Analysis of D.C.’s Competitive Environment and Information Need Dream Chocolate (D.C.) is a small company trying to survive in an industry with many competitors. The competitive environment comes from some factors. Firstly, D.C. bars are sold in specialty markets, fine gift stores and also available online. However, the competitive companies can also provide various chocolate bars for customers with the low price on the Internet. Secondly, comparing to the big chocolate company like Mars, D.C. is a small company that has the lower brand reputation. Therefore, there may be not many people would trust their products. On the other hand, facing this competitive environment, D.C. has developed many competitive advantages that could attract customers to choice its products. D.C. Company pursues the high quality chocolate and changes the basic milk chocolate bar into variety of flavors. The company’s niche is European-style custom chocolate bars and labeling, and it is known for its flexibility and speed.
A small customer order can be printed, labeled, and ready for pick up or shipping within one hour if the company already has the label in its system, which few company can achieve that level. Moreover, D.C. also faced the pressure from the continued national recession hurt sales in 2011. Thus, in order to deal with the internal and external competitive environment, the D.C. Company needs more business to utilize their capacity and make a profit. The main issue will be training people. It takes up long time to train people adequately. Also, customer labeling needs to be more effectively marketed, which is D.C.’s best margin area. For purpose that the company’s strategy and product can be efficiently carried out, D.C. Company should provide actual cost per order or per unit that can compute the operating margin for the individual products and the allocation of overhead costs that can know whether orders are profitable or not.
Pros and Cons for Different Costing Systems
Job Costing System
A job is simply a product or service that can be easily distinguished from other products or services and for which the firm desires that a specific cost be recorded for the product or service. Job order costing records the actual materials and labor expenses for specific jobs and assigns overhead to jobs at a predetermined overhead rate. Job order costing offers a detailed analysis of the costs of materials, labor cost and overheads by functions and nature. One advantage of job order costing is that it allows managers to calculate the profit earned on individual jobs, helping them to better decide whether specific job are desirable to pursue in the future. This is best for businesses that do highly custom work, such as construction contractors and consultants. Also, Job order costing gives managers the advantage of being able to keep track of individuals’ and teams’ performance in terms of cost-control, efficiency and productivity. It can evaluate efficiency of different types of jobs with cost records by using statistical techniques.
Job order costing facilitates the estimation of the cost of a similar job and allocates overheads on the basis of a predetermined rate. Moreover, job order costing makes easy to identify spoilage and defects to take corrective actions. However, there are also several problems with the job order costing system. Firstly, job order costing needs a great deal of clerical work in recording material issue, wage computation, payment and overhead charges. Therefore, the employees are required to track all materials and labor used during the job, which will need more accountants to works and creates additional cost for small company.
Secondly, job order costing focuses attention primarily on products rather than on departments or activities. This is not an issue if there is supplemental systems in place that record information about other cost categories, but it leaves management with inadequate information if this is not the case. Additionally, strict control of cost associated with a job is difficult since overheads are allocated on estimation, which should using reasonable parameters like selecting suitable basis.
Process Costing System
Process costing typically used by companies that produce large quantities of identical products that are made in long, continuous production runs through a series of process centers (departments). Process costing accumulates costs in a department for an accounting period and then spreads them evenly, or on an average basis, over all units produced that month. Process costing is an easier system to use when costing homogenous products compared to other cost allocation methods. Each process applies direct materials, labor and manufacturing overhead to the production cost total. Management accountants take the total number of goods leaving the process and divide the total process cost by this number. This creates a simple average cost for each item produced. Another advantage is that business owners use process costing because it creates a flexible production process. Companies needing to refine their process can simply add or remove a process as necessary.
This also allows companies to lower their production cost for each good. Adding a process allows companies to produce slightly different goods or improve product quality. This flexibility ensures companies can produce at the most competitive cost in the economic marketplace. Also process costing provides an approach to allocate costs to partially completed production. But the process costing also exists several disadvantages. Production cost error is a significant disadvantage for cost accounting systems. Process costing does not use direct allocation to apply business costs to individual goods, which will arbitrarily increase each item’s cost and also increases the consumer product price. Management accountants may also create under-costed products.
Under-costed products usually result in lower business profits because goods are actually more expensive than actually reported. Other problem is that accountants must calculate equivalent units in the process costing system. Equivalent units represent the amount of unfinished goods left in a process at the end of an accounting period. This information is reported as the work-in-process on a company’s balance sheet. Inaccurate work-in-process accounts may also result in distorted finished good totals. This creates a difficult process for managing inventory and determining how many products the company has to sell in the open marketplace.
Operation Costing System
Operation costing is a hybrid of job and process costing, which is used in manufacturing goods that have some individual characteristics plus some common characteristic. An operation is a standardized method of making a product that is repeatedly performed. Operation costing is often used when different products use common processes but differ in their material. The advantage of operation costing system is that some products are mass-produced and can be customized to order, which cost accountants use the operation costing system. Using operation-costing system could be more accurate to record the cost of product because it separates materials for each type of products and allocate the conversion costs through departments.
Also, because much of the production is the same for all products manufacture, accountants use operation costing to distinguish these costs and determine individual product costs However, operation-costing system is more complex to calculate, company should require collecting much more data comparing to process costing or job costing. It needs to compute the units of production and the product cost of each unit according to the information of materials be collected and the unit of equivalent products.
Activity-Based Costing System
Activity-based costing (ABC) is two-stage product costing method that first assigns costs to activities and then assigns them to products based on the products’ consumption of activities. The use of ABC is especially important to businesses that provide customized products or services. A customized production environment requires ABC’s allocation of actual indirect costs to a product to identify its true cost. Implementing ABC is a challenging task for any business and the process carrying several advantages and disadvantages. One of advantage of ABC system is to improve business processes. It allocates indirect cost based on a product’s cost drive or the factor that creates the cost, which would be more accurate than the other costing methods. ABC can be used to identify non-valued added activities and can help to better allocate resources to efficient and profitable activities. Another advantage of ABC system is to identify wasteful products.
ABC can allow the business to better understand where overhead costs are going. The data can identify wasteful products and unnecessary costs, so that resources can be used productively. The method also helps to fix the price of products or services that are excessive or incorrect. Overall product and service quality can improve as ABC’s data details production and cost issues that need to be resolved. Additionally, ABC system tends to reduce per unit cost of high volume products and increase per unit cost of low volume products, but the impact is more dramatic on the low volume products. However, implementing an ABC system can be expensive and time-consuming. Manager should break down business activities into each activity’s individual components.
The entire process needs to collect much valuable resource as data to measure and enter into the new system. Businesses may also require hiring the assistance of a consultant who specializes in the setup of an ABC system and provide training for them. Moreover, using ABC system sometimes is easily to misinterpret the data. It is also possible that some ABC may be irrelevant in certain decision-making scenarios. For instance, ABC does not conform to accounting standard and should not be used for external reporting. Since traditional cost figures tend to be the norm, interpreting ABC data along with regular accounting information can be confusing and lead to bad decision-making. Recommend a Costing Method to D.C.
D.C. is a small but growing company trying to survive in an industry with many players. This small company has limited staff and they do not currently track actual cost information during production. However, D.C. has the competitive advantage that it combines high-quality, variety of flavors and custom labeling together. Due to D.C.’s high-end process, high volume and various types of chocolates, I recommend D.C. use operation costing system that combines the process costing and job costing together. Firstly, D.C. has three sizes of chocolate, which are 1.25 oz. bar, 3.0 oz. bar and 3.25 oz. Bar. And the three sizes bar can be divided into two types chocolates that are organic and non-organic. The different materials will be added into production to get various flavors. Thus, the martial of production that is direct cost can use job-costing method. Using job order costing is that it allows D.C. to calculate the profit earned on individual jobs, helping them to better decide whether specific job are desirable to pursue in the future.
Job order costing also makes easy to keep track of the production, identify spoilage and defects to take corrective actions during the period of production. Then, the labor cost should be included in product cost. Direct labor comes from pouring, inspecting, foiling and labeling. Notice that larger bars can be inspected twice as fast as the smaller bars. Because each area might be working on multiple customer jobs at a time, it is difficult to track labor hours for each customer order. Therefore, using the job costing system records the different type of customer order, which would be more accurate to record labor cost. And we should also calculate equivalent unit to compute labor cost per bar for each department. Finally, for the overhead cost which is indirect cost, each product is produced using the same process, which means there is no difference in the overhead costs for the different products. So it is suitable to use process-costing method.
And process costing is more flexible in allocating conversion costs, because it only accumulates the total costs and allocates the costs to each department or process. The operation costing system is a flexible way to handle high-volume or low-volume production month. It is used when different products use common processes but differ in their materials. When the volume is high, D.C. company do not need to hire more employee to work because the combination of job costing and process costing could figure out the mass production. Also, the operation costing can easily find any mistakes and don’t have to wait till the end of the month to fix the problem.
Handling the new special order and new cost
Recent order from the wellness company shows that bars can have one or more types of special flavors and ingredient additives. Bars with higher-cost flavor additives such as coffee and Kava can be viewed as direct cost. Thus, they would be treated for the same as direct materials and be allocated to the specific products. But less expensive additives, such as flavoring oils are not included in direct costs and these cost usually show up in overhead cost. In addition to the direct materials cost for these ingredients, there is additional labor required for stirring to achieve equal distribution throughout the bar. Moreover, the labeling design cost for new special order is overhead cost, which is related to the product cost. So it would be allocated to the specific product separately as well.
Summary and Implementation
In conclusion, I will recommend the company using the operation costing system, which combine the job costing and process costing. In case of DC the manufacturing environment is complex. Product in its initial stages has identical processing, and then is finished using specific procedure like adding activities or customized packaging. The method accounts for costs based on difference in the products. Also operation costing as it will give clear cost of products and their profitability. It will help Kay to set up the price of the products will help him to determine most profitable product. In order to calculate the cost of chocolate bar, we should require the actual production for organic and non-organic bars, cost of ingredients for special orders and additional training and labor hours for special order.