Accounting Topic 5

Internal Auditing and Cost Accounting

Purpose of Internal Auditing

• It helps an organisation accomplish its objectives, evaluate & improve the effectiveness of risk management, internal control, and accountability processes

• It is done internally (by accountants within the organisation) and not by an independent external organisation

How internal auditing is linked to internal control within a business

Internal auditing (performed by an internal auditor) involves reveiwing the business’s intenal control prodcedures to ensure that the principles of internal controls are maintained. This includes:

• Checking the reliability and integrity of financial & operational information

• Appropriate security of assets & records

• Revewing the effectiveness and efficiency of operations

Detection and correction of errors and deficiencies

• Through regularly revewing the business’s procedures and policies internal auditors will find errors and deficiencies with the businesses internal control systes

• Internal auditors upon finding errors in the internal control system need to determine how the error occurred and what can be done to fix the error occuring in the future. The internal auditor may also uncover fraud or mismanagement in the discovery of an error and need to rake appropriate action

• Internal auditors upon finding deficiencies in the internal control system need to revise the business’s policies and procedures to determine why the deficiency exists and then they must advise management how to resolve and correct the issue

Definition of cost

An economic sacrifice of resources for a particular purpose, such as making a product or providing a service.

Costs can be classified in several wats according to:

• Their relationship to a cost object (are they direct or indirect)

• Their behaviour (variable, fixed, or mixed)

• Whether they are a product or period cost

Classification of costs: Direct vs Indirect

Direct costs are costs which are directly traceable to the manufacturer of a particular product - direct material (for example wood to make a table) and direct labour (for example wages to pay to workers who make the table

Indirect costs are costs which are indirectly or incidentally associated with, but still necessary to production. These costs cannot be directly allocated to a particular product, (for example factory electricity)

Types of direct costs: Direct materials & Direct labour

Direct materials are those materials that are readily traceable to the manufacture of a particular product. For example, in the manufacture of particular product. For example, in the manufacture of wooden furniture, the wood used is a direct material cost

Direct labour is that labour which is directly traceable to the manufacture of a particular product. Direct Labour means the cost of employing people working on the actual production line

Overhead costs (indirect)

Overhead includes all the expenses, other than direct materials and direct labour, which are necessary to make a product. These costs are indirectly associated with but still necessary to production. However, their costs cannot be directly allocated to a particular product. Examples:

• Other factory costs: For example, factory lights and power, depreciation of factory plant and machinery, factory repairs and maintenance, factory insurance

• Indirect material costs, for example, sandpaper, oils, lubricants and cleaning materials

• Indirect labour costs, for example, wages/salaries of factory supervisors, factory cleaners, factory security personnel or factory office staff

Product costs/Manufacturing Costs

To make a product there are three costs involved - direct materials, direct labour and overhead (indirect). These are called product costs

Period costs/Non manufacturing costs

• Non-manufacturing coss (not necessary for the manufatcure of goods)

• For example: Interest expense, office stationery, advertising, office salaries

Definition of cost accounting

Cost accounting is the measuring, analysing, recording and reporting on the costs of a product or a service

Why cost accounting is useful

• Control and compare actual costs with planned costs

• Use past costs to estimate future product costs

• To value inventory on hand

• Set selling price

• To determine whether it is profitable to produce or sell a product or service

What types of businesses use the job costing method

• Used when product being manufactured is relatively unique for each job or order

• A job-order system assigns costs t specifically identifiable batches of goods or to a specifically identifiale project

• Costs of each job is accounted for separately so that an accurate cost per unit can be calculated

Examples of businesses which would use Job costing

• Manufacturer of custim made equipment

• Specifal order printing business for example printing invitations for a birthday for a client

• A manufacturer of special custom desgined machines

• Batch of special t shirts

• Made to order furniture

Key features of the job costing system

• each job has its own special characteristics

• Each job uses its own specific resources/materials

Concept fo markup and how its determined

Markup is the difference between the selling price of a good or service and cost. It is often expressed as a percentage over the cost. A markup is added into the total cost incured by the producer of a good or service in order ot cover the costs of doing business and create a profit

Definition of standard costing

A standard cost is a carefully predetermined estimate unit cost. It is usually a standard cost per unit of production or per unit of service rendered. Although standard costing can be used in a variety of costing situations, the greatest benefit from its use can be gained if there is a degree of repetition in the production process. Therefore, standard costing is most suited to mass production and repetitive assembly work. For eg car manufacturing, a soft drink manufacturer, a manufacturer of clothing

Why standard accounting is useful

The use of standard costs in preference to actual manufacturing costs enables the more ready determination of selling proces for products, the cost of new products or the cost of effect of altering the product specifications of an existing product

Reasons for variance: Material price

Favourable:

• Unforseen discounts received

• Greater care taken in pruchasing

• Change in material standard

Adverse

• Price increase

• Careless purchasing

• Change in material standard

Reasons for variance: Material usuage

favourable:

• Material used of higher quality than standard

• More effective use made of material

• Errors in allocating material to jobs

Adverse

• Defective material

• excessive waste

• Errors in allocating material to jobs

• Stricter quality control and more rejections

• Theft

Reasons for variance: Labour rate

Favourable:

Use of apprentices or other workers at a rate of pay lower than standard

Adverse:

Wage rate increase

Reasons for variance: Labour efficiency

Favourable

• Output produced more quickly than expected (i.e. actual output in excess of standard output set for the same number of hours due to higher than expected work motivation, better quality of equipment or materials

• errors in allocating time to jobs

Adverse:

• Lost time in excess of the standard allowed. Output lower than standard set because of deliverate restriction, lack of training, or sub standard material used

• Errors in allocating time to jobs