A poultry firm and concepts of costing, budgeting, budgetary targets


Introduction

Cost can be defined as the amount of resources, usually measures in monetary terms, sacrificed to achieve particular objective (McLaney & Atrill, 2008:281). This report will consider a specific poultry firm to analyse the concepts of costing, budgeting, budgetary targets and provide implementation details and recommendations based on the analysis. The analysis, implementation and recommendations of costing and budgeting would be done on the basis of the learning in this course and my previous work experience.

Costing

There are different types of costs associated with a manufacturing firm. Fixed cost is the company spending which is autonomous on the amount of operations. Variable cost changes according to the capacity of production. Moreover, product cost is the cost involved in producing or purchasing a product. Period cost is non- manufacturing cost which is not included in the cost of purchase or production. Furthermore, traditional cost accounting has been one main, widely-used approach to costing both internally and externally. This general ledger (GL) system performs as the firm’s indicator measuring the healthiness and prosperity of the whole company. The conventional GL methodology can only recapitulate the firm’s everyday expenditure as per the individual account details (for example labor, material) (Narong 2009).Any expenditure and overheads are not linked to any exact activity or procedures. This shows that the firm lacks the aptitude to assess the inner competence, excellence and prosperity per product. Activity based costing (ABC) is the appropriate entirety value management solution that can increase these deficiencies. The activity based costing approach records, recapitulate and hearsays the expenses into the costs of behavior or procedure and ultimately related to each manufactured goods and clients. “Unlike traditional accounting reports that make managers react to by being happy or sad, activity based costing data makes them smarter” (Narong 2009).

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Overview of the firm

KPC farm is a hen and egg production firm. The fixed costs for KPC farm are rent, insurance, interest, real-estate taxes, wage and salaries and maintenance costs. The variable costs for KPC farm are labor, electricity, transportation. Furthermore, vaccination, food, crops cost, direct labour (assembly line workers), manufacturing overhead (indirect material and indirect labour, depreciation on plant and machinery, and utilities) are the product costs at KPC farm. Marketing costs (depreciation of delivery van, advertisement, sales commission and cold storage) and administrative costs (depreciation of land and building, management costs like salaries and travel) are period costs.

Capital Investment Cost Straight line Depreciation (Yrs)
Land £ 450,000.00 N.a No salvage value
Buildings £ 200,000.00 25 No salvage value
Equipment £ 100,000.00 12 No salvage value
Farm machinery £ 13,000.00 10 10% salvage value
Car £ 4,000.00 5 7% salvage value
Total Investment cost £
Working Capital
Hens No of hens x price per bird
Vaccination No of hens x vaccination cost
Food Price of food for first three months
Crops cost Production costs per bale x no of bales produced
Capital
Value Weight
Equity @ 18% £ 357,000.00
Debt @12.5% (interest included in total) £ 467,320.00
Total Capital £
Bank Loan Agreement to be repaid over 5 yrs
Yr 1 £75,000 Yr 2 £75,000 Yr 3 £100,000 Yr 4 £100,000 Yr 5 £117,320
New car cash purchase in Yr 5 £ 20,000.00 Depreciate over 10 years
Planning cost £ 5,000.00
Operating cost
No of hens 9000
Cost per hen £ 3.00
Weekly food consumption per 1000 hens 0.167 Per KG
Price per KG £ 0.28 £ 0.36
Vaccination per hen £ 1.00
Salaries and wages
Farm manager £ 500.00 Per week
Casual labour £ 60.00 Per week
Insurance £ 3,000.00 Per Year
Utilities £ 350.00 Per month
Fuel £ 200.00 Per month
Hen waste removal £ 1,600.00 Per year
Technical Information
Life cycle of Hen 52 Weeks
No. Of Acres 25
Production capacity
first 6 weeks 75% 4.5
Effective from week 7 to week 52 90% 41.4
Average weight effective rate 88%
Mortality rate 2.5%
Daily Egg production per hen 1
Resale price per hen in 52 weeks £ 0.50
Note: The effective rate takes in consideration waste and damage
Extra revenues items:
Revenue from cropping the land
1 crop per year (Silage) 12 Bales per acre
Production cost per bale £ 10.00
Selling price per bale £ 22.00
Note: The government has an ambitious plans to shift from battery based egg farms to free range egg farms in 4 years time, this means that the growth rate in price will begin to decline by 4% from year 5 onwards.
Price per dozen Growth rate 2% per yr £1.15
Tax Rate 35%
Inflation rate to be applied to costs and revenues excluding egg prices 3%

Design of appropriate costing system for KPC farm

The ABC systems focus on the accurate cost assignment of overheads to products. In the cost assignment view, the assignment of costs through ABC occurs in two stages: cost objects (i.e., products or services) consume activities, activities consume resource costs. In practice, this means that resource costs are assigned to various activity centers by using resource drivers in the first stage. An activity center is composed of a group of related activities, usually defined by function or process. The group of resource drivers is the factor chosen to estimate the consumption of resources by the activities in the activity centers. Every type of resource assigned to an activity center becomes a cost element in an activity cost pool. And, in the second stage, each activity cost is distributed to cost objects by using a suitable activity driver to measure the consumption of activities by products or services (Turney, 1992). Then, the total cost can be calculated by adding the various activities costs to a specific product or service. And the total cost divided by the quantity of the product can acquire the unit cost of product. In our case, the inn provides three products, lodging, hot spring use and meal serving. We define five activity centers, namely the cleaning center, the customer service center, the reception center, the cooking and foodservice center and the management center. Each activity center is composed of related activities, clustered by their function. activity based costing. Figure 1 shows the proposed costing system for optimal performance of KPC farm. Adapted from Tsai and Hsu 2008

Budgeting

The simplified Original and flexed budget for KPC farm are as follows,

Original Budget Flexed Budget
Egg Hen Egg Hen
Output units 230000 8000 241637 8775
Sales Revenue 253000 4000 265800 4387.5
Raw material 59000 1000 61985 1096
Labour 27000 1000 28366 1096
Fixed Overheads 8000 600 8404 658
Operating Profit 159000 1400 167045 1537.5

Actual

Sales Quantity Price
Eggs Unit sold (dozen) 241637 £ 1.15 £ 277,882.57
Hens Unit 8775 £ 0.50 £ 4,387.50
Total £ 282,270.07
Crops per bale 300 £ 22.00 £ 6,600.00
Total sales £ 288,870.07
Growth rate of egg price 2%
Declining rate 4%
Revenue Year 1 Year 2 Year 3 Year 4 Year 5 Year 6 Year 7
Revenues from eggs £ 277,882.57 £ 283,440.22 £ 289,109.03 £ 294,891.21 £ 283,095.56 £ 271,771.74 £ 277,882.57
Revenues from hens £ 4,387.50 £ 4,387.50 £ 4,387.50 £ 4,387.50 £ 4,387.50 £ 4,387.50 £ 4,387.50
Revenues from crops £ 6,600.00 £ 6,600.00 £ 6,600.00 £ 6,600.00 £ 6,600.00 £ 6,600.00 £ 6,600.00
Total revenues £ 288,870.07 £ 294,427.72 £ 300,096.53 £ 305,878.71 £ 294,083.06 £ 282,759.24 £ 288,870.07
COGS
Hens £ 27,000.00 £ 27,810.00 £ 28,644.30 £ 29,503.63 £ 30,388.74 £ 31,300.40 £ 32,239.41
Vaccination £ 9,000.00 £ 9,270.00 £ 9,548.10 £ 9,834.54 £ 10,129.58 £ 10,433.47 £ 10,746.47
Food £ 21,840.0 £ 22,495.2 £ 23,170.1 £ 23,865.2 £ 24,581.1 £ 25,318.5 £ 26,078.1
Hen waste removal £ 1,600.00 £ 1,648.00 £ 1,697.44 £ 1,748.36 £ 1,800.81 £ 1,854.84 £ 1,910.48
Crops cost £ 3,000.00 £ 3,090.00 £ 3,182.70 £ 3,278.18 £ 3,376.53 £ 3,477.82 £ 3,582.16
Total COGS £ 62,440.0 £ 64,313.2 £ 66,242.6 £ 68,229.9 £ 70,276.8 £ 72,385.1 £ 74,556.6
Gross Profit £ 226,430.1 £ 230,114.5 £ 233,853.9 £ 237,648.8 £ 223,806.3 £ 210,374.2 £ 214,313.4
Gross Profit Margine 78.4% 78.2% 77.9% 77.7% 76.1% 74.4% 74.2%
G&Admin
Salaries and wages £29,120.0 £ 29,993.60 £ 30,893.41 £ 31,820.21 £ 32,774.82 £ 33,758.06 £ 34,770.80
Insurance £ 3,000.00 £ 3,090.00 £ 3,182.70 £ 3,278.18 £ 3,376.53 £ 3,477.82 £ 3,582.16
Utilities £ 4,200.00 £ 4,326.00 £ 4,455.78 £ 4,589.45 £ 4,727.14 £ 4,868.95 £ 5,015.02
Fuel £ 2,400.00 £ 2,472.00 £ 2,546.16 £ 2,622.54 £ 2,701.22 £ 2,782.26 £ 2,865.73
Others £ 5,000.00
Total G&Admin £43,720.0 £39,881.6 £41,078.0 £42,310.4 £43,579.7 £44,887.1 £46,233.7
Operating Profit £ 182,710.07 £ 190,232.92 £ 192,775.88 £ 195,338.45 £ 180,226.59 £ 165,487.07 £ 168,079.74
% of OP 63.25% 64.61% 64.24% 63.86% 61.28% 58.53% 58.19%

Analysis on activity based costing and budgeting and evaluation of corrective action

According to the survey by Stratton et.al (2009), managers consider that precise overhead allotment and action price data is missing in non- activity based costing methods, while activity based costing methods deal with these requirements. activity based costing methods improve top management anxiety regarding the accuracy of cost allocations, the cause-effect rapport between share and capital consumption, the relevance of cost/profit in sequence, and the ability to inform the arrangements. The considerable gap between present usage charges of activity based costing methods and their attractiveness in perfect systems may foretell amplified usage. Specifically, activity based costing methods provide greater hold up for financial, operational, and strategic decisions. activity based costing methods are better integrated into budget and planning processes. activity based costing methods support strategic product/customer emphasis verdict better than non- activity based costing methods. Thus “activity based costing methods do indeed provide significant value to managers and the use of activity based costing provides companies with superior cost and profitability measurement systems” (Stratton et.al 2009). This analysis clearly shows that the optimal method for KPC farm in costing is ABC and the flexible budgeting and variance analysis also will be effective by preparing in the ABC environment. The existing ABC literature has emphasized the difference in assignment of overhead under ABC and traditional costing for product costing purposes, and that product costs calculated under ABC provide a better basis for making pricing decisions (Mak and Roush 1998). Furthermore effective costing and budgeting in KPC farm could be possible by controlling the factors price variance, efficiency variance, budget variance and capacity variance. The ‘variable activity cost’ could be controlled by analysing the price variance from the actual costs and flexible budget (actual quantity) and analysing efficiency variance from flexible budget (standard quantity) and flexible budget (actual quantity). The variable ‘fixed activity cost’ could be controlled by analysing the budget variance from the actual costs and budgeted activity spending and analysing capacity variance from budgeted activity usage and budgeted activity spending.

Conclusion

Over the past several years, consultants and practitioners have observed that activity based costing methods, which were developed to improve decision support and the accuracy of cost-and profit-measurement systems, are not yielding the desired results. The benefits of activity based costing include its use in making product decisions, such as pricing, design, and outsourcing. activity based costing is also useful for budgeting, performance evaluation, and planning. Customisation in the approach of ABC method and budgeting based on the firms’ nature could yield more positive results for the firms.

References

McLaney, E., and Atrill, P. 2008. Accounting an Introduction. FT Prentice Hall. Narong D. Activity-Based Costing and Management Solutions to Traditional Shortcomings of Cost Accounting. Cost Engineering [serial online]. August 2009;51(8):11-22. Available from: Business Source Premier, Ipswich, MA. Accessed February 28, 2010. STRATTON W, DESROCHES D, LAWSON R, HATCH T. Activity-Based Costing: Is It Still Relevant?. Management Accounting Quarterly [serial online]. Spring2009 2009;10(3):31-40. Available from: Business Source Premier, Ipswich, MA. Accessed February 28, 2010. Wen-Hsien Tsai, Jui-Ling Hsu Activity-Based Costing: a Case Study on a Taiwanese Hot Spring Country Inn’s Cost Calculations. 2008 Cokins G. Repairing the Budgeting Process. Financial Executive [serial online]. December 2008;24(10):45-49. Available from: Business Source Premier, Ipswich, MA. Accessed February 28, 2010. Mak Y, Roush M. Flexible Budgeting and Variance Analysis in an Activity-Based Costing Environment. Accounting Horizons [serial online]. June 1994;8(2):93-103. Available from: Business Source Premier, Ipswich, MA. Accessed February 28, 2010. Gary Cokins 2008 Repairing the budgeting process

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