The Classification of Cost

Question: Discuss about the classification of cost and highlight the importance of budget. Answer: Introduction The activity of the company needs to be regulated so that the company can proceed with ease and flexibility. In this scenario, the need of management, as well as financial accounting comes to the forefront. However, in the current scenario the use of software is mainlyeded so that management can be properly controlled. In the report we will discuss about the classification of cost and highlight the importance of budget. Requirement of softwares The presence of softwares has greatly revolutionized the area of accounting. It has made things easier, and the records can be classified, as well as reported with ease and flexibility. In short, the presence of software in JB Hifi will bring a deal of opportunity to the company. The investment in softwares will lead to proper decision making. With the help of the softwares, a quick decision can be takenpreparation of budget can help in better cost allocation. The presence of softwares will help JB Hifi to have a better presentationnd inventory management can be done in a better fashion that will contribute to enhance the productivity. Management accounting vs. financial accounting Management accounting is a support to the internal management that aids in linking the activities of the organization and helps to present a better picture. It keeps the wheels of the management revolving and helps in preparation of financial report (Shim Siegel, 2009). Management accounting ensures that proper back up to the management that happens internally and this back up is mainly applicable when it comes to people within the organization like employee, managers, etcwhereas financial accounting deals with providing information to the parties that are present externally like government, creditors, etc (Horngren, 2013). Secondly, management accounting aims at preparation of the budget that will aid the organization in decision-making. Management accounting is flexible in nature that means it can be tailored as per the requirement. Management accounting is as per the whims of the management and therefore it is termed as optional (Horngren, 2013). On the other hand, financial accounting deals with the process of decision-making that enables preparation of reports that is on a period basis. It is compulsory for the organization to follow financial accounting. Classification of cost Classification of cost can be termed as a process that is simple in nature and where we group or categorize costs according to some standard features. Classification of cost in terms of their nature, source or feature enables proper understanding and thereby leads to proper decision-making and makes understanding easier. Cost can be classified in different manner and such a classification leads to understanding in a different way (Drury, 2011). It aids in decision-making and the manager gets a different way to ascertain the process of decision-making. There are plenty of ways in which the cost can be classified like components, link with time, avoidable and unavoidable, controllable and uncontrollable, normal and abnormal costs, relevant costs, direct and indirect nature, etc. (Drury, 2011). On the basis of type Direct cost such costs can be easily traced and spotted to any object such as a product, department and does not require huge effort. It pertains to the material, labor and expense that are associated with the production of goods, as well as services. JB Hifi is associated with appliances linked to household and the cost of raw material, engineers can be termed as direct costs and easily traceable (Vanderbeck, 2013). Indirect cost Such costs cannot be traced with ease. It can be fixed or variable in nature. For example, JB Hifi has its office expenses, advertising, etc. On the basis of Behaviour Fixed costs these are the fixed costs and not related to any activity that means it will be incurred even if there is no production. Insurance premium is an apt example of it. Variable costs it fluctuates with the level of production. When the production enhances, the costs rises and opposite when the production gets decrease. Commission to sales personnel are apt examples (Shim Siegel, 2009). On the basis of function Production cost this ascertainment helps in knowing whether the associated costs are direct or indirect cost and even known as production costs. It is important for the product development. For JB Hifi such costs are salary of the supervisor, charges to a product, etc. Administration cost the costs associated with the general management are termed as administration costs and are indirect in nature. It helps in regular performance such as rent, taxes, etc (Vanderbeck, 2013). Selling costs - the costs that are incurred for selling of goods and services are termed as selling cost. Such expenses are incurred by JB Hifi like salary of staff, market research, etc for selling the product. On the basis of relevance Relevant cost these costs are management specific and enable eliminating information that is not desired. This cost helps to strong practice and leads the organization forward. Such costs are important to be incurred by the management to accept a special order or keep a unit. Irrelevant cost costs that is not linked with the management decision and can be positive or negative is irrelevant cost. For product development it is important to incur such costs. In the case of JB Hifi we can see that fixed overhead and sunk costs can be termed as irrelevant costs. Budget Preparation A budget is an estimation of the future income and expense so that the financial planning can be done with ease and flexibility. It associates expenses, future cost and income that pertain to the future that is predicted over a definite period of time. It is done before the accounting period so that expenses can be traced and even the expected revenues. Thereby, the preparation of budget is essential for the preparation of the financial statements. The financial statements can be chalked out in a perfect manner if the preparation of budget is done in a proper manner. There are various kinds of budget and each budget has its own function. The preparation of budgets enables proper forecasting and helps in creating a situation that helps to know the proceedings. If there is deviation it can be easily traced and rectified with the budgeted figures. Budget is a strong step towards financial management and helps the process of financial accounting. Though it is a part of management account ing yet helps the process of financial accounting and ultimately takes the organization near to the goals of the organization. The main function of creating operating budget is that the functioning of the business can be ascertained and compared with the estimated figures. It enables the management to have a grasp over the expenses of the current period. When it come to tracing of the operational expenses it helps in spotting areas that helps in savings and leads to benefit. The problems can be eased when it comes to the financial problem. This way the budget helps the business and aligns the business process (Robinson Last, 2009). Secondly, the expenses can be forecasted. When the past performance is evaluated, a comparison can be made with the current figures that help in alignment of the business function. Moreover, the operational budget can be termed as liberating in nature and enables to limit debt because the main aim is to establish the financial reserves (Robinson Last, 2009). The main function of the operational budget is savings, investing and planning. Temporary jerks can be restricted when there operational budget is prepared (William, 2010). However, it needs to be known that spending beyond a particular level is stopped if the operational budget is strong and proper course of action is taken in this regard. Example of operational budget There are various operational budgets that i prepared in the case of JB Hifi that is linked to sales, manufacturing, selling expenses and other expenses that pertains to administration. Sales budget can be said to be the prior stage of the budget that is done for a business and where the process of budgetary control initiates (Robinson Last, 2009). It is important to ascertain that sales budget must be drafted with a lot of precision as other budget resides on it. Secondly, the production budget gives the number of units that can be produced. Production budget that is prepared annually depend on three factors that is the units to be sold, requirement of the inventory and other units (Lanen et. al, 2008). Thirdly, the direct material budget enables to ascertain the units of raw material that is needed for the purchase. If the units purchased are ascertained then the multiplication is done with the cost per unit to know the budgeted amount. Fourthly, the direct labor budget is done th at sheds light on the labor hour and labor cost to know the entire cost of labor. Fifthly, the manufacturing overhead budget is done to know the variable that is expected and the fixed overhead. Sixthly, the selling expenses budget leads to variable and fixed selling expenses. Lastly, the general, as well as administrative expenses budget is ascertained that provides an estimate of the variable and the expenses that is operational in feature and is associated with the administration (Lanen et. al, 2008). Standard costs used for variance analysis Both standard costing and variance analysis are used by the management as a tool to determine whether the business is performing good or bad by comparing with the actual budget or standards. Whenever any business uses standard costing in their management, accounts related to cost of goods sold and inventory are always recorded at their standard cost. In order to employ this method in a variance analysis method, the management has to reconcile the standard cost to the actual cost of their business (Horngren, 2011). The financial statements must show the actual costs that are incurred by the business and ultimately, variance analysis can be done by subtracting these actual costs with the standard costs already prepared. The outcome of this analysis must be reported in a variance analysis report and the management is bound to observe the report and investigate the underlying cause, if negative in nature. For instance, there has been an increase in the labor rates and it is necessary to investigate the cause so that this change can also be done in the standard rates. However, it is very necessary to understand that both standard costing and variance analysis must be inter-related. As standard costing is used in variance analysis, the variances of price and quantity (Direct Material Costs), variances of wage rate (Direct Labor Costs) and variances of Overhead costs can be obtained. It is to be noted that a business cannot determine whether it has been successful in controlling costs or not, without using standard costing in variance analysis (Horngren, 2011). With the help of this interrelation, costs can be controlled and new ways can be recognized for more profitability and efficiency (Needles Powers, 2008). Adverse variance In variance analysis, when the actual costs or expenses are greater than the standard or expected costs, then it is called an unfavourable or adverse variance. This variance is helpful in alerting the management that the profit of the company will be less than what is expected (Albrecht et. al, 2011). It is very important to identify this variance as soon as possible because the sooner it gets identified, more attention can be given towards fixing other problems. For instance, if the sales budget of a company is $10000 and the actual sales is $9500, then there is an unfavourable variance of $500. Similarly, if the standard cost of a company is $50000 and the actual cost incurred is $55000 then there is an unfavourable variance of $5000. ($55000 - $50000) Favorable variance A favorable variance in variance analysis indicates that either the management has obtained more revenue in contrast to what is anticipated or it has incurred lesser costs than what is anticipated. When it is a case of an expense, then the favorable variance will be the excess amount of a standard cost over the actual cost and when it is a case of revenue, then the favorable variance will be when the actual revenue is more than the estimated or standard revenue (Albrecht et. al, 2011). In simple words, when there is an increase in net income whether by low costs of business or high revenue, then it is signifies a favorable variance. For instance, if the standard revenue of a company is $200000 and it earns $250000, then there is a favorable variance of $50000. Similarly, if the standard costs of a company is $25000 and it has actually incurred $20000, then $5000 is the favorable variance. Conclusion Management accounting is essential when it comes to the operations of the company and plays a vital role in the success of the organization. The presence of management accounting along with proper financial accounting tends to better allocation of cost and preparation of budget. In the report, the selection of JB Hifi is made that is concerned with electrical, as well as appliances related to household. The chief aim of the study is to increase the operating efficiency by cost control and presentation of report to the Board. References Albrecht, W., Stice, E. Stice, J 2011, Financial accounting, Mason, OH: Thomson/South-Western. Drury, C 2011,Cost and management accounting, Andover, Hampshire, UK: South-Western Cengage Learning. Horngren, C 2011, Cost accounting, Frenchs Forest, N.S.W.: Pearson Australia. 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