Table of Contents

Introduction................................................................................................1
Contents of the reports...............................................................................1
1.1 Classifying different types of cost incurred in Vang Company with
appropriate cost classifications...................................................................1
1.2 Explaining about different costing methods with example and
making relation with scenario of the Vang Company................................3
Job costing..............................................................................................4
Batch costing..........................................................................................4
Service costing.......................................................................................5
Contract costing......................................................................................6
Process costing.......................................................................................7
1.3 Calculating costs using appropriate techniques....................................8
Task 1:....................................................................................................9
Task 2:...................................................................................................11
Task 3:..................................................................................................14
2.2 Using performance indicators to identify potential improvements....16
2.3 Suggesting improvements to reduce cost, enhance value and quality18
Conclusion................................................................................................18
References................................................................................................19

Introduction

Vang Company starts implementing the production of customized t-shirts that

are manually cut and sewn using electric sewing machines to ensure quality,
and printing is done by hand silk screens. Moreover, the t-shirts are
individually wrapped in recycled brown paper bags. It serves company, family
and group events and gets orders from some local government agencies. The
company has established in Da Nang City since 2006 by Mr. Ha Long and his
sister Thuy. It has 25 employees including 4 people in administration and sales
department and 21 people in production department. The owners think of
expanding their business operations and producing their own product line of
printed t-shirts. Their long-term goal is to export the products.
The report helps Mr Ha Long to have good decisions in his business operations
in the future. The report includes the following contents as follows: (1)
classifying different types of cost incurred in Vang Company with appropriate
cost classifications, (2) explaining about theory of different costing methods
with example and making relation with Vang Company, (3) calculating costs
using appropriate techniques, (4) using performance indicators to identify
potential improvements and (5) suggesting improvements to reduce cost,
enhance value and quality.
Contents of the reports
1.1 Classifying different types of cost incurred in Vang Company with
appropriate cost classifications
Cost classification involves arranging costs into groupings of similar items in
order to make stock valuation, profit measurement, planning, making decision,
and control easier (Eiteman, 2012).

Cost Classifications for stock valuation and profit measurement (material,

labour and other expenses, direct and indirect cost, product cost and period
cost). The total cost of a cost unit is made up of costs including materials,
labour and other expenses (such as rent and interest rates and so on) (Droms,
2003).
The total cost includes direct cost and indirect cost. Direct cost is a cost that
can be traced in full to the product, service, or department that is being cost.
Direct cost includes direct material cost, and direct labour cost. Direct materials
costs are the costs of materials that are known to have been used in making and
selling a product (or providing a service). Direct labour costs are the specific
costs of the workforce used to make a product or provide a service. Direct
labour costs are established by measuring the time taken for a job, or the time
taken in direct production work (Brealey, Myers and Allen, 2006).

Indirect cost is a cost that is incurred in the course of making a product,

providing a service or running a department, but which cannot be traced
directly and in full to the product, service or department. Indirect cost includes
production overheads (indirect materials, indirect labour and indirect factory
cost), administration overhead and selling overhead. Indirect material cost and
indirect labour cost which cannot be traced in the finished product. Factory
overheads are expenses (other than material and labour) not charged directly to
production such as rent, rates and insurance of a factory, depreciation, fuel,
power, repairs and maintenance of plant, machinery and factory buildings.

Administration overheads include depreciation of office equipment, Office

salaries, including salaries of secretaries and accountants. Rent, rates,
insurance, lighting, cleaning and heating of general offices, telephone and
postal charges, bank charges, legal charges, audit fees. Selling overheads
include printing and stationery, cost of packing cases, salaries and commission
of sales representatives and sales department staff, wages of packers, drivers
and despatch clerks, advertising and sales promotion, market research, rent and
insurance of sales offices and showrooms, and so on (Bodnar and Hopwood,
2013).
The total cost includes product cost and period costs. Product costs are costs
identified with a finished product. Such costs are initially identified as part of
the value of stock. They become expenses (in the form of cost of goods sold)
only when the stock is sold. Period costs are costs that are deducted as
expenses during the current period without ever being included in the value of
stock held (Boczko, 2012).
Cost Classifications for decision making (fixed cost and variable cost). Fixed
cost is a cost which is incurred for a particular period and which, within certain
activity levels, is unaffected by changes in the level of activity. Variable cost is
a cost, which tends to vary with the level of activity (Boczko, 2007).
Cost classification for patterns (fixed, step, variable and semi-variable cost).
Step cost is cost, which is fixed in nature but only within certain levels of
activity. Semi-variable cost is a cost composed of a mixture of fixed and
variable components. Costs are fixed for a set level of production or
consumption, becoming variable after the level is exceeded (Berk, and
DeMarzo, 2013).
1.2 Explaining about different costing methods with example and making
relation with scenario of the Vang Company
Costing methods include job costing, batch costing, service costing, contract
costing, and process costing.

Job costing
A job is cost unit, which consists of a single order or contract. Job costing is a
costing method applied where work is undertaken to customers, special
requirements and each order is of comparatively short duration. A time sheet is
filled in by the employee as a record of how their time has been spent. The total
time on the time sheet should correspond with time shown on the attendance
record. In job costing, production is usually carried out in accordance with the
special requirements of each customer. It is therefore usual for each job to
differ in one or more respects from every other job, which means that a
separate record must be maintained to show the details of a particular job.
When an order is received from a customer, the estimating department will
prepare an estimate for the job. If the customer accepts the estimate, the job
will be given a separate job number, to identify it from all other jobs. Material
requestions are sent to store and will be used to cost the materials issued to the
job concerned, and this cost may then be recorded on a job cost sheet, which
records all costs relating to a particular job. Job ticket is given to the worker
who is perform the first operation of the job- starting and finishing operation
are recorded on the ticket and passed to the person who carry out the second
operation, when jobs is completed, the job ticket is sent to cost office. In
factory overhead, the jobs share of the factory overhead based on the
absorption rate in operation, is recorded on the job cost sheet. Relevant cost
related to materials issued, direct labour performed and direct expenses
incurred as recorded on the job cost sheet are charged to the job account in the
work in progress ledger. On completion of the job, the job account is charged
with the appropriate administration, selling and distribution overhead, after
which the total cost of the job can be ascertained (Atrill and McLaney, 2008).
Batch costing
A batch costing is a cost unit which consists of a separate, readily identifiable
group of product units which maintain their separate identify throughout the
production process. Batch costing is used for calculating total cost of each

batch. Batch is small group of units, which are produced for production
purposes. We also identify batch of units in our production. All raw material is
supplied on batch basis and other expenses are also paid on the basis of each
batch. A batch costing is a cost unit which consists of a separate, readily
identifiable group of

product units which maintain their separate identify

throughout the production process. The batch is treated as a job during

production and the costs are collected in the manner already described in this
previous lecture. Once the batch has been completed, the cost per unit can be
calculated as the total batch cost divided by the number of units in the batch
(Atrill and McLaney, 2012).
According to Atrill and McLaney (2013), features of batch costing:
- Each batch is treated as a cost unit.
- All costs are accumulated and ascertained for each batch. A
- A separate batch cost sheet is used for each batch and is assigned a certain
number by which the batch is identified.
- The cost per unit is ascertain by dividing the total cost of a batch by the
number of items produced in that batch).
Service costing
A cost accounting method concerned with establishing the costs of services
rendered. Service cost is useful for providing and operating a service. Service
costing is usually applied to transport service, utility service and the cost
rendering or providing a service, and involve determination of the cost of
services. Service costing is also applied within a manufacturing setting. A
particular problem with service costing is the difficulty in defining a realistic
cost unit that represents a suitable measure of the service provided. Frequently,
a composite cost unit may be deemed more appropriate if the service is a
function of two activity variables. Features of serving costs are to find the cost,

express in terms of the units, classify the cost, specific period, and accurate
estimation of cost difficultly (B. Elliott and J. Elliott, 2013).
Contract costing
A contract is a cost unit of cost centre, which is charged with the direct costs of
production and appointment of head office overheads. Contract costing is the
same given to method of job costing where the job to be carried out is of such
magnitude that a formal contract is made between the customer and supplier.
Contract costing applies where work is undertaken to customer special
requirements and each other is of long duration (compared with the time to
which job costing applies). The work is usually constructional and in general
the method is similar to the job costing, although there are, of course, a few
differences (Khan, 1993).
According to Kay, and Ovila (2013), features of contract costing:
- A formal contract made between customer and supplier.
- Work is undertaken to customer special requirements.
- The method is good for relatively long duration.
- The work is frequently constructional in nature and the method of costing is
similar to job costing.
- The work is frequently based on site and it is not unusual for a site to have its
own cashier and time-keeper.
The direct materials used on a contract may be obtained from the company
central stores or they may be delivered direct to the site by the companys
suppliers. In both cases carefully prepared documentation must ensure that the
correct contract is charged with the correct materials. A materials requisition
note would record the movement of materials from stores; the suppliers
supported by a goods received note would document the cost of materials
delivered direct to site (Griffin, 2009).

Since all the work done by direct labour on contract site is spent exclusively on
a single contract, the direct labour cost of the contract should be easily identify
from the wages sheets. If some employees work on several contracts at the
same time, perhaps travelling from one site to another, their time spent on each
contract will have to be recorded on time sheet, and each contract charged with
the cost of these recorded hours. The cost of supervision, which is usually a
production overhead in job costing, will be a direct cost of contract. On large
contracts, many works may be done by the subcontractors. The invoices of
subcontractors will be treated as a direct expenses of the contract, al though if
the invoiced amounts are small, it may be more convenient to accounts for
them as direct materials rather than as direct expenses. In the cost of plant, a
feature of the most contract work is the amount of plant used on a contract may
be owned by the company, or hired from a plant hire firm. Overhead costs are
added periodically and are based on predetermined overhead absorption rates
for the period. You may be come to across examples where a share of head
office general costs is absorbed as an overhead cost to the contract, but this
should be happened if the contract is unfinished at the end of the period,
because only production overheads should be included in the value of any
closing work in progress (Feibel, 2003).
Process costing
Process costing is a type of operation costing which is used to ascertain the cost
of a product at each process or stage of manufacture. It is a method of
allocating manufacturing cost to determine an average cost per unit. Its traces
and accumulates direct cost, and allocates indirect cost, through a
manufacturing process. Costs are assigned to products, usually in a large batch,
which might include and entire months production. Eventually, costs have to
be allocated to individual units of product. Alternatively, job costing can be
used to track the flow of costs (Mishkin, and Eakins, 2011).
According to Melville (2013), features of process costing:

- Process costing is a costing method used where it is not possible to identify

separate units of production, or jobs, usually because of the continuous nature
of the production processes involved.
- It is common t identify process costing with continuous production such as oil
refining, the manufacture of soap, paint, food and drink
1.3 Calculating costs using appropriate techniques
Explaining ABC (Activity Based Cost) and steps with examples
Absorption cost appears to be relatively straightforward way of adding
overhead costs to units of production using, more often than not, a volumerelated absorption basis (such as direct labour hours or direct machine hours).
The assumption that all overheads are related primarily to production volume is
implied in this system. Absorption costing was developed at a time when most
organisations produced only a narrow range of products and when overhead
costs were only a very small fraction of total costs, direct labour and direct
material costs accounting for the largest proportion of the costs. Errors made in
adding overheads to products were therefore not too significant (Rice, 2011).
According to Robert (2009), ABC costing system operates as follows:
Step 1: identifying the organisations major activities
Step 2: identifying the factors, which determine the size of the costs of an
activity/cause the costs of an activity.
Step 3: collecting the costs of each activity into what are known as cost
pools (equivalent to cost centres under more traditional costing methods).
Step 4: charging support overheads to products on the basis of their usage of
the activity.
Showing the comparison between ABC and Absorption costing with
suitable examples

Absorption costing and ABC are similar in many respects. In both systems,
direct costs go straight to the product and overheads are allocated to production
cost centres/cost pools. The difference lies in the manner in which overheads
are absorbed into products (Ryan, 2008).
Absorption costing most commonly uses two absorption bases (labour hours
and/or machine hours) to charge overheads to products. ABC uses many cost
drivers as absorption bases (number of orders, number of despatches and so on)
(Rommey and Steinbart, 2011).
Activity based costing improves the quality of management accounting
information, especially in large and multi-product operations where
conventional overhead allocation methods such as absorption costing may
produce misleading results. Absorption costing, however, remains more
suitable for small firms and enterprises with homogeneous products or services
(Ryan, 2008).
Task-1: The full calculation of estimated overhead of each service department
(X, Y, Z) (before any service department allocations)

Producing
Department
S
$60,000

Service Departments
P

$90,000 $20,000

$20,000

$10,000

The interdependence of the departments is

tabulated as follows:

Service provided
Departments

Producing S

30%

40%

Producing P

50%

40%

30%

Service X

20%

Service Y

20%

Service Z

30%

10%

Marketing

20%

General Office

10%

Total

100%

100%

100%

(1.3)
Showing total factory overhead (P+S) and assigning the cost of Z department to
marketing department and general office.
Having the development from scenario information:
X= 20000+20%Y (1).
Y=20000+20%X (2)
Z=10000+30%X+10%Y (3)
From (1) and (2), results are:
X= 20000+20% x (20000+20%X)
X = 20000+4000 + 4%X

96%X = 24000

X = 25000

And when having X, give that value to (2), having Y:

Y = 20000+20%X = 20000+20%x 25000 = 25000

With the value of X and Y, it is easy to get Z value:

Z = 10000+30%25000+10%25000 = 20000

Production S = 60000 + 30%Y + 40%Z (4)

= 60000 + 30% x 25000 + 40% x 20000 = 75500
Production P= 90000+ 50%X + 40%Y + 30%Z(5)
= 90000 + 50% x 25000 + 40% x 25000 + 30% x 20000
= 118500

10

Cost of Z department to marketing department: 20%Z = 20%x 20000

= 4000
Cost of Z department to general office: 10%Z = 10%20000= 2000
Total factory overhead (P+S) = 75 500 + 118 500 + 4000 + 2000 = 200,000

Task 2:
Calculating the recovery rate for factory overhead, selling, and
administration overhead with appropriate calculations
(1.3)
Budget figues

2009
Recover
$

Direct Materials
Direct Wages
Factory Overhead

120,000
100,000
60,000 60.00% of Direct Wages : 100,000
20.00% of work costs: (120,000 +

Administrative overhead
Selling
and
distribution
overhead
Total

Rate:

56,000 100,000 + 60,000)

15.00% of work costs: (120,000 +
42,000 100,000 + 60,000)
378,000

Calculating the budgeted sales for the year 2010

Sales = net income + total of costs, total of costs is 167,400, net income = 20%
total of costs. Therefore, sales = 20% total of costs + total of costs = 167,400 +
20% x 167,400 = 200,800

Budget figues
Sales
Direct Materials
Direct Wages
Factory Overhead

2010
$

$
200,880 Recover Rate:

60,000
40,000
24,000

60.00% of Direct

11

Wages: 60000
20.00% of work costs:
(60,000 + 40,000 +
Administrative overhead

24,800

24,000)
15.00% of work costs:

Selling and distribution

overhead
Total

(60,000 + 40,000 +
18,600
167,400

24,000)

Showing the full calculations and explanations in relation of marginal and

absorptions costing:
Absorption costing is a system, which treats all manufacturing costs including
both the fixed and variable costs as product costs. In absorption costing, closing
stocks are valued at full production cost, and include a share of fixed
production costs. This means that the cost of sales in a period will include some
fixed overhead incurred in a previous period (in opening stock values) and will
exclude some fixed overhead incurred in the current period but carried forward
in closing stock values as a charge to a subsequent accounting period (Ryan,
2008).

ABSORTION COSTING METHOD

Sales
Production costs:
Direct Materials
Direct Wages
Factory Overhead

200,880
60,000
40,000
24,000
124,000

12

Gross profit
Operating cost:
Administrative overhead
Selling and distribution overhead

76,880
24,800
18,600
43,400

Net profit

33,480

Marginal costing is a costing system which treats only the variable

manufacturing costs as product costs. The fixed manufacturing overheads are
regarded as period cost. Marginal costing is an alternative method of costing to
absorption costing. In marginal costing, only variable costs are charged as a
cost of sales and a contribution is calculated which is sales revenue minus the
variable cost of sales. Closing stocks of work in progress or finished goods are
valued at marginal (variable) production cost. Fixed costs are treated as a
period cost, and are charged in full to the profit and loss account of the
accounting period in which they are incurred (Walsh, 2008).
MARGINAL COSTING METHOD
$
Sales
Variable cost:
Direct Materials
Direct Wages

$
200,880

60,000
40,000
100,000
100,880

Total Contribution
Fixed cost:
Factory Overhead
Administrative overhead
Selling and distribution overhead

24,000
24,800
18,600
67,400
33,480

Net profit
Task 3:

(1.1) Classified by Traceability & by Behaviour against activities

2006

2007

13

2008

By

By

Traceability

Behaviour

Sales
Variable factory

150,000

285,000

costs
Fixed factory

(70,000) (95,000) (120,000) Direct costs

Indirect

cost
Fixed

costs
Administrative

(20,000) (25,000) (30,000)

costs

costs

Indirect

Fixed

400,000
Variable

and selling

expenses
(25,000) (70,000) (130,000) costs
costs
(1.2) Explaining the need of and operation of different costing methods
used by Vang Company
According to cost classifications for stock valuation and profit measurement,
Vang Company has two costs including direct costs and indirect costs. Direct is
a cost that can be traced in full to the product, service, or department that is
being cost (Arnold, 2012). The direct costs of Vang Company are variable
factory costs. Indirect cost is a cost that is incurred in the course of making a
product, providing a service or running a department, but which cannot be
traced directly and in full to the product, service or department (Arnold, 2012).
Indirect costs of Vang Company are fixed factory costs, administrative and
selling expenses.
According to cost classifications for decision-making, Vang Company has two
costs including fixed cost and variable cost. Fixed cost is a cost which is
incurred for a particular period and which, within certain activity levels, is
unaffected by changes in the level of activity (Wood and Robison, 2013). The
fixed costs of Vang Company are fixed factory costs, administrative and selling
expenses. Variable cost is a cost, which tends to vary with the level of activity
(Watson and Head, 2013). The variable costs of Vang Company are variable
factory costs.

14

(1.4, 2.1) Collecting, analyzing, and presenting data based on the

information given in the scenario using appropriate techniques, as well as
preparing and analyzing routine cost reports.
2006
2007
2008
$
$
$
Sales
150,000
285,000
400,000
Variable factory costs
(70,000)
(95,000)
(120,000)
Fixed factory costs
(20,000)
(25,000)
(30,000)
Gross profit
60,000
165,000
250,000
Administrative and selling expenses
(25,000)
(70,000)
(130,000)
Net income
35,000
95,000
120,000
Growth of profits, costs for the years 2006-2008, shown two charts (one in
figures and one as percentage of sales).

2.2 Using performance indicators to identify potential improvements

15

Performance indicator is not possible to manage what a company cannot

control and a company cannot control what you cannot measure (Alexander
Nobes, 2013).
Performance measurement is a fundamental principle of management. The
measurement of performance is important because it identifies current
performance gaps between current and desired performance and provides
indication of progress towards closing the gaps. A key principle of performance
management is to measure what you can manage. In order to maintain and
improve manufacturing performance each function in the organization must
focus on the portion of the indicators that they influence. Maintenance
performance contributes to manufacturing performance (Feibel, 2003).
Key performance Indicators:

Items
Net profit/Sales (ROS)
Variable factory costs/Sales
Fixed factory costs/Sales
Production cost/Sales
Administrative and selling expenses/Sales
Total Costs/Sales

Year

Year

2006

2007
2008
33%
30%
33%
30%
9%
8%
42%
38%
25%
33%
67%
70%

23%
47%
13%
60%
17%
77%

Year

+ Reducing factory cost over the years 2006-2008:

-

Variable factory costs reduced from 47% to 33% and continue to

reduce to 30% of sales

Fixed factory costs reduced from 13% to 9% and then to 8% of

Sales

Production cost s reduced from 60% to 42% and then to 38% of

Sales

+ Increasing Administrative and selling expenses over the years 2006-2008:

16

Administrative and selling expenses increase from 17% to 25% and

then to 33% of Sales

+ Total costs change over the years 2006-2008:

-

Total costs reduced from 77% to 67% and then increased to 70% of
Sales

+ Net profit change over the years 2006-2008:

-

Net profit increased from 23% to 33% and then reduced to 30% of
Sales

2.3 Suggesting improvements to reduce cost, enhance value and quality

For reducing factory costs Vang Co. have to increase Administrative costs.
Administrative costs increase for increasing quantity of products and
controlling production process and quality of products.
Quantity and quality of products increasing helps sales increasing too. But
Administrative costs increasing over production cost decreasing then net
income may decrease (Arnold, 2009).
For example:
In year 2007: Production cost reducing from 60% (year 2006) to 42% of Sales,
Administrative and selling expenses increasing from 17%(year 2006) to 25%
of Sales then Net profit increasing from 23%(year 2006) -> 33% of Sales
But in year 2008: Production cost reducing from 60%(year 2006) to 38% of
Sales, Administrative and selling expenses increasing from 17% to 33% of
Sales then Net profit only increasing from 23% to 30% of Sales instead of 33%
of year 2007.

Conclusion:
The report completes to classify different types of cost incurred in Vang
Company with appropriate cost classifications, explain about theory of
different costing methods with example and making relation with Vang

17

Company, calculate costs using appropriate techniques, use performance

indicators to identify potential improvements and suggest improvements to
reduce cost, enhance value and quality. The report helps Mr Ha Long to have
good decisions in his business operations in the future.

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