Cost Accounting

Outcomes Assessed:

1. Apply accounting techniques related to inventory, labour, and overheads.
2. Use different costing techniques such as marginal, absorption, job and batch costing.

Instructions to the student:

1. You are required to answer all
2. Students should complete the assignment individually.
3. This assessment would be weighted to 20% towards the final marks.
4. Choice of the organization (used for this assignment) should be approved by the instructor.
5. The report should have a table of contents, answers to the questions and appropriate references.
6. Use Harvard style of referencing to do this assignment.
7. The report must have a cover page indicating the module title, name of student, name of faculty and date of submission.
8. The report should be done in Word, font size 12, font style Times New Roman, text color black, colors can be used ONLY in appendices, if required.
9. The report should be submitted through Moodle before the deadline, which is as mentioned in the module Information Guide.
10. As per MEC policy, any form of violation of academic integrity will invite penalty. Plagiarized documents, in part or in whole, submitted by the students will be subject to this policy. (Refer Plagiarism Policy in detail in Page 2)
11. Assessment is subject to MEC viva policy.
12. Late submission shall be penalized as per the norms of MEC mentioned in the Module Information Guide.  Penalty for late submission – 5% of the maximum mark specified for the assessment is to be deducted for each working day for a maximum of one week.

INTRODUCTION.. 3

TASK 1. 3

1. General description of Al Maha Petroleum.. 3
2. Identification of manufacturing and non manufacturing overheads. 4
3. Method of overhead allocation. 5
4. Accounting techniques of inventory and labour methods. 7
5. Costing technique used by the organization and its effectiveness. 8

CONCLUSION.. 10

REFERENCES. 11

INTRODUCTION

Cost accounting is a process of capturing cost of any production process of the organization to understand the cost of each process. This includes differentiation between fixed and variable cost of the production process. This helps in comparing the cost individually and organization as a whole so that financial performance can be measured. Al Maha Petroleum is an Oman based organization dealing in exploration of oil and gas. The organization has emerged as one on the leading organization in the oil exploration industry. This assignment describes the manufacturing and non manufacturing overheads incurred in the organization and methods of allocation of such overheads (DRURY, 2013). Later in the assignment accounting technique for inventory and labour are also discussed. The last task discusses the costing technique employed by the organization and their effectiveness in current scenario.

TASK 1

1. General description of Al Maha Petroleum

Al Maha Petroleum majorly deals in oil exploration and manufacturing activities also known as Arabian Oryx. It was founded in 1993 and currently it is having petrol station in nearly 200 service stations. It deals in exploration of oil including auto services and convenience store. Al Maha majorly supply high quality, retail petroleum based products and lubricants etc. The organization emphasis on providing high quality customer services for the money value they pay. Distribution channels of the organization are stretched throughout the country and locations chosen are easily reachable by the customers. Apart from distribution facilities it also provides related services such as convenience stores, aircraft refuelling, smart card payment services, auto services etc.

Additionally the organization also supports to aviation industry and harbour ports. The organization contributes to the country’s cultural and economic development by providing high quality services. The organization works in the conditions and chooses activities that are naturally favorable and does not harm the environment. By providing innovative, reliable and sustainability in services the organization has successfully created an environment of trust between the customers and other stakeholders (Online).

In late 1999 the organization was demerged from Oman refinery and emerged as a separate business entity to fulfil the increasing demand of the sultanates. It almost 65% investment is hold by government of sultanates and rest by an Abu Dhabi based organization. This organization incurs main cost of direct material, labour and overheads. Apart from direct expenditure, indirect expenditures such as office and administration expenses are also incurred.

2. Identification of manufacturing and non manufacturing overheads

Any business which is engaged in manufacturing activities has two different types of costs that is manufacturing and non manufacturing expenses. The costs which are directly associated with manufacturing activities are manufacturing overheads whereas costs that are incurred for related services to increase the efficiency of product are known as non manufacturing overheads. Different manufacturing and non manufacturing overheads can be bifurcated as below:

Manufacturing Overheads:

Direct material: The raw material used in the production process is known as direct material and it is essential for the production and development of final product. These are the material purchase or development costs that are directly associated with the manufacturing activities (Zimmerman and Yahya-Zadeh, 2011). These are the raw material related costs can be substantially avoided if no production was made. For example, in case of Al Maha Petroleum lubricant oil can be considered as direct material

Direct labour: Labour cost which is directly associated with the production or manufacturing activities are direct labour cost. Directly associated labour cost is considered for determination of cost of goods sold. In context with Al Maha Petroleum direct labour cost is the salaries and wages of employees who are directly associated with oil exploration and refinery activities.

Direct manufacturing overheads: Overheads can be bifurcated in two categories; direct and indirect overheads. These are the costs that are directly associated with manufacturing activities but does not form part of direct material and labour cost (Jones, 2010). These cost are either fixed or variable in nature, fixed overheads are of fixed amount irrespective of quantum of production whereas variable overheads are fixed per unit but vary due to the quantum of production activity. For instance Al Maha Petroleum incurs cost in respect of wages, insurance premium of refinery, electricity expense of factory, depreciation of oil refinery etc.

Non Manufacturing overheads:

Costs that is associated with general business functions such as administration cost, office overheads, indirect labour cost, sales and distribution expenses etc. form part of non manufacturing overheads. Costs that do not form part of manufacturing process but essential for the operations of the conduct of business are non manufacturing overheads. For instance, Al Maha Petroleum incurs office staff salaries, depreciation of assets used in office, Commission charges, selling and distribution overheads, operator’s overheads etc. The main purpose of bifurcation these costs from other direct cost is due to the different treatment in cost estimation sheet and income statement.

It can be summarized that cost that are directly associated with production process and can be avoided if no production activities are carried out, are direct manufacturing overheads. Whereas cost that are associated with general business activities and can only be avoided in event of shut down are known as indirect or non manufacturing costs (McLellan and Moustafa, 2011). These costs can be fixed or variable in nature depending upon the production process.

3. Method of overhead allocation

The overheads incurred by the organization needs to be allocated to respective products in order to find the cost of the product and the margin required to be earned. The selection of overhead allocation depends upon the organization’s choice based on level of accuracy needed and pattern of cost allocation. It also depends on the standards followed by the industry as a whole as prices wholly depends on the cost and competitor’s prices. Following are the widely used methods of allocation of overheads:

Traditional method / Plant-wide allocation: In this method of overhead allocation all the fixed overheads are aggregated and distributed on the bases of a predetermined overhead absorption rate. In this method one common account is used to pool all the overhead costs and a single rate is applied to total overhead amount. This rate is generally based on direct labour hour, machine hours, direct labour cost etc. Al Maha Petroleum uses this method when cost incurred is substantially same for the products, for example the cost of fuel consumption is based on the uses of machine capacity. Further, any under-absorption or over-absorption is adjusted. Thus, all the fuel cost can be allocated on the basis of machine hour used in the respective products (Snyder and Davenport, 2013).

This method is easy to employ as all the costs are aggregated and distributed on the bases of single element. It happens to be useful where products manufactured are of same nature and require almost same level of activity. However, allocating all the expenses on single rate irrespective of the amount of expense incurred on product will provide with wrong results (Lewis, 2013). This may provide higher cost where actually the cost incurred was low which will affect the prices adversely. Thus, using this method is appropriate only where activity level is almost same in all the products. Oil extraction and processing entities usually incurs same activity in all the product hence using traditional method of costing is preferred.

Activity based costing: Under this method firstly costs of the organization are bifurcated according to the supporting activity. For example, machine overheads are allocated on bases of machine hours, set up cost is allocated on bases of number of setups. This method is considered as better approach to overhead allocation rather than plant wise approach as this method distribute the fixed cost depending on the activities associated with the product manufacture (Popesko, 2010).

Although this method is a better approach still it unnecessary burden on large scale organizations where are number of products are produced. In large entities it is practically not possible to separately account for all the overheads and distributing them in all the products. Further, if ABC is not used industry wide then using this costing method may represent higher/ lower cost than competitor, high cost can affect the product pricing adversely (Chea, 2011). In Al Maha Petroleum this method is used for allocation of overheads where it is practically possible to determine the cost separately and activities associated with them.

Operating costing: In continuous and well defined costing process, cost accounting is done on the basis operations and process. This method is most appropriate in circumstances where output of one process is transferred to another process as input. In this method cost is ascertained at the end of each process and each unit cost is also ascertained. Al Maha Petroleum has employed operating costing as it has a continuous process and result of one process is transferred to another (Sun.et.al. 2011).

Thus overheads can be allocated using various methods and these methods are useful in determining the cost of production. Generally all variable costs are directly attributable to the products but fixed costs are allocated by using allocation methods. There are additional methods of allocation such as job order costing, process costing method etc.

4. Accounting techniques of inventory and labour methods

Inventory Valuation methods

Inventories and labour costs are accounted for using techniques such as FIFO, LIFO, Average cost and weighted average etc. Inventory valuation is done for the items of raw material in stores not issued for production process (Raw material inventory) or goods engaged in production process, manufacturing not completed (Work in progress inventory) or finished goods lying in stock not sold (Finished goods inventory). It is essential to select better inventory valuation techniques in order to win over competition. Main inventory valuation methods are as under:

FIFO: FIFO stands for first in first out technique, which means the inventory which has first entered into the stores is first issued for production process. This method is used widely around the globe but it is not suitable in circumstances where inflation and price differences cannot be analysed (Muller, 2011). Thus use of this method may reflect wrong inventory value then the actual inventory in the stores.

LIFO: This method is based on the concept that newest inventory is first issued for production. LIFO stands for first in first out; it is best suitable in inflating economy as it reduces tax liability of the organization. But this method is highly regulated under international financial reporting standards.

Average cost: Under this method cost of inventory is taken as aggregate of value of inventory is divided total number of units in stock for sale. Then by using such average cost, cost of goods sold and inventory is valued (Needles.et.al. 2013).

While there are various methods of inventory valuation average cost is assumed to be the best suitable method to value inventory in oil extraction business. In As exact units sold or remaining in stock is cannot be determined reliably, average cost is widely used. Hence in reference to Al Maha Petroleum average cost method is widely used.

Labour Valuation:

Labour cost has two bifurcations that is direct and indirect labour cost. Costs related to workers that are directly associated with production activity is known as direct labour cost whereas, any other cost incurred in relation to labour is known as indirect labour cost. Direct labour cost is included in cost of production and closing and opening inventory valuation whereas indirect labour forms part of cost of goods sold. Labour cost is accounted for to reach at the correct cost of the product, management accounting purpose, decision making etc. It includes normal wages to the workers/employees, overtime premium, labour turnover and idle time etc.

5. Costing technique used by the organization and its effectiveness

For controlling cost and decision making process management uses various costing techniques. Following are the main costing techniques:

Marginal Costing: Marginal costing is a costing technique which focuses on increase in variable cost by increase of output by one unit. It is used in ascertaining the variable cost charged to production and all other costs. Variable cost varies as per the production level whereas fixed cost remains same in all circumstances. In marginal costing, only variable costs are included for ascertaining the cost per unit and fixed cost is totally excluded while calculation cost of production. It works on the concept that fixed cost is incurred irrespective of level of production.

Al Maha Petroleum uses this costing method in case of high competition in the oil and gas industry. Thus, the organization continues the production if prices charged is able to cover the variable cost. As fixed cost does not vary due to the production activity hence in long run fixed costs are expected to cover (Fisher and Krumwiede, 2012). Thus, this technique of differentiating variable cost from fixed cost is most suitable in highly competitive environment where prices charged by competitors are lower than cost of the organization.

Absorption Costing: In this costing technique all the manufacturing fixed overheads are aggregated and allocated to the products based on one single activity. Fixed overheads expected to be incurred are absorbed using a pre determined rate. Inventory valued under this method consist both variable and fixed overheads hence, it is also considered as full costing method. In any other fixed overheads are not considered while calculating cost per unit (Davies and Crawford, 2011).

The main advantage of using this is it shows accurate profit margin. It has granted recognition by various costing institutions. As Al Maha Petroleum is one of the leading oil extraction and manufacturing organization it has price determining capabilities. Hence using absorption costing for price determination helps the organization to decide the prices after considering the entire variable as well as fixed overheads. It also contains the concept of under absorption and over absorption of fixed cost which clearly shows the efficiency or inefficiency of production department (Gupta.et.al. 2010).

As disadvantages are always inevitable this technique also has its cons. It is not very much helpful in managerial decision making as actual cost incurred due the product is not ascertainable. Another thing is including fixed cost as per the absorption rate is not justifiable as it is not directly associated with the production. Apart from these it also main issues of inclusion of fixed cost in inventory valuation, not helpful for flexible budgets etc.

Job Costing: For a particular order job costing technique is used to ascertain the total cost and order quotation. Job costing is a technique of costing, helpful for determining cost to be incurred for any specific order. It considers account of all direct, indirect, variable and fixed cost associated with any specific order. Any cost which will not be incurred if order is not accepted in included while determining job cost. Thus, quotation can be made as per the cost estimated.

Al Maha Petroleum deals in aviation industry as well. As and when the order for aviation fuel is received, management decides the offer to be accepted or not on the basis of such job costing. This helps the organization to determine the expected cost and profit margins required and help in determining the prices for such order. Hence it can be said all the costing techniques are useful depending upon the circumstances and importance of the cost (Greenberg and Schneider, 2010).

CONCLUSION

This assignment has discussed general cost overhead elements of oil manufacturing organization Al Maha Petroleum. It has focused on various manufacturing and non manufacturing overheads, their methods of allocation to the products manufactured. Further, inventory and labour valuation techniques such as LIFO, FIFO, average cost etc. are explained and their relevance in current scenario is discussed. In the last task, costing techniques such as marginal costing, absorption costing are discussed. Thus, cost accounting is necessary in order to reach at the exact cost of production, this will help to determine the cost and required margin. Cost accounting process is useful for all type of manufacturing units.

REFERENCES

Books and Journals:

Chea, A.C., 2011. Activity-based costing system in the service sector: A strategic approach for enhancing managerial decision making and competitiveness. International Journal of Business and Management, 6(11), pp.3-10.

Davies, T. and Crawford, I., 2011. Business accounting and finance. Pearson.

Drury, C., 2013. Costing: an introduction. Springer.

DRURY, C.M., 2013. Management and cost accounting. Springer.

Fisher, J.G. and Krumwiede, K., 2012. Product costing systems: Finding the right approach. Journal of Corporate Accounting & Finance, 23(3), pp.43-51.

Greenberg, R.K. and Schneider, A., 2010. Job order costing: A simulation and vehicle for conceptual discussion. Academy of Educational Leadership Journal, 14(3), p.39.

Gupta, M., Pevzner, M. and Seethamraju, C., 2010. The implications of absorption cost accounting and production decisions for future firm performance and valuation. Contemporary Accounting Research, 27(3), pp.889-922.

Jones, M.J., 2010, June. Accounting for the environment: Towards a theoretical perspective for environmental accounting and reporting. In Accounting Forum (Vol. 34, No. 2, pp. 123-138). Elsevier.

Lewis, W.A., 2013. Overhead costs (Vol. 6). Routledge.

McLellan, J.D. and Moustafa, E., 2011. Management Accounting Practices in the Gulf Cooperative Countries.

Muller, M., 2011. Essentials of inventory management. AMACOM Div American Mgmt Assn.

Needles, B.E., Powers, M. and Crosson, S.V., 2013. Principles of accounting. Cengage Learning.

Popesko, B., 2010. Activity-based costing application methodology for manufacturing industries. E+ M Ekonomie a management, (1), p.103.

Snyder, H. and Davenport, E., 2013. What does it really cost? Allocating indirect costs. Asian Libraries.

Sun, A., Davis, R., Starbuck, M., Ben-Amotz, A., Pate, R. and Pienkos, P.T., 2011. Comparative cost analysis of algal oil production for biofuels. Energy, 36(8), pp.5169-5179.

Zimmerman, J.L. and Yahya-Zadeh, M., 2011. Accounting for decision making and control. Issues in Accounting Education, 26(1), pp.258-259.

Online:

Al Maha Petroleum, 2017 [Online], Accessed through < http://www.almaha.com.om/ >, [Accessed on 28 may 2017]