Cost Accounting for SleepEase Ltd

Managerial Accounting for Sleepease Ltd.

"Identify, discuss and critically evaluate the advantages and problems of using the following costing methods for internal reporting purposes":

absorption costing; marginal costing.

"Refer to the Sleepease case as and when necessary"

absorption costing

The absorption costing is the type of managerial costing where both the variable and fixed costs are charged to process or product. Thus, "absorption costing is a method for appraising or valuing a firm's total inventory by including all manufacturing costs as product costs, regardless of whether they are variable or fixed and therefore it is frequently referred as the full cost method." (Nawaz, 2013 p 50).

Accordingly, the company will be able to determine costs of a product after determining both the variable costs and fixed costs. Sleepease will derive several benefits from using the absorption costing for the production of their product.

First, the absorption costing will assist the company to take the account of all the production costs because the absorption costing will take into account all the fixed costs such as utility bills, facility rental and salaries. Moreover, the absorption costing will provide the accurate picture of the company profitability than the marginal costing. (Noreen, Brewer, Garrison, 2013). Additionally, the absorption costing is the best estimate the job costing for the Sleepease because the costing method considers all the element of the fixed overhead values of the inventory. (Lay, 2011).

Despite the benefits that Sleepease will derive from using the absorption costing, however, the absorption costing can cause organizational profits to appear better than the actual profit in the accounting period. Moreover, the absorption costing is not appropriate for the analysis volume and cost of production. Typically, management may face challenges in making decision about the operational efficiency since it may be difficult to determine the cost variation at different production levels.

B. Marginal Costing

Marginal costing is the cost production where a change in the total costs arises from making or producing additional item. (Murthy, Gurusamy, 2009). In other words, the marginal costing arises when an increase in the aggregate cost occurs because of an increase in the production of an extra unit of product. Thus, marginal cost is the cost incurred by producing an additional unit of an item. (Bhattacharyya, 2011). The major reason for analyzing the marginal costs is to identify the point a firm can achieve the economic of scale. Based the analysis of the marginal cost model, when there is a change in the number of items produced, there will be a change in the total costs of production. In most cases, the marginal costs deal with the change in the variable costs with there is a change in the total item produced.

"Under the marginal costing, only those manufacturing costs that vary with output are treated as product costs. This would usually include direct material, direct labor, and the variable portion of manufacturing overhead. Variable costing is sometimes referred as direct costing or marginal costing. Fixed manufacturing overhead is treated as period cost just as selling and administrative expenses. Thus in inventory valuation or in the cost of goods sold fixed manufacturing overhead is not treated as product cost in marginal costing technique." (Nawaz, 2013 p 50).

The benefit of marginal costing is that it assists in understanding the impact of variable costing on a production of an item. Typically, the marginal costing assists a firm to control costs of production, and help in avoiding the unnecessary fixed overhead costs. By using the marginal cost model, management will be able to concentrate on producing the products that have the lowest variable cost.

Moreover, the marginal costing assists management to understand the impact of cost on profit fluctuation in the volume of sales. The marginal costing will also assist Sleepease to make the short-term profit planning which can be realized through the break-even profit charts and graph. The company can also make a comparative profit analysis of the different type of products produced, which will assist the management to make a decision regarding a particular product. Another benefit of marginal costing is that it is easy to implement because it focuses on the variable and fixed cost concepts. Moreover, the marginal costing delivers better information, which is useful for managerial decision. It also reveals information about the relationship between cost, volume and price. The marginal costing will also assist the company to control the cost of production by avoiding unnecessary allocation of the fixed overhead costs, the strategy will assist the management to concentrate on maintaining and achieving the consistent and uniform marginal costs. (Khan,., & Jain, 2003).

Despite the benefits that the Sleepease can derive from the application of marginal costing, the problem of using the marginal costing is that it will be difficult to separate the variable costs and fixed costs clearly, which may lead to a misleading result. Moreover, the marginal costing will not applicable for the Sleepease when the company decides to produce multiple products. (Horngren,. and Sorter, 1964):Moreover, the application of marginal costing is not suitable for all industry. For example, Sleepease may not be able to use the marginal costing to do the contract business. By eliminating the fixed overhead, the company may face challenges in determining the selling price. Moreover, the marginal costing can not provide the standard method for the budgetary control. The application of marginal costing may also lead to the undervaluation of stock. (Rajasekaran, & lalitha, 2010).

Moreover, "Marginal costing technique remains no longer useful for inventory valuation in case of abnormal loss." (Nawaz, 2013 p 54).

Task 2

"Produce absorption and marginal cost profit statements for Sleepease for the year ending 2014 and for the year ending 2015."

SleepEase Marginal Cost profit statements for 2014

First, the study calculates the company variable production cost as follows:

Variable Production Cost Per Max-ease bed in 2014

£

Direct materials

Direct labor

Variable manufacturing overhead

Variable distribution cost

50

Total

£650

The next step is to calculate the value of production and inventory value at £650 per unit

SleepEase's Marginal costing income statement 2014

£

£

Sales

900 units x £1,000

900,000

Less Cost of Sales

Opening Inventory

0

Cost of Production (Variable)

£650

Value of Opening Inventory

1,200 x £650

780,000

Less Closing Inventory

300 units x £650

(195,000)

(585,000)

315,000

Less Fixed Costs

Total fixed manufacturing overhead costs

200,000

Total fixed selling and administrative costs

67,000

(267,000)

Profits

£48,000

SleepEase Marginal profit statements for 2015

Variable Production Cost Per Max-ease bed in 2015

£

Direct materials

Direct labor

Variable manufacturing overhead

Variable distribution cost

50

Total

£650

SleepEase's Marginal costing income statement 2015

£

£

Sales

1000 units x £1,000

1,000,000

Less Cost of Sales

Opening Inventory

Cost of Production (Variable)

£650

Value of Opening Inventory

800 x £650

520,000

Less Closing Inventory

0

(520,000)

480,000

Less Fixed Costs

Total fixed manufacturing overhead costs

200,000

Total fixed selling and administrative costs

67,000

(267,000)

Profits

£213,000

Absorption costing income statement

SleepEase's Absorption costing for income statement 2014

First, we calculate the company variable production cost as follows:

Variable Production Cost Per Max-ease bed in 2014

£

Direct materials

Direct labor

Variable manufacturing overhead

Variable distribution cost

50

Total fixed manufacturing overhead costs

200,000

Total fixed selling and administrative costs

67,000

Total Cost

£267,650

The absorption cost of producing one unit of Max-ease bed is

Total cost/ Units of output

=£267,650/ 900

=£267.38 per unit

SleepEase's Absorption costing 2014

£

£

Sales

900 units x £1,000

900,000

Less Cost of Sales

Opening Inventory

0

Cost of Production per unit

£267.38

Value of Opening Inventory

1,200 x 267.38

320,856

Less Closing Inventory

300 units x £267.38

(80,214)

(240,642)

Profits

659,358

SleepEase's Absorption costing income statement 2015

£

£

Sales

1000 units x £1,000

1,000,000

Less Cost of Sales

Opening Inventory

Cost of Production

£267.38 per unit

Value of Opening Inventory

800 x £267.38

213,904

Less Closing Inventory

0

(231,904)

Profits

£786,096

Task 3

"Using the data provided in the Sleepease case and your profit statements produced in task 2, explain the board's decision not to pay Mr. Spenser a bonus and provide opposing arguments as to why Mr. Spenser should receive a bonus for his performance in 2015."

SleepEase

After the fiscal year has ended, the management has decided to pay the My Spenser a bonus of total amount of £10,000 id he is able 10% of the increase in the sale on 2014 and providing the 10% on the net profits. However, the management did not pay Mr. Spencer the bonus of £10,000 because they believed that he did not meet their target. By using the marginal costing method for the 2014 income statement, the 10% of sale is 10% x 900,000 =£90,000

10% of Profit is:

10% x £48,000 =4,800

Based on the 2015 income statement, the company realized the sales of £1,000,000 which is more than the actual company sales target (900,000 +£90,000 =990,000).

The company realized the £213,000 which is more than net profit target (£48,000 +4,800 =£52,000). Based on the result of the sales and net profit analysis, Mt Spencer has met the target set by the company, thus, Sleepeasy should pay him the bonus of £10,000 because he has been able to meet the target set by the company.

By using the absorption cost method, Mr. Spenser has also been able to increase 10% in sales and 10% of the net profit for 2015 income statements because the company net profit is for 2015 is £786,096, which is more than company net profit target (659,358 +65,935 =£725,293).

Thus, the analysis of the company income statement for 2014 and 2015-year ending reveal that Mr. Spenser is entitled to the £10,000 bonus.

The paper argues that the board of director should pay Mr. Spencer the bonus of £10,000 because he has been able to meet the company targets 10% increase in sales and net profit. However, the marginal costing that the company uses to determine the net profit is not an appropriate strategy to estimate the company profitability. Typically, the marginal costing overvalues the cost of production and make the net profit to be reduced than the actual target for the net profit. On the other hand, the absorption costing is appropriate to calculate the income statement of a company because it allows the company to apply part of the company fixed costs to the production costs. Moreover, the absorption costing assists in assigning the cost of a unit of items on fixed expenses. This, the paper advises the board of director to desist using the marginal costing because it is not appropriate to make an effective decision. Thus, the paper suggests that the board of should consider using the absorption costing for the cost of production.

Task 4

'Discuss why performance measurement systems and rewards should focus on performance that employees can control. Your answer must include a critical evaluation of financial and non-financial performance measures."

Performance measurement is the management policy that makes employee focusing on their job. It is the responsibility of the management to implement the performance management system to make employees improve organization productivity. Different benefits that organization can drive from the performance measurement:

First, the performance measurement will assist Sleepeasy to derive the best from the employees. However, if an organization focus on rewards and performance measurement systems that employees can control they will be able to improve their skills because they understand that their performance will depend on their pay rise. Different strategies an organization can employ in implementing performance measurement. For example, the company can give the employees a target and if they are able to meet the target, they will be entitled to the bonus. This strategy will make employees delivering their best for the production of goods and services. Moreover, the performance management will make employee improving their skills because they will realize that their skills will assist them earning rewards.

Reference

Bhattacharyya, D. (2011). Management Accounting. New Delhi: Pearson

Horngren, C.T. and Sorter, G.H. (1964): An Evaluation of Some Criticisms of Relevant Costing" The Accounting Review, 39(2) :417-420

Khan, M. Y., & Jain, P.K. (2003). Cost Accounting.New Delhi: Tata Mcgraw-Hill Education

Nawaz, M. (2013). An Insight Into the Two Costing Technique: Absorption Costing and Marginal Costing. BRAND. Broad Research in Accounting, Negotiation, and Distribution. 4(1).50-61.

Noreen, E.W. Brewer, P.C. Garrison, R.H. (2013). Managerial Accounting for Managers ( 3rd Edition). Mcgraw-Hill Higher Education.

Murthy, A., Gurusamy, S. (2009). Cost Accounting (2thed.). Chennai: The Mcgraw-Hill Companies.

Lay, D. (2011). Fixed Cost vs. Variable Cost. Learn HR. Retrieved Dec 7, 2016, from http://leanhrblog.com/fixed-cost-vs.-variable-cost/

Rajasekaran, V., and lalitha, R. (2010).Cost Accounting. New Delhi: Pearson.