COST ACCOUNTING

EXECUTIVE SUMMARY:

The report is an understanding of a case study on Jacob's Meat Limited which is using the absorption costing. The report provides an overview of reasons due to which Adelaide Company exists in the market in the long-term and also provides information on major reasons for the difference in absorption costing and activity-based cost. The adsorption cost is calculated here in the case of Jacob's meat limited and also provides the target cost at which the company can compete in the market. There are details provided of non-value-added cost which has no direct impact on the value of the product and also provides a view on the recommendation of the accountant.

REASONS FOR PROFIT IN LONG-TERM ADELAIDE COMPANY:

· QUALITY OF METTWURST:

The quality of “Mettwurst” produced by Adelaide Company is the same as the quality of Jacob's Meat Limited at a low price. The quality of meat is liked by the customers due to which “Mettwurst” sales down of Jacob’s Meat Limited. The quality with low cost helps the company to achieve the market share which is currently held by Jacob’s Meat Limited.

· COST OF PRODUCTION:

The company has used updated techniques of costing which helps the company to maintain the lowest price of the product with effective mark-up. The cost of production plays a vital role in the price calculation and profitability of the company. (Owusu, & Alhassan, 2020) Adelaide Company has minimum cost due to the latest techniques of costing calculation and considers the variable cost for production.

· LATEST MACHINES:

The company is using fancy new machines which have an effective capacity of production. As Jacob's Meat Limited has used machines with limited capacity such as load mincer, unload mincer, load mixer, unload mixer which activities have to be performed more than once per batch. While the activities are performed in larger than existing batch size which helps in maintaining the effective costs.

· INCREASE IN THE MARKET SHARE:

The low cost and effective quality of product help Adelaide company to maintain the business in the long-term. The revenue of the company will increase and profitability on production also increases as the company is focusing on variable cost and reducing the fixed cost. (Ringelstein, 2018) The increase in the market share helps the company to further increase the price and profits in the following years.

CALCULATION OF COST PER STICK:

The company is using the absorption costing system by which the price is calculated using the cost-plus 40% percent mark-up. The existing price per 500-gram stick is $ 7 which includes the 40% percent mark-up on cost. Therefore the cost per stick is as follows:

Cost per stick =Price per stick / (1 + Mark-up)

=$ 7 / (1 + 0.40)=$ 5 per stick

According to the absorption costing the cost per unit of the stick is $ 5 per stick according to the cost plus mark up the price. The Mark up on the cost is 40 % that means the sale price is 140 % of the cost. And therefore the cost is $ 5 per stick as per the absorption costing techniques.

KEY CAUSES OF THE DIFFERENCE BETWEEN THE ABSORPTION COST AND THE ACTIVITY-BASED COST PER UNIT:

The basic difference between the absorption costing and the activity-based costing can be accessed based on the below-mentioned points:

• Absorption costing is a method in which the whole fixed cost is spread over the units of production irrespective of the activities performed in such product whereas in activity-based costing cost per activity is identified and calculated and the cost is spread over the production of the product based on the activities performed in the production of the unit. The activity-based costing is more important and tactful as compare to the absorption costing because it will provide more accuracy in the production of the product.
• The absorption cost is not correct for costs in this case as the cost should be apportioned and distributed between the various units of production. In this method, the company is spreading the overhead costing of the product on the products based on the direct labor hour basis that is not a suitable method for spreading the overhead cost. (Lu, Wang, Wu, & Cheng, 2017) In activity-based costing the overhead cost of the factory is spread over the units based on the activates performed on the product and the basis of the per activity rate.
• The irrelevant cost of the production that is not related to the product is not unnecessary spread on the product that will lead to the correct cost and the pricing of the product. The correct pricing of the product is providing a competitive edge and the price of the company is competitive in the market.
• The absorption costing method is a traditional old method for calculating the cost of the product whereas activity-based costing is the new scientific method of costing that is used for identification of the costing of the product effectively and correctly comparative to the absorption costing. (Lueg, 2020).

TARGET COST THAT IS REQUIRED BY JACOB TO MEET WITH THE COMPETITION OF THE MARKET AND GAIN THE REQUIRED MARK UPON THE COST OF THE STICK:

In the aforesaid case, Mr. Jacob is selling the stick for $ 7 per stick of 500 grams and the competitor Jacob sold the stick for $ 5.5. to compete the Jacob should sell its sticks for $ 5.5 per stick because in a competitive market it is not possible for Mr. James to charge more in the market for the per stick. Therefore, the company should review its pricing of the product so that the company can be in completion and preserve its market share in the market. 

The standard mark-up that is required by Jacob is 40 % of the total cost calculated by Jacob. Mr. Jacob wants to maintain its markup in the future business so that there should be no loss in the mark up by Jacob. (Klenert, Mattauch, Combet, Edenhofer, Hepburn, Rafaty, & Stern, 2018) Therefore, it is required by Mr. Jacob to reduce the cost of the stick so that the sticks can be sold by Jacob at competitive prices.

The price at which the sticks are sold by the competitor Adelaide is 5.5 so Mr. Jacob cannot charge more than the $ 5.5 price per stick. And mark-up required by the company is 40 % on the cost therefore the target cost for Mr. Jacob is 5.5 /1.4 *1 = $ 3.93 per stick.

The target cost per stick of the product is $ 3.93 per stick. 

NON-VALUE-ADDED ACTIVITIES:

The non-value-added activities refer to the activities that do not increase the quality of the product and also not important for the production process. (Pei, & Shang) Jacob Meat's Limited can eliminate these activities or reduce the cost of these activities for achieving the target cost as calculated above. The non-value-added activities in the production of Mettwurst are as follows:

· DISPOSAL OF SUBSTANDARD MEAT:

The cost of disposal of substandard meat is not part of the production and also it has no impact on the quality of meat. The cost of inspection also helps in identifying the substandard meat, while the disposal cost incurred by the company for substandard meat has no direct impact on the cost of production of Mettwurst.

· MOVE TO THE MINCING ROOM:

The cost of moving the product from one point to another point is a non-value-added cost as the cost of moving to the mincing room does not helps to improve the quality of the product. (Wegmann, 2019) The activity of moving the meat to the mincing room is referred to as waste because it does not enhance the value of the product.

· OPERATE MINCER:

The cost of setting up the mincer or operating the mincer is a non-value-added cost as it is not able to increase the value and quality of the product which is $ 1500 for 5000 stick.

· MOVE TO THE MIXING ROOM:

The cost of moving the meat to the mixing room is a waste cost which does not help to improve the value of meat. The cost of moving the meat to the mixing room is $ 360 for 5000 sticks which is not adding any value to meat. (Jing, & Songqing, 2011).

· MOVE TO THE PACKING ROOM:

The cost of moving the meat to the packing room of $ 300 for 5000 sticks is also a non-value-added cost which is a waste cost and has no direct impact on the value of meat.

· MOVE TO SMIKEHOUSE:

The cost incurred by the company for moving the meat to smokehouse of $ 400 for 5000 stick is related to non-value-added cost as has no direct impact on the value of Mettwurst’s quality.

· MOVE TO THE TRUCK:

The amount of $ 1000 for 5000 stick for moving meat to the truck after packing and smoke is a non-value-added cost that is not directly related to the value of the product. (Ojua, 2016).

Therefore, based on the above explanation it is found that the total cost of $ 4540 for 5000 stick is a non-value-added cost that has no impact on the value of the product.

RECOMMENDATION OF ACCOUNTANT FOR REPORTING:

The accountant of Jacob’s Meat Limited has recommended that the company should use variable costing instead of absorption costing. The recommendation provided by the accountant for reporting the income statement and the balance sheet of Jacob’s Meat Limited is incorrect as accounting is based on the actual expenses incurred by the company whether it is fixed cost or variable cost. As per rules and regulations, the company is required to show the actual financial position of the company which is based on complete disclosure. (Waddock, 2004) The only use of variable costing breach the account laws and regulation of complete disclosure of all expenses in income statement and disclosure of actual financial position in the balance sheet which is calculated after considering all cost whether the cost is related to the production process or not such as marketing expenses, rent, salary, repair, and maintenance, etc. which the company is liable to incur and also required to report in the financial statements of the company. Therefore, the recommendation of the accountant is incorrect in this case.

CONCLUSION:

The case study is based on the absorption costing and batch costing and their impact on the price of meat that is sold by Jacob's Meat Limited in the market. The new competitor Adelaide Company has entered the market with the same quality meat at the price of $ 5.5 per stick 500 gram which is sold by Jacob's Meat Limited at $ 7 per stick 500 gram. The company is using absorption costing also used the old method of production which increases the cost per stick which can reduce by identifying the non-value-added and set the target cost based on which the price of the product should be calculated. The absorption costing is the major cause of the high cost of Jacob's Meat Limited which can be controlled by activity-based accounting; however, the income statement and balance sheet are required to prepare including both variable and fixed cost.