THE IMPORTANCE AND IMPACTS OFCOSTING METHOD ON THE PROCESS OF MANAGERIAL DECISION MAKING BY PHAM THI HOAI THANH E0700060 BARCHELOR OF BUSINESS (ACCOUNTING) HONS HELP UNIVERITY COLLEGE MARCH, 2011 i DECLARATION OF ORGINALITY AND WORD COUNT I hereby declare that the graduation project is based on my original work except quotations and citations, which has been duly acknowledged I also declare that it has not been previously or concurrently submitted for any other course/degree at Help University or other institutions The word count is 11363 words PHAM THI HOAI THANH March 28, 2011 i ACKNOWLEDGEMENT First of all, I would like to express my sincere appreciation to my supervisor, Dr Dao Thi Thu Giang who has guided me throughout this thesis Her constant guidance, insightful suggestions, and constructive ideas are the essential inputs and encouragement for me in order to complete this thesis Next, I would like to acknowledge to manager and all of employees in Ha Tinh Medical Material Company who allowed and assisted me to collect all of necessary information for me to get this thesis done Without their contribution, I could not be able to gather much information for my research Lastly, I would also like to extend my heartfelt gratitude to my friends for their continuous support, encouragement and contribution, which have been crucial during the presentation of this report My thesis cannot be finished without your supports ii TABLE OF CONTENT DECLARATION OF ORGINALITY AND WORD COUNT Error! Bookmark not defined ACKNOWLEDGEMENT Error! Bookmark not defined TABLE OF CONTENT iii ABSTRACT vi LIST OF FIGURES vii LIST OF TABLES viii CHAPTER 1: INTRODUCTION 1.1 Introduction of topic 1.2 Problem statement 1.3 Issues expansion 1.4 Structure of the research CHAPTER 2: LITERATURE REVIEW 2.1 Managerial decision-making process 2.1.2 Decision making process 2.1.3 Accounting information and its role in decision-making process 10 2.1.4 Managers and management accounting 12 2.2 The importance and impacts of costs accounting methods on decision-making process of the managers using SWOT model analysis 13 2.2.1 Costing methods ● Absorption costing 13 Figure 1: Absorption costing method 14 ● Variable costing method 15 Figure 2: Variable costing method 16 iii ● Activity based costing system (ABC) 17 2.2.2 The importance and impacts of accounting methods on managerial decision making process 21 CHAPTER 3: RESEARCH AND METHODLOGY 26 3.1 Aims of the project 26 3.2 Research methodology 27 3.3 Data sources 28 3.4 Limitation 28 CHAPTER 4: CASE STUDY ANALYSIS 30 4.1 Introduction 30 4.1.1 Process of formation and development of the company 31 4.1.2 Facilities of the company 32 4.1.3 Company’s mission statement 33 4.1.4 Potention on production of the company 33 4.1.5 Potention on marketing of the company 34 4.1.6 Structure of Ha Tinh Medical Materials’ management structure 35 Figure 3: Structure of management team 36 4.1.7 Accounting policy adopted 37 4.2 Difference when using different cost accounting methods 37 4.2.1 Incurred expenses during the period of 2008 – 2009 37 Table 1: Total revenue for Vitamin A of Ha Tinh Medical Materials 38 Table 2: Direct material cost of Ha Tinh Medical Materials 39 Table 3: Direct labor cost of Ha Tinh Medical Material 40 Table 4: Manufacturing overhead cost of Ha Tinh Medical Materials 41 4.2.2 Cost of goods manufactured under absorption costing method and variable costing method 42 Table 5: Cost of Vitamin A using absorption cost and variable cost method 42 iv 4.2.3 A profit comparison using absorption costing and variable costing method to calculate 43 Table 6: Cost of good sold for Vitamin A 43 Table 7: Gross profit for Vitamin A 44 Table 8: Variable cost of goods sold for Vitamin A 44 Table 9: Contribution margin for Vitamin A 45 Table 10: Difference between variable costing and absorption costing 45 CHAPTER 5: CONCLUSION AND RECOMMENDATION 47 5.1 Conclusion 47 5.2 Recommendation for calculating product cost of Ha Tinh 48 Medical Materials 48 REFERENCE………………………………………………………………………… 51 v THE IMPORTANCE AND IMPACTS OFCOSTING METHOD ON THE PROCESS OF MANAGERIAL DECISION MAKING BY PHAM THI HOAI THANH MARCH, 2011 Supervisor: Dr DAO THI THU GIANG ABSTRACT The purpose of this paper is to analysis the importance and impacts of cost accounting method on decision-making process of managers Cost accounting method can be considered as the most concerning problem with an organization, according to different costing methods will lead to different profit to a company, therefore choosing a suitable costing method is very important for managers There are three cost accounting methods, namely absorption costing method, variable costing method, activity-based costing method are analysis in this thesis And SWOT model will be used to explore the advantages and disadvantage of each method After that, I make some recommendation for calculating product cost of Ha Tinh Medical Materials Company vi LIST OF FIGURES Figure 1: Absorption costing method Figure 2: Variable costing method Figure 3: Structure of management team vii LIST OF TABLES Table 1: Total revenue for Vitamin A of Ha Tinh Medical Materials Company Table 2: Direct material cost of Ha Tinh Medical Materials Company Table 3: Direct labor cost of Ha Tinh Medical Materials Company Table 4: Manufacturing overhead cost of Ha Tinh Medical Materials Company Table 5: Cost of Vitamin A using absorption cost and variable cost method Table 6: Cost of good sold for Vitamin A Table 7: Gross profit for Vitamin A Table 8: Variable cost of goods sold for Vitamin A Table 9: Contribution margin for Vitamin A Table 10: Difference between variable costing and absorption costing viii CHAPTER 1: INTRODUCTION In this chapter, the whole picture about the ideas of this thesis will be depicted, and these help users easy to follow and link them to each other to figure out the potential relationship between cost accounting methods and managerial decision making process This chapter will cover the structure of this thesis, an introduction about the topic as well as related issues 1.1 Introduction of topic Historical documentation about the origins of cost accounting is limited due to a fire at the headquarters of the National Association of Accountants (NAA) in 1984 Many irreplaceable documents were destroyed in that fire (Cheryl Cunagin and JohnL Stancil, 1992) Therefore, no one can ensure and know about the accurate time that the cost accounting methods were born The role of accounting in the ancient world is coming into clearer focus with new archaeological discoveries and innovative interpretation of the artifacts Cost accounting is the process of accounting for cost, which begins with regarding and classifying costs and ends with the preparing periodical statements and reports for ascertaining and controlling costs Today, cost accounting may be defined as the process of measuring, analyzing, computing, and reporting the cost There are different cost Vitamin A and sold 15,000,000 pills The rest is maintained to the next year Average selling price for Vitamin A is VND 35.0 Table 1: Total revenue for Vitamin A of Ha Tinh Medical Materials Company Selling price per unit VND 35.0 Unit sold 15,000,000 pills Total revenue VND 525,000,000 Costs of goods manufactured include direct materials cost, direct labor cost, and manufacturing overhead In this part, assigning of these costs will be introduced The company used different materials in manufacturing process The total cost for direct material during the year ending on 31/12/2009 is VND 333,910,052 In comparison with last year, this amount is higher, as the expanding of manufacturing, higher cost of purchased material The details of direct material are described in the table as follow: 38 Table 2: Direct material cost of Ha Tinh Medical Materials Company DIRECT MATERIAL Unit Quantity Price/unit Total cost Amidon Kg 981 25,952.34 25,454,318 Lactose Kg 717 56,204.94 40,319,737 Magiestearat Kg 23 41,991.16 955,299 PVA Kg 59 57,718.01 3,390,356 Vitamin A Kg 946 193,612.74 183,124,737 Pure water Liter 30 1,500.00 45,000 Medicine cotton Kg 27 47,864.93 1,301,926 Glue Kg 37,053.26 340,890 Item 203,178 29.99 6,092,940 Kg 34 28,026.28 964,104 Paper 353 28.06 9,904 Package PE (07x12) kg/2520 package Kg 42,860.67 128,582 Package PE (0.8x1m) kg/12 package Kg 45,625.00 54,750 Large glue Unit 8,340.35 70,893 Bottle of PET 25ml Bottle 134,138 392.87 52,699,157 Bottle PET 35ml Bottle 65,744 250.00 16,435,739 Partition 170 1,135.60 193,052 Box 353 6,596.79 2,328,668 Tag named “Vitamin C 0,05” Parafin Package ballok Partition (Vitamin C, B6) Box of Vitamin A TOTAL DIRECT MATERIAL 333,910,052 39 During the manufacturing process, the company used machine hours to allocate direct labor The total machine hours at the end of this year are 10,000 hours Detail of direct labor cost is calculated in the following table: Table 3: Direct labor cost of Ha Tinh Medical Material Company DIRECT LABOR Labor cost Vitamin A Per hour VND 1,687.6997 Total manufacturing labor Vitamin A hrs 10,000 VND 16,876,997 In manufacturing process, direct labor cost is only calculated based on basic average salary of direct labor taking part in medicine producing The differences between actual salary and basic salary, as insurance expenses, as union fees of direct labor, etc are considered as computed of manufacturing overhead The manufacturing overhead is divided into two categories: fixed and variable costs Fixed cost is identified that the amount will be unchangeable during the manufacturing period (including depreciation expenses, tool manufacturing, factory manager’s salary, and other expenses); whereas variable cost is identified that the amount will be changeable during the manufacturing period (including electricity expenses, telephone expenses, and indirect materials) In short, account method is used to classifying manufacturing cost as variable or fixed cost 40 Table 4: Manufacturing overhead cost of Ha Tinh Medical Materials Company VARIABLE COST Electricity expense 39,508,048 Telephone expense 10,547,000 Indirect materials 20,869,089 TOTAL VARIABLE COSTS 70,924,137 FIXED COST Depreciation expenses 30,910,000 Tool manufacturing 9,847,000 Factory manager’s salary (including insurance cost of direct labor, and union fees) 18,576,759 Other expense 33,585,042 TOTAL FIXED COST 92,918,801 TOTAL MANUFACTURING OVERHEAD 163,842,938 After collecting all information about direct material costs, direct labor costs, and manufacturing overhead costs of Ha Tinh Medical Materials Company, absorption costing method and variable costing method will be adopted to calculate and analyze in order to perform the differences in the decision making process of the managers This will be the answer to the question: “whether the cost accounting method can have any 41 significant impacts on the decisions of managers, and what is the importance of cost accounting method in business operation of Ha Tinh Medical Materials Company” 4.2.2 Cost of goods manufactured under absorption costing method and variable costing method Fixed manufacturing costs include administrative expenses, maintenance expenses, rental expenses, and one part of other expenses under variable costing method, these costs are excluded from inventory cost and are instead treated as costs of the period in which they are incurred Besides that, under absorption costing method, both variable manufacturing cost and fixed manufacturing cost are regarded as inventory costs Table 5: Cost of Vitamin A using absorption cost and variable cost method Absorption costing (VND) Variable costing (VND) Direct materials 333,910,052 333,910,052 Direct labor 16,876,997 16,876,997 Manufacturing overhead 70,924,137 70,924,137 Total variable manufacturing cost produced 421,711,186 421,711,186 Fixed manufacturing cost produced 92,918,801 Total inventoriable costs produced 514,629,987 421,711,186 Produce units 19,200,000 19,200,000 Cost per unit 26.8 21.96 Variable manufacturing cost produced 42 Following the computing mentioned above, it is easy to see that the difference between absorption costing method and variable costing method is assigning the fixed manufacturing overhead costs In comparison these two methods, it is reveals that variable costing method generated lower costs than absorption costing method and this difference will lead to the managers’ different profit, basic for decisions of management However, as mentioned in the literature review, although total cost produced can be lower but actual profitability remains the same As a result, calculating and comparing the income using two methods are necessary to achieve the final goal of this thesis 4.2.3 A profit comparison using absorption costing and variable costing method to calculate Table 6: Cost of goods sold for Vitamin A Beginning finished goods 2,000,000 pills x 25.7 Cost of goods manufacture 19,200,000 pills x 26.8 Dividing by finished goods available for sale 19,200,000 pills + 2,000,000 51,400,000 514,629,987 566,029,987 21,200,000 pills 26.696 Multiply by Units sold 15,000,000 pills Cost of goods sold 400,443,396 43 Table 7: Gross profit for Vitamin A Sale revenue 525,000,000 (15,000,000 pills x 35.0) Cost of goods sold 400,443,396 Gross profit 124,556,604 Table 8: Variable cost of goods sold for Vitamin A Beginning finished goods 41,600,000 2,000,000 pills x 20.8 Cost of goods manufacture 421,711,186 463,311,186 19,200,000 pills x 21.96 Dividing by finished goods available 21,200,000 pills 21.85 for sale 19,200,000 pills + 2,000,000 Multiply by Units sold 15,000,000 pills Variable cost of goods sold 327,814,518 44 Table 9: Contribution margin for Vitamin A Sale revenue 525,000,000 (15,000,000 pills x 35.0) Variable cost of goods sold 327,814,518 Contribution margin for manufacturing process 197,185,482 Fixed manufacturing overhead 92,918,801 Profit before deducting administrative and marketing cost 104,266,681 As can be seen from table 10 and table 12, comparing profit before deducting administrative and marketing cost under absorption costing method and variable costing method are compared as follow: Table 10: Difference between variable costing and absorption costing Variable Absorption Difference between costing costing two methods 104,266,681 124,556,604 VND 20,289,923 Profit before deducting administrative and marketing cost The different of profit before deducting administrative and marketing cost in Table 10 can be explained as follow: 45 Under variable costing method, fixed manufacturing overhead costs are treated as periodic cost and excluded from inventory cost to determining profit target Under absorption costing method, fixed manufacturing overhead costs were delayed one part to correspond with unsold unit, therefore if ending finished goods higher than beginning finished goods (for example: in 2009, the beginning finished goods of the company is 2,000,000 pills Vitamin C, but the ending finished goods of the company is 6,200,000 pills = 2,000,000 + 19,200,000 – 15,000,000) therefore profit under absorption costing method will be higher than profit under variable costing method The Board of Directors has claimed that they would like to use absorption costing method rather than variable costing method because of the following reasons The first reason is absorption costing method can increase the profit of the company and their performance is also improved Another reason for this preferable method is that it requires preparing the financial statements to investors; therefore it helps the company attract more investment from potential investors 46 CHAPTER 5: CONCLUSION AND RECOMMENDATION 5.1 Conclusion Through the data and information collected in this thesis, the managers are in favor cost accounting methods because of its importance and effectiveness It is difficult to figure out the history of cost accounting methods as well as the numbers of methods that are used; however they play an important role in managers' on decision-making process As mentioned above, there are three popular methods includes absorption costing, variable costing, activity based costing Each of them provides the managers’ decision by different ways and different implications Absorption costing method is used in popularity because it has foreseeable economic benefits for the company Absorption costing method better matches costs with revenues, it can be analyzed that all manufacturing costs must be assigned to products in order to properly match the costs of producing units of product with the revenues from the units when they are sold However, this method emphasized on total costs (include both fixed cost and variable cot), the cost volume profit relationship is ignored, so the managers sometime need to use their intuition to make a decision Unlike absorption costing method, variable costing method focuses on variable costs, which are allocated directly to the cost object so cost per unit of product will be lower than absorption costing method, and the data that require cost volume profit (CVP) analysis can be taken directly from an income 47 statement However, the income under variable costing method is lower than income under absorption costing method so it is not advisable for management to consider it when making a decision Based on the comparison between two methods it is obvious that, activity-based costing method only helps the managers allocate cost effectively; however applying this method will have some disadvantages for the company, therefore activity-based costing method is not popularly applied 5.2 Recommendation for calculating product cost of Ha Tinh Medical Materials Company With the knowledge and insight gained from the study, several recommendations can be suggested in relation with the Ha Tinh Medical Materials Company Firstly, the company needs the entire production costs more accurately For example, direct labor costs need to be supplemented with social insurance costs, health insurance costs, and union fees of direct labor, there are not included in manufacturing overhead cost and according to Vietnam Accounting Standard (VAS) Secondly, now the company is allocating manufacturing overhead cost for medicines based on direct labor costs, but in fact direct labor costs only takes up a small proportion of total production costs Therefore this cannot show causal relation between costs and cause of cost incurred In the author’s opinion, these costs should be allocated according to direct labors and direct materials 48 Next, with the production cost under variable costing method, the company should classify costs more clearly, such as telephone expenses, gas expenses, electricity expenses, etc Further more, the company should use scientific methods to classify, such as high – low method, least square, etc Finally, for activity-based costing method, Ha Tinh Medical Materials Company is middle or small company, so when applying this method there will be such disadvantages as high expenses, unqualified accountants, and insufficient capital therefore the company should not apply activity-based costing method 49 REFERENCE Activity Based Costing (ABC), available at http://managers-net.org/activityBC.html, accessed at 24th, August 2010 Advantages | Disadvantages | Limitations of Activity Based Costing (ABC) System, available at http://www.accountingformanagement.com/limitations_of_activity_based_costing.ht m, accessed at 26th, August 2010 Alvin, A.A.; Randal, E J.; Beasley; and Mark; 2010, Auditing, Assurance, Service and Ethics in Australia, Pearson, Australia Bach Hung Tan, 2008, Solutions to enhance the usefulness of cost accounting for decision-making process of managers Available at http://thuvienluanvan.com Accessed on 25, August 2010 Charles T Horngren, George Foster, Srikant M Datar, Madhav Rajan, Chris Ittner ; 2008, Cost Accounting: A Managerial Emphasis, 13th edition Craig Deegan; 2009, Australian Financial Accounting: McGraw-Hill Irwin Cunagin, C., & Stancil, J., L., 1992, COST ACCOUNTING: A HISTORY OF INNOVATION, available at http://www.ucumberlands.edu/academics/history/upsilonian/files/vol4/CunaginStanc il92.html, accessed at 24th, August 2010 50 Drury, C., 2007, Management and Cost Accounting, Cengage Lrng Business Press; 7th edition 14 Drury, C., 2006, Cost and Management Accounting: An Introduction, Thomson; 6th edition 10 Edward J, Principles of Cost Accounting 11 Egenhofer, C., Kaczynski, P., M., Kurpas, S., & Schaik, L., V., 2010, The Everchanging Union: An Introduction to the History, Institutions and Decision-making Processes of the European Union 12 GS.TS Ngo The Chi, TS Truong Thi Thuy, Giao Trinh Ke Toan Tai Chinh, and second edition: Finance publisher, 2008 13 H.J Wheldon, L.W.J Owler, John Lewis Brown, Cost Accounting and Costing Methods 14 Hoggett, Edward and Merlin, 2006, Financial Accounting, 6th edition, Wiley, Australia 15 Horngren, C., T.; Datar, S., M; Foster, G.; Rajan, M.; & Ittner, C., 2009, Cost Accounting: a managerial emphasis, Prentice Hall 16 http://www.caneval.com/images/pictures/fiveforcesmodel.jpg, accessed at 12th, August 2010 17 Lucius, C., 2009, Vietnam's Political Process: How education shapes political decision making (Routledge Contemporary Southeast Asia Series), Routledge; edition 18 Michael R Kinney, Cecily A Raiborn; Cost Accounting: Foundations and 51 Evolutions, 7th edition 19 Rajput, 2007, Primary data and secondary date, available at http://www.rajputbrotherhood.com/knowledge-hub/statistics/difference-betweenprimary-and-secondary-data.html Accessed on 25 August 2010 20 Simms, J., 2008, The Variable Costing Income Statement for External Reporting, VDM Verlag 21 Vanderbeck, E., J., 2009, Principles of Cost Accounting, South-Western College Pub; 15th edition 22 VietNamese Accounting Standards available at http://www.saga.vn/CongViec/NghiencuuSaga/6461.saga Accessed on August 2010 23 Weygandt, J., J.; Kimmel, P., D.; & Kieso, D., E., 2009, Managerial Accounting: Tools for Business Decision Making (Wiley), Wiley; 5th edition 52 ... METHODLOGY 3.1 Aims of the project The studies and literature concerning the topic of managerial decision- making process, cost accounting methods, and impact of these on decision- making process have... accounting method be one of the factors that impact the decisions of managers? What are the consequences of these choices on the decision making process? Which cost accounting method should be concerned?... information and its role in decision- making process 10 2.1.4 Managers and management accounting 12 2.2 The importance and impacts of costs accounting methods on decision- making process of