Muddled, who is enrolled in ACFI2003, is having trouble understanding the concepts underpinning Question 1 of the Major Assignment.
Muddled says: “I’m confused. I understood the first lecture and thought this course would be a walk in the park but now I am freaking out as new terms are being introduced in every lecture topic.
The loaf of bread example that was used in the first lecture was easy to understand: we costed the loaf of bread by tracing direct materials and direct labour to the loaf and then applied the remaining costs as overhead. I could see from the diagram showing T-accounts how materials, labour and overhead are utilised in the production of bread, and how they were transformed into WIP and finished goods.
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But Question 1 does not fit the template I have developed for the loaf of bread example. For a start, Question 1’s information on the combining process provides data on WIP, units completed and transferred out. It also has material, labour and overhead being added to production at different times. I understand that. But I cannot, for the life of me, figure out what ‘equivalent units’ are, and why they are necessary. Why is Question 1 so much more complicated than the bakery example?
I decided to memorise the calculation for equivalent units as I had given up trying to understand what it meant. The calculation involves manipulating the ‘physical flow of units of production’. I do not understand the difference between the ‘physical flow’ and ‘equivalent units.’
I could get the gist of job costing – for instance, in a construction site, you have different contracts that have been undertaken, and all I have to do is to trace direct materials and direct labour to each contract, and apply overhead to each contract. Why is the manufacture of herbicides (in Question 1) not costed in the same way?
While I was struggling with job and process costing, the course introduces actual and normal costing. I get actual costing, but do we need normal costing in an organisation? I think it just complicates matters by jumbling up actual and estimated figures. I think organisations provide management with stewardship accounts that are based on objective verifiable evidence.”
Required (The rubric on page 5 will be used to mark this question):
ACFI 2003 is based on the following fundamental costing principle: cost-management systems should reflect the fact that different costs are relevant for different purposes. It means that the design of a costing system should represent the unique characteristics of the production process. Muddled does not “get” this; it is far too abstract for him.
You are asked to help Muddled by explaining how this fundamental costing principle affects the way in which job and process costing systems are designed/constructed. Write an essay which compares job and process costing systems. Your essay should be in plain English. Your essay must be broken down into the following subheadings (2.1) to (2.4) below:
2.1) Your essay should explain the axiom, “different costs are relevant for different purposes” by briefly describing the process and job costing systems, and explaining the production context in which each system produces relevant and useful information for management.
2.2) In explaining the axiom above, you are required to explain the following differences between job and process costing systems:
2.2.i) The cost object for job costing is a contract, but the cost object for process costing is the process (or department). Explain the rationale for choosing these different cost objects for each system.
2.2.ii) How are costs accumulated under each costing system?
2.3) Then explain the following costing concepts that are found in process costing: ‘equivalent units’ and ‘transferred in costs.’ Why are these concepts not used in job costing?
2.4) Lastly, describe actual and normal cost-management systems. The indirect nature of overhead costs makes them difficult to control. Which system better enables management to control overhead costs? Explain.