BTEC HNC - Business Systems - Select and Apply Costing Systems and Techniques

8/2/2019 BTEC HNC - Business Systems - Select and Apply Costing Systems and Techniques

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Select and Apply Costing

Systems and TechniquesBusiness Management TechniquesBy Brendan Burr


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Brendan Burr BTEC Higher National Certificate in ElectronicsBusiness Management Techniques

Table of Contents

TABLE OF CONTENTS ........................................................... 2

TASK 1 ................................................................................ 3

Identify and describe appropriate costing systems andtechniques for specific engineering business functions. ........ 3

Solution:- .........................................................................................3

TASK 2 ................................................................................ 7

Measure and evaluate the impact of changing activity levels

on engineering business performance. ................................. 7Solution:- .........................................................................................7

EVALUATION ..................................................................... 10

CONCLUSION ..................................................................... 10

Books ............................................................................... 11

Catalogues ........................................................................ 11

Websites ........................................................................... 11

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Task 1

Identify and describe appropriate costing systems and techniques for specificengineering business functions.

A market has been established for your product and it has been passed toproduction for manufacture. The sales and marketing team have contactedyou and asked for your estimation of the selling price.You now have to produce a document that explains the theory of costingsystems. You are to explain a range of costing systems that can be applied toa product.

Solution:-

There are a number of costing systems and techniques that can apply

to a product. Primarily I will break costing systems down to helpexplain each one separately. But first I will explain why there is a needto use costing systems in any business.

Costing systems are effective to take into account the real cost ofmanufacturing a product or delivering a service. Without a costingsystem in place it is extremely difficult to control costs and determinethe overall profitability of an operation.This control can give details on things such as the actual costs incurredcompared with the planned expenditure. This allows a suitable costingsystem to be used to identify any costs which are running out of

control, but can also provide a tool that can help in determining theaction that may be required to put things right.

The first costing system I will talk about is Job Costing. Thistechnique is very simple; it usually applies to a unique operation, suchas fitting a part or carrying out a modification to a product.Job costing always has three elements, which are: direct labour, directmaterials and absorbed overheads. There is sometimes an additionaldirect cost, which are direct expenses.This system is useful in companies who produce a variety of differentproducts. The products are normally referred to as custom built, witheach being regarded as a job and having separate costs. This type ofmanufacture is different from the assembly line production, associatedwith mass produced products, and is described as intermittent.The costs are normally worked out before manufacture begins, usingthis system. The price is agreed and forms a contract between themanufacturer and the customer.

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The second costing system I will talk about is Parts Costing. Thistechnique is also very straightforward; it involves calculating the cost ofall the physical parts and components used in the manufacturedproduct.This technique is said to work from the bottom up, so it will start with

the basic components and then move on to the more detailedcomponents, the sum of all the costs is the overall cost of the product.When listing the parts, it is useful to group parts together. This ensuresthat any future market fluctuations in individual components can beeasily justified, and also the impact of assembly costs can also bejustified much easier.

The third costing system I will talk about is Contract Costing. Thisform of costing technique is used in a similar way to Job Costing,however in a much larger and longer term scenario.Contract costing is often used in engineering companies, whichproduce large ships or have defence contracts with the MoD, or evenused in civil engineering.

Finally, the last costing system I will talk about is Process Costing.This system takes into account the cost of a continuous manufacturingprocess. Each individual product will then take a part of the cost ofeach process. These processes may be; forming, bending, ormachining of metal and plastic parts, flow soldering of PCBs, heattreatment of metal parts, paint spraying and finishing.This form of system is often used in industries that operate on a

continuous basis, such as food production, fuel production or chemicalplants.

I will now break the costing techniques down, to explain each oneseparately. But first, as before, I will explain the need for costingtechniques.

When an engineering business operates, they are likely to incur anumber of costs from a variety of sources. Some of these include; rentfor the factory premises, energy costs (such as heating and electricity),salaries, telephone charges, and insurance premiums. Because there

are such a vast variety of different costs, it is useful to list the costsunder different headings, including fixed and variable costs, overheadand direct costs, average and marginal costs. The consequences ofnot knowing all of the costs can be devastating to a company.The costing techniques are used to determine the total cost of theproduct or service that will be delivered. The key elements to thetechniques are to give an understanding of how many units will need tobe produced in order to make a profit, to work out if it is cheaper to buyor make an item, and to determine what happens to the profit margin ifthe cost of production or the cost of parts changes.

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The first costing technique I will talk about is Absorption Costing.This technique involves accumulating all of the costs from theproduction, such as overheads and adding them to the direct costs bya process of allocation, apportionment and absorption. The overallcost calculated from this is then divided by the total number of units.

This gives a total amount that will need to be added to the cost per unit,which will balance the costs of manufacture. This way, the more unitsthat are created, the less additional cost there is to each one.

The second costing technique I will talk about is Marginal Costing.This costing technique offers many advantages and disadvantages;however the technique itself offers an insight into the way costs behaveby allowing a company to observe the interaction between the costs,volumes and profits.A number of the advantages are; they are simpler to operate thanabsorption costing techniques, because they avoid the problemsassociated with overhead apportionment and recovery. Also it is easierto make decisions based on marginal cost calculations. The marginalcosting can detail which products are making a profit and which arefailing to cover their variable costs.There are however some disadvantages, such as; the effect of timetends to be overlooked, and there is a temptation to spread fixed costs.

The final costing technique I will talk about is Activity Based Costing.This costing technique is used to try and calculate the true cost ofdelivering a product or service. This is the technique to use if you want

to make well informed decisions when making cost savingimprovements.Activity based costing focuses on indirect costs. It makes costs whichwould normally be considered indirect into direct costs. In doing so, ittraces the costs and expenses to an individual cost object. This is veryuseful when the costs associated with a particular product aresignificant and where products are produced in varying volumes.This costing technique is useful when the competition is severe, as itcan precisely determine the costs required for each product, thereforeenabling a company to make a much better decision on providing anaffordable market cost.

To be able to carry out this costing technique, you will need to; identifythe activities, determine the cost of each activity, determine the factorsthat drive the costs, collect the activity data, and calculate the productcost.

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I will now take a few engineering business functions and describewhich costing techniques will be suited for each.

Design This engineering business function has to be done, beforemanufacturing can commence. Therefore the costs will have to be

added to the final cost of each product, before any income from theproduct is being received.It is difficult in the design stage to implement a concrete plan, due tothe potential of unforeseen problems, which will always arise in thedesign stages. Using the finished design, you are able to implement asuitable plan for the manufacturing stage, as you know all the areasyou will need to cover.I would recommend Job Costing, as this would enable the company towork out the costs of each task before it commences, but still have theprocess under control and relative financial constraint.

Manufacturing I would use Parts Costing for this engineeringbusiness function. This is because all of the parts which have comeout of the design phase, will now need to be manufactured, and puttinga cost on each part will enable a simplistic way of monitoring theoverall cost of each assembled unit.Process Costing could also be used, to determine the overall cost ofmaking each of the parts, which would be used in a similar way toParts Costing.

Engineering Services This engineering business function can present

a significant cost, and will need to be accounted for so that it can becovered from the product income. An approximation will have to bemade to ensure that this service is covered, so I would suggest ActivityBased Costing which can list the processes required with much greaterdetail than all of the other costing techniques.

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Task 2

Measure and evaluate the impact of changing activity levels on engineeringbusiness performance.

Your new product will be entering an untapped market and therefore itsmarket uptake is unknown. You have therefore been asked to asses theresources needed to manage an unknown market.

Solution:-

Below is an example of the overall profitability of our new product if itwas priced at 45.00 for the sale of the first 1,000 units.

Fixed Costs

Overheads 18,000.00Fixed Cost Tooling 2,000.00

Total Fixed Cost 20,000.00

Variable Costs 18.00 Per Unit

Sale Price (First 1,000) 45.00 Per Unit

Sale Price (Last 500) 35.00 Per Unit

Break Even Data

Quantity Fixed Cost Variable Cost Total Cost Income

0 20,000.00 0.00 20,000.00 0.00

200 20,000.00 3,600.00 23,600.00 9,000.00400 20,000.00 7,200.00 27,200.00 18,000.00

600 20,000.00 10,800.00 30,800.00 27,000.00

800 20,000.00 14,400.00 34,400.00 36,000.00

1000 20,000.00 18,000.00 38,000.00 45,000.00

500 0.00 9,000.00 9,000.00 17,500.00

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Using this information we can see that for the first 1,000 units we wouldhave generated an income of 45,000, at a total cost of 38,000, so wewill be making an overall profit at this point. However, we are actuallygaining a profit from each unit after the breakeven point on the graphabove, this occurs at 740.74 units, calculations of which can be seen

below.

Break Even Quantity Formula

1) Find Contribution Sale Price - Variable Costs

45.00 - 18.00

27.00

2) Break even Fixed Costs/Contribution

20000 / 27.00

740.74 Units

So anything after this number, we would have cleared our fixed costs,

which would have accumulated from the overheads and fixed costtooling. With this cost paid off, our total cost drops dramatically whichhas a beneficial knock on effect to our profits.

Total Cost Per Unit (for the first 1,000) 38.00

Total Cost Per Unit (for the last 500) 18.00

As you can see, the cost of production of each unit being sold at45.00 is 38.00. But after the first 1,000 units the cost of productiondrops to 18.00 and the units can continue to be sold at 45.00! Thisthrows our profit margin through the roof as shown below.

Profit (for the first 1,000) 7,000.00

Profit (for the last 500) 8,500.00

With this in mind we would have flexibility over our competitors, as wecould drop the price of our product and still maintain a healthy profit.

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If we faced an increase before production of the fixed costs, theconsequence could be quite damaging.For example, if the fixed costs increased from 2,000 to 9,000, thenwe wouldnt achieve a break even point until exactly 1,000 units havebeen manufactured, as shown in the graph below.

This would mean that we would receive 0.00 of profit for the first1,000 units we manufacture. To balance this out we could charge more

per unit, to try and balance the effect. This could mean that we thensell less products as we may no longer remain competitive.

A similar problem could be presented if we are trying to remaincompetitve on the market. Just say that our competitors are offering asimilar product for 40.00, and we wished to offer it at 39.99, then thiswould push our breakeven point to 909.5 units and reduce our profits to1,990.00 for the first 1,000 units sold, potentially giving us implicationsif we wanted to invest this profit into future products. To get aroundthis problem we could try an tighten our belts in terms of productioncosts. Getting second hand machinery would lower the potential fixed

cost price, however there is a greater chance of it breaking down so itmay cost more to maintain.

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Evaluation

For Task 1, I gathered some information from my trusty HNC NationalEngineering Book. I tend to not find the information I require in this book so

end up having to do web searches as well, however the business unit iscovered quite comprehensively. This sped up my ability to answer Task 1, asall the information I needed to learn and portray was all in one source.This ease of finding the information allowed me to complete the task relativelyquickly and easily. It took me around an hour and a half to write a few pages,which detailed everything required to cover the points necessary.I did try to go into a description of how engineering functions were affected byeach of the costing systems and techniques. I found this difficult, as thesystems and techniques are not specific to individual departments, but morefor the type of service a company provides. A small company, such as a oneman carpenter, would use job costing for almost everything, however a large

company, such as AgustaWestland Ltd, would find contract costing moreappropriate.For Task 2, I cast back over some work I completed when I was in year 2 ofthe BTEC National Certificate. The breakeven chart had already beenconstructed from a previous question I had completed, so I decided to recyclesome of my work to answer this Task. I understood the processes required tocalculate the breakeven point, and explained the various aspects of it in myanswer above. Using the breakeven chart, I ran three simulations, one toexample the breakeven point, one to example the effect of a fixed costincrease and one more to determine what would happen to the profit if Iincreased/decreased the cost of sale price of each unit.

Conclusion

I feel I have covered all of the areas necessary for this assignment. I will nextbe focusing on completing my third business assignment, so that I will be leftwith only one more for the rest of the academic year.I believe I am learning new things through this unit which will help meunderstand some of the general workings of a company, which can potentiallybe very beneficial to me in the future.

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Bibliography

Through guidance from my lecturer, the following text books, catalogues andwebsites I was able to complete this assignment:

Books

Higher National Engineering (Mike Tooley & Lloyd Dingle)ISBN: 978-0-7506-6177-5

Catalogues

N/A

Websites

N/A

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Documents

BTEC HNC - Business Systems - Select and Apply Costing Systems and Techniques