Companies make a profit if they sell their products at a price that exceeds cost. For this reason, the two main concerns of entrepreneurs are: up to what price can they go and how can they keep costs low, while maintaining or increasing the level of quality.
The price depends on the type of market in which the company operates, if it has many competitors, or if it has the market for itself. In order to understand what is the maximum price that a company can set for its product, it is necessary that we analyze production costs.
CONCEPTS AND BASIC FOUNDATIONS
CONVENTIONAL COST (TRADITIONAL):
They are based on units produced to calculate indirect cost allocation rates.
In conventional methodology, costs are assigned to products at the unit level; This assumes that all costs depend on the volume of production.
Until recently, many companies used direct labor hours as a fundamental variable to allocate costs to products, however, due to the increase in mechanization in factories, this criterion was changed to apply or assign costs: now it is they use machine-hours.
One of the main problems in determining the cost of products in traditional costing systems is the
of the allocation to the products of the indirect costs of manufacturing, sale and administration, because the
Selling and administrative expenses are considered period expenses and not product costs.
Indirect manufacturing costs are allocated to products based on a certain rate, which is obtained by selecting an application criteria that
normally it does not contemplate the cause-effect relationship of the incursion of the product in said cost. Not used
identify or assign administration and selling expenses to
a specific activity, product or a specific customer: they are always carried to the period. This problem
it causes a distortion in the cost of products and services and a loss of relevance of the information.
Indirect Costs: Indirect manufacturing costs, these are the components that supply the information necessary for measuring income and setting the price of the product.
Indirect manufacturing costs (CIF) are all those costs that accumulate from indirect materials and labor plus all those incurred in production but that at the time of obtaining the cost of the finished product are not easily identifiable directly with the same.
MARGINAL COST:
It is the cost of the last unit produced, corresponds to the variable costs
involved in the growth of the production of a unit of the good in which the fixed costs have been distributed among the units produced.
Traditional cost activity in manufacturing companies does not record the costs of:
- Do not produce such as poor quality, or damaged machine, or parts that are required for production but have not been shipped, yet these unregistered and uncontrolled costs in some cases are as high as those traditional accounting records.
Process allocation
The traditional method uses volume-related measures, such as labor (hours or cost) as the sole generator to allocate costs to products.
Direct variable manufacturing costs
The traditional model that has used cost management and accounting for decades has classified materials and labor as variable and direct costs.
For example: in a pants factory the fabric used for each pants is variable and direct, as well as the labor to cut and sew each pants, but the supervisor's salary is an indirect and fixed cost.
PRODUCT COST VS. PERIOD COST
➢ Traditional cost accounting systems differentiate product and period costs using basic definitions of financial accounting.
➢Traditional systems only use costs that can be inventoried, which are known as product costs.
ATTRIBUTION VS. ASSIGNMENT.
The traditional costing system assigns GIFs (manufacturing overhead) under the basic assumption that GIFs are closely related to the units produced.
GIFs are assigned to the product using a proration.
The traditional costing system is correct in the event that a company produces a single product in its plant, since all GIFs would be easily identified for a particular product.
THE USE OF ARBITRARY PROPORTIONING MAY BRING SERIOUS IMPACTS FOR THE COMPANY:
Under the traditional costing system, the cost of attending to electronic orders is not taken into account, which may cause the company to maintain a portfolio of clients whose cost is higher than the income it receives from it.
➢The sale price of the product is higher than the costs invested in its production, or, conversely, the price may be lower, causing little competitiveness in the market. ➢ Profit margins difficult to explain.
➢Elimination of a product that appears to be very expensive, however, is the one that subsidizes the other uncompetitive products.
➢If you decide to undertake a process of cost reduction, the traditional cost system is of little use since it is impossible to determine which activities consume resources and do not add value to the company.
THE COSTING TECHNIQUE
As previously mentioned, the traditional costing system is based on the assumption that all manufacturing indirect costs are generated as the product goes through its production process, this view is incorrect because:
➢ There are indirect manufacturing costs that are independent of the number of units produced.
➢The very diversity of products that a company can make. It implies that systematically each type of unit produced will have different proportions of manufacturing overhead.
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