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Select and Apply Costing Systems and Techniques

Business Management Techniques By Brendan Burr

Brendan Burr

BTEC Higher National Certificate in Electronics


Business Management Techniques

Table of Contents
TABLE OF CONTENTS...........................................................2 TASK 1................................................................................3 Identify and describe appropriate costing systems and techniques for specific engineering business functions.........3 Solution:-.........................................................................................3 TASK 2................................................................................7 Measure and evaluate the impact of changing activity levels on engineering business performance..................................7 Solution:-.........................................................................................7 EVALUATION.....................................................................10 CONCLUSION.....................................................................10 Books...............................................................................11 Catalogues........................................................................11 Websites...........................................................................11

Brendan Burr

BTEC Higher National Certificate in Electronics


Business Management Techniques

Task 1
Identify and describe appropriate costing systems and techniques for specific engineering business functions. A market has been established for your product and it has been passed to production for manufacture. The sales and marketing team have contacted you and asked for your estimation of the selling price. You now have to produce a document that explains the theory of costing systems. You are to explain a range of costing systems that can be applied to a 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 help explain each one separately. But first I will explain why there is a need to use costing systems in any business. Costing systems are effective to take into account the real cost of manufacturing a product or delivering a service. Without a costing system in place it is extremely difficult to control costs and determine the overall profitability of an operation. This control can give details on things such as the actual costs incurred compared with the planned expenditure. This allows a suitable costing system to be used to identify any costs which are running out of control, but can also provide a tool that can help in determining the action that may be required to put things right. The first costing system I will talk about is Job Costing. This technique is very simple; it usually applies to a unique operation, such as fitting a part or carrying out a modification to a product. Job costing always has three elements, which are: direct labour, direct materials and absorbed overheads. There is sometimes an additional direct cost, which are direct expenses. This system is useful in companies who produce a variety of different products. The products are normally referred to as custom built, with each being regarded as a job and having separate costs. This type of manufacture is different from the assembly line production, associated with mass produced products, and is described as intermittent. The costs are normally worked out before manufacture begins, using this system. The price is agreed and forms a contract between the manufacturer and the customer.

Brendan Burr

BTEC Higher National Certificate in Electronics


Business Management Techniques

The second costing system I will talk about is Parts Costing. This technique is also very straightforward; it involves calculating the cost of all the physical parts and components used in the manufactured product. 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 detailed components, 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 ensures that any future market fluctuations in individual components can be easily justified, and also the impact of assembly costs can also be justified much easier. The third costing system I will talk about is Contract Costing. This form 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, which produce large ships or have defence contracts with the MoD, or even used 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 manufacturing process. Each individual product will then take a part of the cost of each process. These processes may be; forming, bending, or machining of metal and plastic parts, flow soldering of PCBs, heat treatment 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 chemical plants. I will now break the costing techniques down, to explain each one separately. But first, as before, I will explain the need for costing techniques. When an engineering business operates, they are likely to incur a number of costs from a variety of sources. Some of these include; rent for 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 costs under different headings, including fixed and variable costs, overhead and direct costs, average and marginal costs. The consequences of not knowing all of the costs can be devastating to a company. The costing techniques are used to determine the total cost of the product or service that will be delivered. The key elements to the techniques are to give an understanding of how many units will need to be produced in order to make a profit, to work out if it is cheaper to buy or make an item, and to determine what happens to the profit margin if the cost of production or the cost of parts changes.

Brendan Burr

BTEC Higher National Certificate in Electronics


Business Management Techniques

The first costing technique I will talk about is Absorption Costing. This technique involves accumulating all of the costs from the production, such as overheads and adding them to the direct costs by a process of allocation, apportionment and absorption. The overall cost 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 units that 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 behave by allowing a company to observe the interaction between the costs, volumes and profits. A number of the advantages are; they are simpler to operate than absorption costing techniques, because they avoid the problems associated with overhead apportionment and recovery. Also it is easier to make decisions based on marginal cost calculations. The marginal costing can detail which products are making a profit and which are failing to cover their variable costs. There are however some disadvantages, such as; the effect of time tends 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 of delivering a product or service. This is the technique to use if you want to make well informed decisions when making cost saving improvements. Activity based costing focuses on indirect costs. It makes costs which would normally be considered indirect into direct costs. In doing so, it traces the costs and expenses to an individual cost object. This is very useful when the costs associated with a particular product are significant and where products are produced in varying volumes. This costing technique is useful when the competition is severe, as it can precisely determine the costs required for each product, therefore enabling a company to make a much better decision on providing an affordable market cost. To be able to carry out this costing technique, you will need to; identify the activities, determine the cost of each activity, determine the factors that drive the costs, collect the activity data, and calculate the product cost.

Brendan Burr

BTEC Higher National Certificate in Electronics


Business Management Techniques

I will now take a few engineering business functions and describe which costing techniques will be suited for each. Design This engineering business function has to be done, before manufacturing can commence. Therefore the costs will have to be added to the final cost of each product, before any income from the product is being received. It is difficult in the design stage to implement a concrete plan, due to the potential of unforeseen problems, which will always arise in the design stages. Using the finished design, you are able to implement a suitable plan for the manufacturing stage, as you know all the areas you will need to cover. I would recommend Job Costing, as this would enable the company to work out the costs of each task before it commences, but still have the process under control and relative financial constraint. Manufacturing I would use Parts Costing for this engineering business function. This is because all of the parts which have come out of the design phase, will now need to be manufactured, and putting a cost on each part will enable a simplistic way of monitoring the overall cost of each assembled unit. Process Costing could also be used, to determine the overall cost of making each of the parts, which would be used in a similar way to Parts Costing. Engineering Services This engineering business function can present a significant cost, and will need to be accounted for so that it can be covered from the product income. An approximation will have to be made to ensure that this service is covered, so I would suggest Activity Based Costing which can list the processes required with much greater detail than all of the other costing techniques.

Brendan Burr

BTEC Higher National Certificate in Electronics


Business Management Techniques

Task 2
Measure and evaluate the impact of changing activity levels on engineering business performance. Your new product will be entering an untapped market and therefore its market uptake is unknown. You have therefore been asked to asses the resources needed to manage an unknown market. Solution:Below is an example of the overall profitability of our new product if it was priced at 45.00 for the sale of the first 1,000 units.
Fixed Costs Overheads Fixed Cost Tooling Total Fixed Cost Variable Costs Sale Price (First 1,000) Sale Price (Last 500) Break Even Data Quantity 0 200 400 600 800 1000 500 18,000.00 2,000.00 20,000.00 18.00 45.00 35.00 Per Unit Per Unit Per Unit

Fixed Cost 20,000.00 20,000.00 20,000.00 20,000.00 20,000.00 20,000.00 0.00

Variable Cost 0.00 3,600.00 7,200.00 10,800.00 14,400.00 18,000.00 9,000.00

Total Cost 20,000.00 23,600.00 27,200.00 30,800.00 34,400.00 38,000.00 9,000.00

Income 0.00 9,000.00 18,000.00 27,000.00 36,000.00 45,000.00 17,500.00

Brendan Burr

BTEC Higher National Certificate in Electronics


Business Management Techniques

Using this information we can see that for the first 1,000 units we would have generated an income of 45,000, at a total cost of 38,000, so we will be making an overall profit at this point. However, we are actually gaining a profit from each unit after the breakeven point on the graph above, 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 Fixed Costs/Contribution 20000 / 27.00 740.74

2) Break even

Units

So anything after this number, we would have cleared our fixed costs, which would have accumulated from the overheads and fixed cost tooling. With this cost paid off, our total cost drops dramatically which has a beneficial knock on effect to our profits.
Total Cost Per Unit (for the first 1,000) Total Cost Per Unit (for the last 500) 38.00 18.00

As you can see, the cost of production of each unit being sold at 45.00 is 38.00. But after the first 1,000 units the cost of production drops to 18.00 and the units can continue to be sold at 45.00! This throws our profit margin through the roof as shown below.
Profit (for the first 1,000) Profit (for the last 500) 7,000.00 8,500.00

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

Brendan Burr

BTEC Higher National Certificate in Electronics


Business Management Techniques

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

This would mean that we would receive 0.00 of profit for the first 1,000 units we manufacture. To balance this out we could charge more per unit, to try and balance the effect. This could mean that we then sell less products as we may no longer remain competitive. A similar problem could be presented if we are trying to remain competitve on the market. Just say that our competitors are offering a similar product for 40.00, and we wished to offer it at 39.99, then this would push our breakeven point to 909.5 units and reduce our profits to 1,990.00 for the first 1,000 units sold, potentially giving us implications if we wanted to invest this profit into future products. To get around this problem we could try an tighten our belts in terms of production costs. Getting second hand machinery would lower the potential fixed cost price, however there is a greater chance of it breaking down so it may cost more to maintain.

Brendan Burr

BTEC Higher National Certificate in Electronics


Business Management Techniques

Evaluation
For Task 1, I gathered some information from my trusty HNC National Engineering 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 is covered quite comprehensively. This sped up my ability to answer Task 1, as all 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 relatively quickly 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 by each of the costing systems and techniques. I found this difficult, as the systems and techniques are not specific to individual departments, but more for the type of service a company provides. A small company, such as a one man carpenter, would use job costing for almost everything, however a large company, such as AgustaWestland Ltd, would find contract costing more appropriate. For Task 2, I cast back over some work I completed when I was in year 2 of the BTEC National Certificate. The breakeven chart had already been constructed from a previous question I had completed, so I decided to recycle some of my work to answer this Task. I understood the processes required to calculate the breakeven point, and explained the various aspects of it in my answer above. Using the breakeven chart, I ran three simulations, one to example the breakeven point, one to example the effect of a fixed cost increase and one more to determine what would happen to the profit if I increased/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 next be focusing on completing my third business assignment, so that I will be left with only one more for the rest of the academic year. I believe I am learning new things through this unit which will help me understand some of the general workings of a company, which can potentially be very beneficial to me in the future.

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Brendan Burr

BTEC Higher National Certificate in Electronics


Business Management Techniques

Bibliography
Through guidance from my lecturer, the following text books, catalogues and websites 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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