Costing Methods for PCL: Process vs
. Job Costing Explained
School
New York University**We aren't endorsed by this school
Course
NURSE-GN GN
Subject
Accounting
Date
Dec 11, 2024
Pages
6
Uploaded by BarristerAtom16003
Part A: Suitable Costing Methods for PCL’s Products1. Mass-Produced Pens: Process CostingStandardized Production ProcessPCL's pen manufacturing is a high production line with slight product variation. All the pensmanufactured must be similar regarding raw material makeup, construction, and finalmanufacturing processes. In such a case, the cost of production is relatively standardized across theoperation units. Process costing is explicitly used for this type of production, where goods areproduced in large quantities and are, in some sense, identical.In process costing, the material, labor, and manufacturing overhead costs are totaled for the totalnumber of cycles completed and then apportioned over the total number of units. This leads to aremarkable uniformity in cost, which is suitable for products produced in large quantities. Sincemass pens involve a highly efficient and standardized production process, process costing allowsPCL to identify the costs attributed to this production scale correctly.Efficient cost Allocation and TrackingIn marginal costing, for the production of mass products, PCL has incurred variable costs which areas follows – The cost account for profit or loss statement of PCL is as follows: These are directmaterial costs, variable rate of wages and salaries, and variable overheads, which are comparativelyeasier to allocate to a large number of units in a mass production environment. Since variable costsare constantly incurred throughout the process, PCL can use process costing to allocate themefficiently and reduce the intricacies of cost-accounting processes while maintaining control overthe per-unit costs.Process costing effectively implements these costs due to the number of manufactured pens,minimizing the paperwork involved. For instance, if PCL manufactures 1,000,000 pens, processcosting enables PCL to spread the total variable expenses of $1,000,000 over all the units and giveseach pen a cost of $1. This means that the cost per unit remains constant, which is advantageous incases where quick decisions have to be made on the pricing of products, primarily in the massmarket.2. Custom-Made Pens: Job CostingUnique Production Requirements for Each OrderSpecial order pen instruments are, as it were, made-to-order products manufactured according to aclient's specifications. These pens usually need unique designs, materials, and special extras such asengraving, which bring different prices for every project. This is why job costing, as a costingmethod, was developed, particularly for situations like this. Job costing involves collecting the costsof each job separately and assigning the actual cost of material and labor for each order and theoverheads applied to each order.
The cost factors in producing the custom-made pens at PCL include metal casings that cost $2,000,engraving costs of $1,000, design fees of $200, and cost for prototypes of $300, as seen in the casestudy. Each cost must be assigned to the particular job to show the costs involved in an individualorder. The advantage of job costing is that it enables PCL to assign these specific costs to theparticular job, hence attracting the total cost of the order.Accurate Profitability Analysis for Custom OrdersThe second essential purpose of job costing can be identified because it enables PCL to determinethe profitability of each order of custom-made pens. Every custom job is different, and with jobcosting, PCL can determine the exact amount it costs to manufacture that particular order, includingthe materials and time.For instance, expenses that fill the job cost card for Order 001234 are the cost of metal casings forthe 100 custom-engraved luxury pens, engraving, and designing costs. These are extra costs thatPCL can incorporate into the total cost of the order and, from there, set a sale price that conforms toa desired markup rate. For example, PCL can add a certain margin to define the selling price if thetotal job cost reaches $6000, as mentioned in the case study. Such accurate specifications preventPCL from underpricing or overpricing custom orders, which would have affected its profitability.Section 1: Differences Between Absorption and Marginal Profits Treatment of Fixed Costs in Absorption and Marginal CostingThe following facts have been identified: In profit making, PCL's use of absorption costing involvesfixed and variable costs in the cost of goods sold and inventory. For instance, supposing PCL printspens with the fixed cost allocation (as reflected in the financial statements), increasing productionwould distribute more of these fixed costs over the entire manufacturing quantity of the unsoldpens, leading to higher profit margins over marginal costing.In contrast, marginal costing elevates the fixed costs to the status of period expenses. Consequently,fixed costs are taken from the contribution margin after only considering variable costs. Thisprovides a low profit margin, including only the costs directly attributable to manufacturing units.For instance, the fixed factory cost of $1,100,000 is a direct deduction from the totals in marginalcosting to obtain the net profit.Impact of Inventory on Profit CalculationIn absorption costing, if PCL makes more pens than it sells, then some fixed overheads will betransferred to the inventory, reducing the cost of the goods sold for the period, which helps boost.This is evidenced in the PCL profit statements, where a change in inventory will directly impact thereported net profit.On the other hand, under marginal costing, fixed costs are regarded as period costs; therefore,inventory fluctuations do not impact profit under this method. Under marginal costing, what isreflected on the profit and loss account will not be impacted by unsold stocks as such costs are not
written off on stocks. The profit, therefore, remains more stable and unswerving towards the actualsales and variable costs.Profit Calculation Differences:The marginal cost calculated in PCL's case study would arise from the variable production costs, i.e.,the raw materials, direct personnel costs, and other variable overheads, which are added whilecalculating the cost of goods sold and Inventories under the absorption costing. This implies thatwhile marginal costing would record low profits where fixed costs are high, absorption costingwould record high profits with increased production or inventories.Section 2: The Implications of These Differences for PCL’s Decision-MakingPricing Decisions:Specifically, under absorption costing, PCL management might set prices flexing the total cost perproduction unit, including fixed costs. This could lead to overpricing of products, particularly whensubstantial fixed costs are spread across units. This can make the products less competitive,especially when PCL is on the list of companies that could be affected by a price-sensitive index.On the other hand, marginal costing allows PCL to set the price based solely on the variable costsand the contribution margin, which offers the company flexibility to issue price reductions forspecials and the like. PCL can price the products with the cost of each unit under marginal costingbecause fixed costs are not included therein, which helps the company cover variable costs.Short-Term Decision Making (e.g., Special Orders)Sometimes, an "order' price' may be a special price lower than the usual market price, such as whatPCL will experience. Marginal costing enables PCL to see whether the variable costs are beingrecovered at a lower price, and if they are, then they help recover the fixed costs as well. Thisenables PCL to make better decisions in accepting special orders without undue consideration ofthe fixed cost charged in the unit cost under absorption costing.In absorption costing, PCL tends not to accept special orders at prices below cost because the fixedcosts have been factored into each unit. If the lower cost does not offset fixed costs, PCL may beforced to decline the order despite making some contribution to the overall profit in the short runthrough the Marginal Costing theory.Production DecisionsThis is because the costing method can influence the decision to increase production at PCL.Absorption costing may increase production since the company can write more production unitsfor fixed expenses, enabling it to show higher profits. However, if the products sell differently thanplanned, this could mean building an excessive stock and holding costs.Still, marginal costing goes even further by only considering variable cost and the contributionmargin. It assists PCL in managing the variable costs by understanding the production quantity
required to accommodate and meet the sales requirements. Absorption costing would involveunnecessary inventory accumulation since marginal costing would result in better productiondecisions, and the holding costs under absorption costing are avoided.Product Discontinuation Decisions:Different from variable costing, under absorption costing, some products that need more salesrevenue to cover what is deemed to be their fair share of fixed overheads may seem unprofitableeven when they help to absorb variables and show a positive contribution margin. Underabsorption costing, PCL may erroneously choose to cease production of some profitable productswithout understanding that such products are still recovering fixed costs.Say for two products, A and B, if variable costs are the exact but total A is more significant than totalB and fixed costs are the exact but total A is less than total B. It shows that marginal costing paints a'more accurate picture' (based on contribution margin). Products with a positive ContributionMargin, even though they cannot recover their proportionate share of fixed costs, will again beprofitable and should be retained. With this method implemented, PCL can be better positioned todecide which products to offer, retain, or remove from the market based on their impact on thecompany's bottom line.Cost Control and Profitability Analysis:On the other hand, absorption costing helps hide inefficiency in unit production since fixed costsare spread out over the units produced. For example, if PCL spends more on fixed costs, it is notgenerating profit or that producing a particular product is costly even though its contributionmargin is positive. Absorption costing can, therefore, distort inefficiency in production or sales.Relative to absorption costing, marginal costing gives a better picture of product profitability sinceit considers variable costs and contribution margins. PCL can quickly see which of its products havehigh variable costs that require cutting, which aids in controlling costs. Marginal costing assistsmanagement in identifying which products absorb fixed costs, hence appropriate resourceallocation.Part D: Situations when the Marginal Costing would be more beneficial to PCL than the AbsorptionCosting in making short-term decisionsAs is the case with most manufacturing firms, PenCraft Ltd. (PCL) has to make short- and long-termdecisions that can affect the level of profitability and the overall strategic direction within thecompany. However, in the short term, marginal costing is more helpful than absorption costing,which is essential in long-term financial planning and producing reports for external use. Comparedto the total crust, marginal costing gives a better indication of variable costs, making it easier tomake better decisions, especially in areas involving the pricing of products, control of cost, specialorders, and production volume change, among others.Pricing Special Orders
A particular order decision occurs when an organization like PCL is presented with a particularorder at a price lower than its sale price. This situation is typical in industries such astelecommunications, IT, or manufacturing, where there is excess capacity or when the customerorders large quantities and the supplier is willing to offer a lower price.It is scoped to variable costs only, which include all the costs that vary with the changes in theoutput level. Period expenses include fixed costs; therefore, these costs do not impact the decision-making process. Here, PCL can determine whether the particular order will accommodate thevariable cost, which includes direct material, labor, and variable overheads. As long as the price forthe particular order covers the variable costs and contributes something towards the fixed costs,the order is profitable and should be accepted even if the quoted price is less than the total productcost.An example is a particular order for 100000 pens for $2.50 per pen against the regular price of$3.00. The direct material and labor costs for writing pads are $3000 and $2000, respectively. Thevariable cost of producing each pen is $ 1.50 each. Under marginal costing, the $2.50 per pensignifies it is barely breaking even. Therefore, if this price is agreed upon between PCL and theclient, the order will be ascertained whether it covers all variable costs, let alone contributestowards the fixed costs.Decision on Whether to Accept a Lower-Than-Usual PriceIn the short run, for instance, PCL may find itself in a fix whereby it has to readjust its price levels,for instance, at specific times during the down working period or when the prevailing marketconditions dictate. This could include giving a rebate to maintain or gain market share.Therefore, marginal costing assists in PCL's short-term pricing decisions by highlighting variablecosts. Suppose the company in question offers a temporary discount. In that case, the decision ispremised on whether or not the price can offset the variable costs and contribute to the company'sfixed costs. As long as the selling price is higher than the variable cost per unit, the companycontributes something toward the fixed costs, even with the lower price, and the company may notrecord any loss.For instance, PCL may need to present a limited-time-only discount of 10% on the retail price tag of$3.00 for each pen. Variable cost per pen is $1.50 Variable cost per pen is $1.50 By using marginalcosting, PCL will be in a position to note that even at a 10% discount price of $ 1.50, they can be in aposition to recover the variable cost and contribute $ 0.50 towards the fixed cost.Short-Term cost Control DecisionsMarginal costing can be valuable in situations requiring PCL to focus on increasing cost control toimprove profitability. It makes it easier to distinguish steps where potential savings can be madewithout the influence of fixed expenses.
PCL can cut variable expenses such as raw materials or employee remuneration to improve itsoperational margin in the short run. Studying the MC structure can rectify these issues since itreveals areas where PCL can improve to influence its profit margin…Should PCL find out that the cost of the material (in this case, the pens) is rising, marginal costingcan assist in singling out this variable cost from among several fixed costs, such as factory rent, toenable the management to look for ways of merely acquiring cheaper rates from the suppliers orusing the pens more efficiently in the production process before they are used up.Production Decisions (Make or Buy)An example of a short-term decision that PCL may make concerns manufacturing a component thatmay be done internally or sourced externally. This decision depends on the variable cost ofmanufacturing the component and the cost of buying the component.Another application of marginal costing can be evidenced in this situation since it will enable PCL tocompare the cost of producing the component in-house (variable costs) and acquiring the itemexternally. The cost of production of the component in-house does not fluctuate with an increase ordecrease in volume; hence, the fixed costs incurred for its production do not play a role in thisdecision.If PCL manufactures a component for its pens at a variable cost of $2 and can buy it from the marketfor $2.50, then according to marginal costing, the company should manufacture the componentitself. This decision would solely focus on variable costs, while fixed costs would not influence thedecision-making process.