K-Chapter 1-5 (To Instructer Elias)
K-Chapter 1-5 (To Instructer Elias)
K-Chapter 1-5 (To Instructer Elias)
By:
KIFLIE BIRHAN
April, 2016
Cost is the sacrifice made usually measured by the resource given up to achieve a particular purpose.
There are different cost concept, classifications and measures used for external financial reporting,
setting of price purpose. Understanding these differences enable the cost management analysts to
provide appropriate cost data to the manager who need it (Hilton, 2003).Product costing is a cost
assigned to goods that were either purchased or manufactured for resale. It used to value the
inventory manufactured goods or merchandise until the goods are sold. The product cost of
manufacturing inventory includes all costs incurred in its manufacture. For example, the labor cost
of a production employee, product costs are also known as inventoriable costs (Hilton, 2003).
Pricing is the process of determining what a company will receive in exchange for its product or
service. Pricing factors are manufacturing cost, market place, competition, market condition, brand
and quality of product. Pricing is also a key variable in microeconomic price allocation theory.
Pricing is a fundamental aspect of financial modeling and is one of the four Ps of the marketing mix
(Horengren, 2004).
Product pricing is the process of determining the selling price of the product which is sufficient to
cover administrative and marketing expenses and give a reasonable percentage of profit (Hilton,
1997).
Product costing and pricing plays a vital role for the success and failure of any organization
whether they are manufacturing, merchandise or service giving organizations therefore a great deal
of emphasis should be given for product costing and pricing. An understanding of the cost concept is
absolutely critical to the cost management and setting price of product. Company cost information
provides the data required for the preparation and operation of budget, for establishing standard costs
and determination of the price the product and for analytical purpose. Any organization starts from
smaller sole proprietorship to the largest corporation acquiring know how and use of product costing
and pricing practice(Hilton,2003).
Previous study, for example, Meksud (2011) had conducted a research on the related topic i.e.
Examine the costing system and classification of cost and their respective recording that he
conducted his study. In this study deeply examine the product costing and pricing practice that Huda
Flour Factory apply (examine the bases that the industry uses in setting selling price, assess how
direct material, direct labor and manufacturing overhead are recorded, see the product costing
system use in the setting of selling price, examine the pricing and product costing practice of the
Huda Flour Factory, and assessment of the accounting treatment for spoilage and scrap).
This study will be conducted to assess the product costing and pricing practice of Huda Flour
Factory.
1.2. Statement of the problem
For any business enterprise whether they are manufacturing, merchandizing and service giving the
product costing and pricing is very important. Therefore, the improper practice of product costing
and pricing may result in the disruption of the operation, affect the profitability of the organization
and even cause bankruptcy. Due to this, the proper practice of product costing and pricing is
important for Huda Flour Factory to sustain its operation and to maintain satisfactory level of
growth. Because proper practice of product costing and pricing is crucial for the success and failure
of the business because every operating business incurs cost and setting their product price (Hilton,
2003).
Product costing and pricing practice is one of the most important factors to insure the survivals of
the organization. Cost management helps an organization management create more value at lower
cost by efficiently managing the organization value chain activities, processes and functions (Hilton,
2003).
Previous study, conducted by Meksud (2011) indicates that the purpose of cost accounting system,
the recording of production costs in accounting department and the role of costing system for
decision making. This study will be intended to assess significantly other cost accounting issues
such as bases in for setting selling price , the pricing and costing strategies ,costing methodology in
using pricing decision, product costing and pricing practice of Huda Flour Factory.
Therefore, the study will be designed to concentrate on the application of product costing and
pricing.
1.3. Objectives of the Study
1.3.1 General Objective
The general objective of this study is to assess product costing and pricing practice in case of Huda
Flour Factory.
1.3.2 Specific Objectives
The specific objectives of this study are:
1) To assess how direct material, direct labor, manufacturing overhead costs (production cost) of
product are recorded.
2) To examine the product costing and product pricing practice that Huda Flour Factory use.
3) To examine the bases that Huda Flour Factory uses in setting selling price.
4) To see the product costing practice use in the setting of selling price.
Time can be broadly classified in to past and future .cost can be also classified according to those
time periods (Cherrington, 1998).
Historical cost
Sunk cost is a cost that has already been incurred and that cannot be changed by any decision
made now or in the future. Sunk costs are those costs that are incurred in the past period they are
also known as historical costs (Cherrington, 1998).
Budgeted costs
Budgeted costs are those costs that are expected to incur in the future time (Cherrington,
1998).
B. Cost classification for predicting cost behavior
Cost behavior means how accost will react or respond to changes in the level of business
activity. As the activity level rises and falls, a particular cost may rise and fall as well or it may
remain constant (Garrison, 2006).Cost behavior describes how the cost changes with time or
changes in volume .Cost behavior refers how the cost will react or respond to change in the
level of business activities (Hilton, 2003). This classifies costs as variable and fixed costs, and
describes as follows;
Variable costs
A variable cost is a cost that varies in total, in direct proportion to changes in the level of
activity. The activity can be expressed in many ways, such as units produced, units sold, miles
driven, beds occupied, lines of print, hours worked, and so forth (Garrison, 2006).
Fixed costs
A fixed cost is a cost that remains constant in total, regardless of changes in the level of activity
within the relevant range (Garrison, 2006).
C. Cost classification for assigning costs to cost objects
Costs are assigned to objects for a variety of purposes including pricing, profitability studies, and
control of spending. A cost object is anything for which cost data are desired. For purposes of
assigning costs to cost objects, costs are classified as either direct or indirect cost (Garrison,
2006).
Direct cost
A direct cost is a cost that can be easily and conveniently traced to a particular cost object under
consideration (Garrison, 2006).
Indirect cost
An indirect cost is a cost that cannot be easily and conveniently traced to a particular cost object
under consideration (Garrison, 2006).
Cost Assignment
Customers: influence price through their effect on the demand for a product or service, Based on
factors such as the features of a product and its quality.
Competitors: No business operates in a vacuum. Companies must always be aware of the
actions of their competitors. At one extreme, alternative or substitute products of competitors
hurt demand and force a company to lower prices.
Costs: influence prices because they affect supply. The lower the cost of producing a product,
the greater the quantity of product the company is willing to supply. Generally, as companies
increase supply, the cost of producing an additional unit initially declines but eventually
increases. Companies supply products as long as the revenue from selling additional units
exceeds the cost of producing them. Managers who understand the cost of producing products set
prices that make the products attractive to customers while maximizing operating income
(Horengren, 2012).
Time Horizon of Pricing Decisions
A. Short-run pricing decisions
Short-run pricing decisions: typically have a time horizon of less than a year and include
decisions such as (a) pricing a one-time-only special order with no long-run implications. And (b)
adjusting product mix and output volume in a competitive market.
Two key factors affect short-run pricing.
1. Many costs are irrelevant in short-run pricing decisions. For example, most of costs in R&D,
design, manufacturing, marketing, distribution, and customer Service are irrelevant for the short-
run pricing decision. These costs will change in the long run and therefore will be relevant.
2. Short-run pricing is opportunistic. Prices are decreased when demand is weak and competition
is strong and increased when demand is strong and competition is weak. As we will see, long-run
prices need to be set to earn a reasonable return on investment
B. Long-Run Pricing Approaches
Long run pricing decision: pricing decisions have a time horizon of a year or longer and include
pricing a product in a market where there is some leeway in setting price.
Long-run pricing is a strategic decision designed to build long-run relationships with customers
based on stable and predictable prices. A stable price reduces the need for continuous monitoring
of prices, improves planning, and builds long-run buyer–seller relationships. But to charge a
stable price and earn the target long-run return, a company must, over the long run, know and
manage its costs of supplying products to customers. As we will see, relevant costs for long-run
pricing decisions include all future fixed and variable costs (Horengren, 2012).
Two different approaches for pricing decisions are as follows:
I. Market-based pricing
II. Cost-based, which is also called cost-plus pricing
I. Market-based pricing
The market-based approach to pricing starts by asking, “Given what our customers want and
how our competitors will react to what we do, what price should we charge?” Based on this
price, managers control costs to earn a target return on investment. Companies operating in
competitive markets (for example, commodities such as steel, oil, and natural gas) use the
market-based approach. The items produced or services provided by one company are very
similar to items produced or services provided by others. Companies in these markets must
accept the prices set by the market (Horengren, 2012).
Target costing for target pricing
Market-based pricing starts with a target price. A target price is the estimated price for a
product or service that potential customers are willing to pay. This estimate is based on an
understanding of customers’ perceived value for a product or service and how competitors will
price competing products or services. This understanding of customers and competitors is
becoming increasingly important for three reasons:
1. Competition from lower-cost producers is continually restraining prices.
2. Products are on the market for shorter periods of time, leaving less time and opportunity to
recover from pricing mistakes, loss of market share, and loss of profitability.
3. Customers are becoming more knowledgeable and incessantly demanding products of higher
and higher quality at lower and lower prices.
II. Cost-based pricing
The Cost-based approach to pricing starts by asking, “Given what it costs us to make this
product, what price should we charge that will recoup our costs and achieve a target return on
investment?” Companies operating in markets that are not competitive favor cost-based
approaches. That’s because these companies do not need to respond or react to competitors’
prices. The margin they add to costs to determine price depends on the value customers place on
the product or service. The general formula for setting a cost-based price adds a markup
component to the cost base to determine a prospective selling price. Because a markup is added,
cost-based pricing is often called cost-plus pricing,
Companies operating in less competitive markets offer products or services that differ from each
other (for example, automobiles, computers, management consulting, and legal services), can use
either the market-based or cost-based approach as the starting point for pricing decisions. Some
companies first look at costs because cost information is more easily available and then consider
customers or competitors: the cost-based approach. Others start by considering customers and
competitors and then look at costs: the market-based approach. Both approaches consider
customers, competitors, and costs. Only their starting points differ. Management must always
keep in mind market forces, regardless of which pricing approach it uses. For example, building
contractors often bid on a cost-plus basis but then reduce their prices during negotiations to
respond to other lower-cost bids (Horengern, 2012).
CAPTER THREE
3. METHODS AND RESEARCH METHODOLOGY
3.1. Description of the study area
The study area is Mekelle city which is located at northern part of Ethiopia, in Tigray regional
state. It is located in a distance of 783 kilo meters from the capital city of Ethiopia, Addis Ababa.
Mekelle is the capital city of Tigray regional state.
Specifically, this study will be conducted on Huda Flour Factory located in Tigray region,
Mekelle city, Ayder a bit distance from Ayder Referral Hospital.
3.2. Research Methodology
3.2.1. Research Design
The study will be focused on a matter that describes the product costing and pricing practice. The
research design to be employed in this study will be descriptive research design by using
diagrams and expressions to assess product costing and pricing practice of Huda Flour Factory.
The reason why the researcher will select the descriptive research design is enable to review the
past and present company’s product costing and pricing. It will be give more information for the
readers after the compilation of the research and it also enable to describe the existing problem
well.
3.2.2. Target Population
The target population of this study will be the accounting staff management of Huda Flour
Factory.
3.2.3. Data type and Sources
This study will use both primary and secondary data. Primary source of data will be collected
from accounting staff management through interview. The secondary data will include
information collected from cost manuals and journals.
The data desirable to assess the product costing and pricing will be obtained from both primary
and secondary source of data. The primary source of data will be collected by using interview for
the accounting staff management. Secondary data will be collected from the analysis of cost
manuals and journals of Huda Flour Factory.
3.2.4. Data Collection Instrument
This study will be used interview questions (close ended) as a data collection instrument. The
interview check list will be prepared to collect data from the management. And also this study
will used analysis of cost manuals and journals of Huda Flour Factory.
3.2.5. Sampling Techniques and Sample Size
Since the target population of this study is the accounting staff management of Huda Flour
Factory, there is no need of sampling technique and sample size.
This chapter deals with the data analysis and presentation of the study on the data obtained from
the accounting and finance department manager and cost department managers through
structured interview.
The products which have similar feature are treated under process costing method and each unit
receives the same or similar amounts of direct materials costs, directs labor costs and indirect
manufacture costs.
4.3. How costs are classified in the factory?
Cost classification is a base for the type of information to be provided by any cost accounting
system. Proper cost classification enables decision makers to concentrate in the areas which are
critical for the factory. According to the response of accounting department manager of Huda
Flour Factory classify cost based on different bases such as based on behaviors, traceability,
presentation on financial statement etc.since we are focusing on product cost the classification
based is on the presentation in financial statement i.e. product and period costs. Product costs
are presented in balance sheets which are not closed at the end of the fiscal year. Product costs or
manufacturing costs includes direct materials, direct labor and manufacturing overheads, in
addition for price build up purpose adds non-manufacturing cost such as administration and
marketing expenses.
On the other hand materials, such as stationary, lubricant, fuel, cleaning materials, other supplies
and all materials which cannot be traced to products are classified under indirect material with in
production overhead category.
These are costs which are not easily and economically identifiable with a product or a job.
Although such costs are difficult to identify with a product or a job to particular production or
service units they could be charged to these units. Any production cost not taken into account as
a direct material or direct labor is included under production overhead category. For Huda Flour
Factory these costs include indirect material (lubricant, fuel), indirect labor (electric and water
technician, guard, managers) and others include rent, utilities, insurance, power, water,
depreciation of factory building, telephone, factory supplies etc.
The cost accounting treatment follows the material flows and uses different source documents.
The cost accumulation system for the factory is in line with its cost classification. Proper
performance evaluation could be made only when the source data accurately coded, classified
and reported in time. The determination of direct material cost used by the factory is based on
generally accepted accounting principles (GAAP). The accounting treatments for raw materials
are described as follow at different stage of production.
For those items not paid through payroll but through other source documents like purchase of
uniform or settlement of medical bills the entries are as follows.
Medical ----------------------xxx
Insurance --------------------xxx
This implies that the cost accumulation for direct labor cost is based on the historical cost
concept. This is an accepted treatment of costs for external reporting and internal purposes.
Work in process-------------------------xxx
Short-run pricing decisions typically have a time horizon of less than a year and include
decisions such as (a) pricing a one-time-only special order with no long-run implications and (b)
adjusting product mix and output volume in a competitive market.
Long-run pricing decisions have a time horizon of a year or longer and include pricing a
product in a market where there is some leeway in setting price. Two key factors affect short-run
pricing. (1). Many costs are irrelevant in short-run pricing decisions. These costs will change in
the long run and therefore will be relevant. (2). Short-run pricing is opportunistic. Prices are
decreased when demand is weak and competition is strong and increased when demand is strong
and competition is weak. As we will see, long-run prices need to be set to earn a reasonable
return on investment. Long-run pricing is a strategic decision designed to build long-run
relationships with customers based on stable and predictable prices. A stable price reduces the
need for continuous monitoring of prices, improves planning, and builds long-run buyer–seller
relationships. But to charge a stable price and earn the target long-run return, a factory must,
over the long run, know and manage its costs of supplying products to customers. As we will see,
relevant costs for long-run pricing decisions include all future fixed and variable costs. There are
two different types of long run pricing decision, these are:
Market-based
Cost-based, which is also called cost-plus
According to the response of accounting department manager of Huda Flour Factory the industry
uses market based /competitive based pricing approach/model/ because it operates in competitive
market Companies operating in competitive markets use the market-based approach. The items
produced by one factory are very similar to items produced by others. Companies in these
markets must accept the prices set by the market. Because of this Huda Flour Factory uses
market (competitive based pricing model).
As we inferred from the data obtained from the accounting department manager the factory apply
what the principle of cost accounting says regarding the pricing models. The factory is operated
in competitive market it uses competitive based pricing model. This implies that the factory is
in line with generally accepted pricing system used internationally.
Customer, competitor and cost are the major factors that affect the pricing decision of the
factory. According to the response of accounting and cost department managers of Huda Flour
Factory, the base of setting selling price of the factory are market/competitor/, customer and
costs. Since the factory operates in the competitive market the base to set selling price is the
market/demand and supply/ to compete with its competitors, to set its selling price the factory
first see the other similar distributors selling price and then set its selling price and the other base
that the factory use as a base for setting selling price are customers purchase power influence
price through their effect on the demand for a product or service of the factory and also it
considers the purchasing power of their customers. Since the factory is a government
development organization the price of the product is lower than the other producers’
/competitors/, sometimes it sells its products with loss to attract customers. This implies that the
major factors that affect the price determination of the factory’s product is customers.
4.6. Role of cost accounting for the management for the fixation of selling
price
As the cost accounting and finance manager of Huda Flour Factory says that cost accounting
play a vital role in the management for the fixation of selling price by providing necessary data
for the management in setting selling price like cost data’s and participate in the fixation of
selling price.
CHAPTR FIVE
The main objective of the study is focuses on assessing the product costing and pricing practice
of Huda Flour Factory. Based on the result of analysis and discussion issue of the research in
the previous chapter, the following conclusion and recommendation are drawn.
5.1. Conclusion
From the analysis this study has made, the following specific conclusions:
As the data obtained from the accounting and cost department managers of Huda Flour
Factory through structured interview the Factory uses process product costing system
because the factory produces mass of identical or similar products. Products with similar
feature treated under process costing system.
As the data obtained from the accounting department manager through structured
interview the factory uses competitive based pricing model. Because it operates in
competitive market.
As the data obtained from the cost and accounting department manager of Huda Flour
Factory the factory use different bases such as market/demand and supply/, purchasing power
of customers and cost even if the factory uses competitive based pricing approaches to set its
selling price the major factor that affect the selling price of the factory is customers.
From the data obtained from the manger cost accounting department plays a vital role to
managements for the setting of selling price by providing necessary information like cost
data’s to management, even if the factory use market based pricing model.
5.2. Recommendation
In this part this study will try to give certain recommendation that can help the factory’s to improve
their product costing and pricing practices and to be strong competitors in the future business
world. From the data obtained the researchers has given the following recommendations:
o The accounting treatment used in the receipt of the items in to stores in good receiving note
debited work in process inventory as production cost for raw materials and similarly the entry
used in direct labor cost accumulation is direct labor expense to be debited instead of cost,
the practical is different from its theoretical part of the cost accounting system in Huda Flour
Factory. Then the factory should match the practical and theoretical parts of the cost
accounting system.
o As the accounting and cost department manger says Huda Flour Factory uses process costing
system. Products with similar feature treated under process costing and product having
different feature are grouped based on their similarity are treated under job-order costing
system. The factory appropriately applies what the cost accounting system says. Therefore it
should be continue by applying these principles because identical or similar unit of products
are mass-produced, not processed as individual jobs, process costing is used to calculate an
average production cost for all units produced.
o As the data obtained from the accounting department manager through structured interview
the factory uses competitive based pricing model. The factory should differentiate his
product for pricing because the factory has competitors and the major factor that affect price
determination are customers.
o Generally, as we inferred from the data obtained from the manger of Huda Flour Factory the
factory apply the cost accounting system related to costing and pricing system, then the
factory strengthen its effort to apply appropriately cost accounting systems.
MEKELLE University
College of Business and Economics
Department of accounting and finance
INTERVIEW:
This interview is designed by Mekelle University Student College of business and economics
department of Accounting and finance student for the purpose of the senior research project work
in the partial fulfillment of the award of bachelor degree of art in accounting and finance. The
main objective of this interview is to collect appropriate information that helps to conduct
research on the title of assessment of product costing and pricing practice of Huda Flour Factory
and to find some solutions. I would like to assume all the information that you will provide is
confidential. Therefore the success of this study depends on your careful response for each
question. Thank you in advances for cooperating and spending your precious time for this
purpose.
INTERVIEW QUESTIONS
1. What are the main products your factory produces?
2. What pricing model that the factory use? Why it select? What are the bases for select-
ing that model?
3. Which product costing system that the factory uses? Why? What are the bases for se-
lecting that costing system?
4. What bases that the factory uses to set selling price of your product?
5. How the factory set selling price of your product?
6. What are the factors that affect the selling price determination?
7. How do you classify production costs?
8. How does the product cost (material, labor and overhead costs) are recorded in the ac-
counting department?
9. How costs are accumulated and allocated?
10. What are the main raw materials that the factory used to produce the products?
11. Form where do you purchase raw materials?
12. How do you charge the labor costs?
13. What are the roles of cost accounting for the management for the fixation of selling
price?
14. What did you say about the product costing and pricing practice of the factory?(it
could be positive or negative )
Reference
1. Arora, N (1997) “Cost Accounting” 1st edition.
2. Cherrington, O (1998) “Cost Accounting” 18th edition. San Francisco
3. Coulthrst, N, (1999) “Cost Accounting: Principles and applications” 4th edition.
4. Garrison, Noreen& Brewer, (2006) “Managerial accounting” 11th edition.
5. Hilton, Maher, Selton, (2003) “Cost management strategies for business decision” 2 nd
edition.
6. Horengren, T.foster, (2004) “Cost accounting and managerial emphasis” 14th edition.
7. Horngren, T.Foster, G.Datar, G. (2003) “Cost Accounting: A Managerial decision” 11th
edition. New York
8. Mc Graw-Hill (2001) “Intermediate Accounting” 5th edition
9. Ronald W.Hilton (2002) “Managerial Accounting” 5th edition