Cost
1 January
500
1
500
1 July
500
2
1,000
31 December
500
1
500
500
2
1,000
Last-In-First-Out (LIFO) Method:
The item or product purchased last to be sold first,
Purchased
Sold
Balance
Date
Units
Unit Cost £
Total Cost
Units
Unit Cost £
Total Cost
Units
Unit Cost £
Total Cost
1 January
500
1
500
1 July
500
2
1,000
31 December
500
2
1,000
500
1
500
Average Price Method:
The cost of goods sold and the cost of closing stock are firm by using an average cost of all goods available for sale during the period.
Average Unit Cost = Cost of Goods available for sale £1,500
No of units available for sale 1,000
Average Cost = £1.5
Purchased
Sold
Balance
Date
Units
Unit Cost £
Total Cost
Units
Unit Cost £
Total Cost
Units
Unit Cost £
Total Cost
1 January
500
1
500
1 July
500
2
1,000
31 December
500
1.5
750
500
1.5
750
Impact of each alternative method on profit
Number of units sold at 31st December = 500
Selling Price per unit = £ 2.4
Total Sale Price = £ 1,200
Different Impacts from the 3 methods:
FIFO:
Selling price - Cost = Profit
£1,200 - £500 = £700
The impact from this method is that it increases net income because stock that may be few years old is used to charge the cost of goods sold. Increasing net income is good for the company and for balance sheet.
LIFO:
Selling price - Cost = Profit
£1,200 - £1,000 = £200
The impact from this method is that it decreased net income it is not a good indicator for company owners. The income is less because cost of goods sold is higher.
Average:
Selling price - Cost = Profit
£1,200 - £750 = £450
The impact from this method is that it make results that drop somewhere between FIFO and LIFO. It will not show too much income and don't show less income.
The selling price is £ 2.4 per unit, so the LIFO method provides a reasonable approximation of replacement cost which is £2.
Advising Rajeev the advantages of the Pricing methods:
FIFO (First In First out):
The advantage of the FIFO method Pricing is that it is taken directly from stock report and characterizes actual costs. Low or high invoice prices do not distress following material pricings as happen when average price methods are used. It is accepted and recommended by the Bureau of Internal Revenue.
LIFO (Last in First Out):
It is accepted and recommended to its associate by the following trade association. American petroleum institute, committee of controllers institute of America etc; as a sound method of costing sales and of formative stock in certain dedicated industries.
Average pricing method:
It is a cost method and supplies an average cost, which is of better concern to some officials in costing production than is an actual cost. An average cost have a tendency to narrow the severe prices, the trend upwards or downwards is more slow, as compare with a stair step type of increase or decline when prices are taken from the actual invoices under the FIFO method.
Major Problems:
FIFO (First in First Out):
It is boring to manage. It make too much of profit at the time of increasing prices, because closing stock is prized at more recent prices. It makes evaluation of job costs excessive as similar jobs are debited with materials at different rates. A regular price is not support on actual price acquire, and therefore is not pragmatic. Ease and convenience are lost when there is so much change in the prices of materials.
LIFO (Last in Last Out):
It direct to unexpected movement in prices. Like FIFO this method also involves boring calculation with resulting clerical mistakes, if the prices vary too often. It is also not acceptable for Income-tax authorities. Matter are not valued in the same order in which the materials are issued.
Average Price Method:
It does not calculate closing stock at current cost and it also makes confirmation of closing stock difficult.
LIFO method used by any organization is not acceptable for the external reporting, the organizations show less income using LIFO method to save the Government TAX, in the balance sheet if they will show less income so they have to pay less tax to the government. The government thinks that they are putting more money in their pocket as they show less profit. Only FIFO and Average methods are acceptable by government.
SALES BUDGET
Sales Forecast
8,500
Selling Price per Unit
100
Sales required
850,000
PRODUCTION BUDGET
Sales Forecast
8,500
Add: Finished Goods Stock at end
1,870
10,370
Less: Finished Goods Stock at start
(170)
Production required
10,200
DIRECT MATERIALS USAGE BUDGET
Material - A
Material - B
Total
Production required
10,200
10,200
Standard material usage for production
10
5
Direct Materials Usage required
102,000
51,000
153,000
Add: Direct Materials Closing Stock
10,200
163,200
Less: Direct Materials Opening Stock
(8,500)
Direct Materials Usuage required
154,700
DIRECT MATERIALS PURCHASE BUDGET
Material - A
Material - B
Direct material required
102,000
51,000
Standard material rate per unit
1.80
4
Direct Material Purchase
183,600
204,000
DIRECT LABOUR BUDGET
Production required
10,200
Standard direct labour usage per hour
10
Total direct labours hours required
102,000
standard direct labour rate per hour
3
Total direct labour cost required
306,000
FACTORY OVERHEAD BUDGET
Budgeted Variable Overhead
Indirect Materials
30,600
Indirect labour
30,600
Power
15,300
Maintenance
5,100
Total Budgeted Variable Overhead
81,600
Budgeted Fixed Overhead
Depreciation
25,000
Supervision
25,000
Power
10,000
Maintenance
11,400
Total Budgeted Fixed Overhead
71,400
Total Fixed Overhead Budget
153,000
SELLING AND ADMINISTRATION BUDGET
Stationary
1,000
Sales - Salaries
18,500
Office - Salaries
7,000
Commissions
15,000
Car Expenses (Sales)
5,500
Advertising
20,000
Miscellaneous (Office)
2,000
Total Selling and Administration Budget
69,000
CASH BUDGET
Quarter 1
Quarter 2
Quarter 3
Quarter 4
Opening Cash Balance
8,500
28,500
73,500
105,496
Add: Receipts from Customer
250,000
300,000
280,000
246,250
Total Receipts
258,500
328,500
353,500
351,746
Less: Payments
Materials
100,000
120,000
110,000
136,996
Payment for Wages
100,000
110,000
120,000
161,547
Other Cost & Expenses
30,000
25,000
18,004
3,409
Total Payments
230,000
255,000
248,004
301,952
Closing Cash Balance
28,500
73,500
105,496
49,794
Evaluate the need for corrective action to Rajeev.
The corrective action for Rajeev is as follows,
Use flexible budgeting techniques
Review master budget after each quarter
Modify the budget if needed.
P7
Principles of Value Analysis and recommendation to Rajeev concerning its application within the company:
Value Analysis is defined as "A systematic interdisciplinary examination of factors affecting the cost of a product or service in order to devise means of achieving the specified purpose most economically at the required standard of quality and reliability". (CIMA Official Terminology)
Value Engineering is also known as value analysis and it is also a systematic and function-based approach to improving the value of product, project, or processes.
Value analysis or value engineering is a prearranged process of discovering and innovating the detail of how value is created.
It mean at identify and removing redundant costs that do not add value to the product in order to offer better value to the customers.
There are some basic steps involved in value analysis which are,
Knowing the cost
Determining the functions
Thinking creatively
Evaluating alternatives by comparison
Obtaining and recording the facts
The recommendation to Rajeev concerning its application within the company is,
Elimination of redundant parts
Substitution with alternative cheaper materials
Substitution of specially designed cloths with standard or fashioned cloths
Development of alternative cheaper methods of manufacturing
Redesigning
