Chapter 4: Cost Assignment for Inventory Valuation and Profit Measurement

4.1. Introduction to companies organizational structure and cost classifications. A functional classification is required for both the valuation of products and services obtained by the company and for an analysis of the efficient use of resources. It should identify them with what they are allocated to or the application they have in the operational cycle. The functional costs classification represents the costs incurred in each responsibility centre. The accounting system is the measurement of costs and returns by existing centres in the business organisation. We can distinguish: purchase costs, manufacturing cost, delivery cost and administration and general costs. 4.2. Basic functional cost assignment with Full Cost methodology. Once the costs are classified by functions their allocation needs to be performed so as to value the assets and determine the company!s earnings. They costs are lin"ed to time and as such are periodic costs: #urchasing costs will be charged to materials or acquired merchandise over the period. $anufacturing costs will be charged to production of products for inventory purposes. The delivery costs arise from sales and therefore will be charged to sold products. The administration and general costs are associated to the operative cycle as a whole. 4. . Cost centres and organisational control. The first step to be able to run controls on the organisation method "nown as decentralisation is to set up cost centres whose activity is supervised by a manager. These cost centres are set up in relation to the company!s functional division: procurement manufacturing sales administration etc. There are several types of responsibility centres which depend on the degree of independence awarded to the operational unit with regards to decisions on costs income investment and earnings. The level of independence may swing between limited authority which is always supervised by central management and complete authority to decide on the production programme sales prices or earnings targets. 4. .1. Cost centres as responsi!ility centres. %ost centres are an organisational unit which groups and have responsibility for one or several activities that are clearly identified in the operative cycle. They are a hub for the allocation of overhead costs in the process of capturing calculating and accumulating costs. These centres act as a lin" between the cost components and those that bear the cost in the end. They aim to control the performance and productivity of each activity performed at responsibility centres.

4. .2. Cost centre classification. In a large company as many cost centres as deemed appropriate can be set up since this will depend on the inherent features of each production process. The company should be split into a sufficient number of centres so that they cover homogeneous costs and each is able to perform its management control function. We can identify: "ain Centres, #u$iliary Centres, "i$ed Centres and %pecial Centres. 4. . . &ifferent 'eys defined as measurement varia!les of the centre activity. The "ey defined must be the "ey allowing cost centre activity to be measured and may or may not be the product sub&ect to sale. This measure will vary depending on the nature of each centre' in this way a production centre will ta"e wor" time amount of material etc. as a wor" unit. (ariables lin"ed to sales are often ta"en as a wor" unit at sales and delivery centres. )or a variable to be used as a wor" unit it must: *e a representative measure for the centre activity it should be homogeneous and be useful to assess centre+s management for efficiency and effectiveness. 4. .4. #ssigning responsi!ility centre costs. The assignment of costs to centres comprises allocating the cost from its origin to those cost centres causing it ,the principle of causality-. When there are auxiliary centres the cost must be allocated to the main centres they have provide the service to' in this way the total cost of the activity performed by the recipient centre will be "nown. These inter.centre services ,they may be auxiliary to main or between auxiliaries- require provider centre costs to be transferred to recipient centres at the equivalent amount of the service' this is what is "nown as secondary allocation or sub.allocation. 4.4. Functional income statement. The income statement is a basic report for the analysis of management since it shows how profit ,or losses- is made. Its usefulness will largely depend on the structure and order adopted. Therefore it is essential that a useful system collect the income and expenses along with the partial earnings ,gross commercial- from the main production process and the earnings ,in terms of costs and revenue- from special activities. The main feature is that with gradual application of the income and expenses correlation principle profit margins are obtained and it shows how each stage of activity contributes to the surplus.