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Analytical Essay on Cost Accounting System: Case Study of Nestlé Lanka Limited

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Executive Summary

The managers and directors of an organization use various types of techniques to ensure the wellbeing of their organization. Management accounting is one of those techniques used. Various types of management accounting reports and systems are prepared by management accountants to provide information to the top-level managers in order to aid them in their decision-making process.

The focus of this report is to identify the costs and benefits of introducing a new product called Nescafé Rapido, a ready-to-drink bottled iced coffee beverage to the market and how the different types of management accounting systems and reports can be used in order to decide the feasibility of this product.

Introduction to Nestlé Lanka Limited

Nestlé is a Swiss based multinational corporation which is known to be the world’s largest food and beverage company with over 2000 local and international brands and operating in 189 countries around the world. It’s foundation dates to 1866 to the Anglo-Swiss Condensed Milk Company and in 1905 it merged with Henri Nestlé’s company to form what is now called Nestlé (Nestlé, 2019).

Nestlé made its presence in Sri Lanka in 1906 as a trading company and became a public quoted company in 1983 as Nestlé Lanka Limited. Since then it has been manufacturing a range of well-known products such as Nestomalt, Nespray, Milkmaid, Milo, Maggi etc. Because of its wide range of products, it has become one of the leading Food and Beverage companies in Sri Lanka and it also provides employment to nearly 1200 people (Nestlé Lanka, 2019).

The Nestlé factory in Kurunegala manufactures over 90% of the Nestlé products sold in Sri Lanka and in order to ensure its smooth operation, Nestlé Lanka actively uses various Management Accounting techniques to help in the overall manufacturing process.

Management Accounting

In the simplest of terms Management Accounting provides information for managers for their decision making. Managers need detailed information regarding the products, departments and activities of the organization and these details are used for the internal management process (Walther and Skousen, 2009). Management Accounting is needed to plan, execute and control the day-to-day operations of an organization.

Within Nestlé Lanka also we see management accounting plays an important role to ensure its success.

  • First and foremost, it is used to determine the price and various other factors of a product by preparing various cost analysis, market research, projected income statements etc. Nestlé Lanka was able to make various products (such as Milo and Nestomalt) healthier by conducting a market research on the dietary intake of customers (Nestlé Lanka, 2018).
  • Budgets are prepared using management accounting techniques to estimate the income and expenses for the following years.
  • Management accounting is constantly used in decision making by analyzing the performance reports to review the performance of individual departments as well as individuals.
  • Since 2007 Nestlé Lanka has been able to save 41% of energy (per ton of production) by effectively allocating their resources using the analyzed data reports (Nestlé Lanka, 2018).

Management Accounting Systems

There are mainly four types of management accounting systems;

  1. Cost accounting system
  2. Job costing system
  3. Price optimizing system
  4. Inventory management system

Cost accounting system

Cost accounting system is a system used by management accountants to estimate the cost of a product. This can be used for profitability analysis, inventory valuation and cost control. With large batches of Milo, Nestomalt, Maggi, Milkmaid, Nespray etc. being produced daily, the use of this method is recommended as it is the most suitable.

There are mainly two types of cost accounting systems:

  1. Job order costing – This method is used for calculating costs separately for each job. This method is mostly used in firms which produce unique products or special orders.
  2. Process costing – This method is used where large batches of homogeneous products are manufactured. This is the opposite extreme of job costing and average costs are assigned to each unit in order to calculate the cost per unit.

Integration within Nestlé Lanka:

  • Process costing can be used to calculate the costs of the products produced in the Kurunegala factory.
  • Can be used to measure the efficiency in processes.
  • Cost control methods will be useful in setting the price of products.

Job costing system

This system accumulates manufacturing costs to specific jobs. When customers order products with specific requirements this system is used in order to submit the cost information to the customers. Within Nestlé Lanka, in an event where a customer orders a large number of homogeneous products with special requirements i.e. an event name or sponsorship on the packaging, this system can be used to prepare the job cost sheet for the product.

Integration within Nestlé Lanka:

  • Nestlé Lanka will be able to estimate all types of costs within the manufacturing process.
  • Product quality can be maximized as jobs are specific.

Price optimizing system

This system is used to calculate demand at different price levels. It is then matched with the cost of inventory and other production costs to identify the price that is most suitable to maximize profits. Nestlé Lanka could use this system to calculate the cost and recommend a suitable promotional price for a product that is set to launch. It can also be used to determine a discount price during promotional campaigns.

Integration within Nestlé Lanka:

  • Can be used to evaluate the different customers at different price levels.
  • Profit can be maximized as it helps to select an optimal price.
  • Helps in customer segmentation.

Inventory management system

This system uses various methods to supervise and manage the inventory level of the company. Barcode scanners, desktop software, physical counts etc. are used in order to maintain inventory at the optimum level to avoid over or under stock situations and to ensure the efficient flow of inventory.

Integration within Nestlé Lanka:

  • Can improve the accuracy of inventory orders.
  • Optimal inventory levels can be achieved at the Nestlé Lanka factory in Kurunegala.
  • Helps in supplying products efficiently without delay.

Management Accounting Reports

Budget reports

Budget reports help the organization measure their performance department wise and as a whole. Budget reports are prepared by using income and expenses from previous years whilst making necessary adjustments for the budgeted period. Furthermore, the budget helps to motivate employees to achieve the desired goals while staying within the budgeted amounts.

Integration within Nestlé Lanka:

  • Nestlé Lanka can use these reports to concentrate on achieving their targeted results.
  • Can be used to evaluate unnecessary expenses.

Accounts receivable aging reports

This report helps in managing the receivables of the organization. It is a detailed report which segregates invoices of customers to derive the credit period of each customer and it also helps the company to analyze its credit policy.

Integration within Nestlé Lanka:

  • Nestlé Lanka uses these reports for the timely collection of receivables.
  • Helps to calculate the necessary discounts that need to be allocated for credit collection.
  • Nestlé Lanka can evaluate their credit policy and its effectiveness.

Job cost reports

These reports provide information regarding the various costs that are incurred in manufacturing a specific product. This also provides an analysis of the projected revenue of the product which helps to evaluate the profitability.

Integration within Nestlé Lanka:

  • Nestlé Lanka can use these reports to decide their pricing strategies.
  • Analyze the profitability of specific products.

Inventory and manufacturing reports

These reports contain the labor costs and per unit overhead costs which can be used to manage the manufacturing process. It also evaluates the wastages related to inventory which helps managers to manage the inventory level more efficiently.

Integration within Nestlé Lanka:

  • These reports can be used to effectively manage the inventory levels of Nestlé Lanka.
  • Helps in calculating the required purchase orders that need to be placed by Nestlé Lanka.
  • Comparison between different assembly lines to measure efficiency.

Performance reports

Performance reports are prepared in order to measure the performance of the organization as a whole and/or department wise. These reports are used by managers in order to make key decisions about the company. It also helps in evaluating the employees of the company and committed employees are awarded for their performance.

Integration within Nestlé Lanka:

  • Helps the managers of Nestlé Lanka to plan the future production of the organization.
  • Helps to identify the best performing product or department.

Cost Accounting

Cost accounting is the method of accounting for costs. It can be defined as the collection, assignment and interpretation of cost (Walther and Skousen, 2009). Cost accounting is a detailed explanation of the various costs incurred within the organization and it is essential for the management of the organization.

For Nestlé Lanka, Cost accounting is essential for several reasons;

  • To analyze the costs incurred for production and operation.
  • Helps to develop the cost standards of each department and evaluate the cost of each production line to reduce costs.
  • To identify wastage within the factory.
  • Can be used to compare actual costs against budgeted costs for management to make better decisions in the future.
  • Can be used for the preparation of the Annual Report.

Classification of Costs

“Cost” is the monetary value of resources which have been sacrificed and it represents the materials, efforts, resources, risks, time and utilities consumed for production of goods or rendering of services (Drury, 2013). Cost can be classified in many ways; here we will look at the classifications and types of costs that are associated with products at Nestlé Lanka.

Classification by nature

i. Direct costs – Costs that can be conveniently and exclusively identified with a cost unit.

e.g. Direct material, Direct labor, Direct expenses

ii. Indirect costs – Costs that cannot be identified with an individual cost unit. These are allocated to the cost units using a cost allocation method.

e.g. Indirect material, Indirect labor, Indirect expenses

Classification by behavior

i. Variable costs – Costs that vary with the level of production. Per unit variable cost remains the same. Variable costs can be either direct or indirect.

e.g. Direct material, Direct labor, freight, sales commission

ii. Fixed costs – Costs that do not vary with level of production. They are called so as they remain fixed for a specific period.

e.g. Rent, Salaries, Insurance

iii. Semi-variable costs – Costs that contain features of both fixed and variable costs and are partly affected by the level of production.

e.g. Electricity

Classification by function

i. Production costs – All direct and indirect costs related to production.

e.g. Direct wages, Raw material, Direct labor

ii. Administration costs – Costs incurred for the management of the organization.

e.g. Administrative salary, Depreciation of office building, Insurance

iii. Selling and distribution costs – Costs incurred in selling products and handling products until it is distributed to the customer.

e.g. Advertising costs, Warehousing, Sales commission, Delivery costs

iv. Research and development costs – Costs incurred for the development of a new product or an improvement of an existing product by means of experiments and new ideas.

Allocation of overheads

Depending on the method overheads are allocated for the product, there are mainly three methods;

  1. Marginal costing
  2. Absorption costing
  3. Activity based costing (ABC costing)

Marginal costing

In marginal costing, cost of sales includes only variable costs. Fixed costs are written off in full and is charged to the profit and loss account.

Integration within Nestlé Lanka:

  • Nestlé Lanka can use this method to calculate contribution per unit.
  • The managers can use this method for decision making purposes as it helps to calculate a cost-volume-profit analysis.
  • Nestlé Lanka can identify the break-even point for products.

Absorption costing

In absorption costing, all manufacturing costs are treated as production costs. Fixed overheads are absorbed to production using pre-determined basis of apportionment.

Integration within Nestlé Lanka:

  • Nestlé Lanka can use this method as it is recommended by International accounting standards.
  • Can be used to calculate the value of inventory in the Statement of Financial Position.
  • Since all manufacturing costs are allocated as production costs, Nestlé Lanka can determine a selling price that covers all costs.

Activity-based costing (ABC costing)

In ABC costing, overheads are calculated for each product based on their usage of an activity. In ABC costing, production is divided into core activities and the costs of those activities is allocated to a product based on how much of a particular activity is needed by a product (Walther and Skousen, 2009).

Integration within Nestlé Lanka:

  • Nestlé Lanka can use this method as it gives a more accurate representation of the costs incurred.
  • As this method identifies costs for each individual activity, Nestlé Lanka can use this information to improve the efficiency of its manufacturing process.

Nescafé Rapido

Made from freshly brewed coffee beans mixed with high quality local fresh milk, together with the richness of Nescafé’s signature taste of coffee, comes a new blend of Nescafé that is sure to keep you wanting more. Introducing Nescafé Rapido; iced coffee, bottled and ready to drink at your heart’s desire.

With the huge success of Nestlé’s Milo in the local market over the years, together with the successful launch of Nescafé Hazel-Ice on the 1st of October of 2018 (Nestlé Lanka, 2018), Nestlé Lanka has planned to introduce Nescafé Rapido as a remedy for those who seek more variations of the unique coffee taste of Nescafé. Nescafé Rapido will be available in 400ml recyclable bottles produced at the Kurunegala factory.

Nescafé Rapido comes in three flavors; KitKat, Cookies and Cream, and Caramel Mocha.

Cost breakdown for Nescafé Rapido

Rs. (per unit)

Direct Material:

Semi-skimmed milk 5

Nescafé Arabica coffee extract 6

Sugar 4

Water 3

Fat reduced cocoa powder 10

Coffee flavoring 7

Rs. 35

Direct Labor: 15

Rs. 15

Variable Production Overheads:

Packaging 40

Equipment utilities 30

Rs. 70

Fixed Production Overhead:

Machinery Depreciation

Rs. 150,000

Heat and Lights

Rs. 320,000

Repair Costs

Rs. 170,000

Machinery Insurance

Rs. 310,000

Canteen

Rs. 220,000

Non-Production Overheads:

Administrative Salaries

Rs. 100,000

Rent & Rates

Rs. 150,000

Selling Expenses

Rs. 80,000

  • 100,000 units of Nescafé Rapido are budgeted to be produced for April.
  • Selling price for one unit of Nescafé Rapido is Rs. 150. (25% markup on cost using marginal cost-plus pricing)
  • Nescafé Rapido will be released to the market on the 1st of April 2019.

Calculation of selling price per unit (Marginal cost-plus pricing)

Rs.

Direct Material

35

Direct Labor

15

Variable Production Overheads

70

Total production cost

120

Markup (25%)

30

Selling Price

150

Justification of the selling price

The 25% markup was selected by analyzing the marginal cost of the product using marginal cost-plus pricing. Rs. 150 for the 400ml Nescafé Rapido was also in line with our other similar products; Milo and Nescafé Hazel-Ice which are priced at Rs. 50 and Rs. 60 respectively. (both of which are 180ml)

Cost of Nescafé Rapido (Absorption Costing)

Note

Rs. (per unit)

Direct Material

35

Direct Labor

15

Variable Production Overheads

70

Fixed Production Overheads

1

9.75

Total Production Cost

129.75

Note 1: Overhead Apportionment Table

Overhead

Basis of Apportionment

Total

Production

Stores

Machinery Depreciation

Machinery book value

150,000

112,500

37,500

Heat and Lights

Floor area

320,000

192,000

128,000

Repair Costs

Floor area

170,000

102,000

68,000

Machinery Insurance

Machinery book value

310,000

232,500

77,500

Canteen

No. of employees

220,000

132,000

88,000

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771,000

399,000

Reapportionment: Stores

No. of budgeted units

399,000

(399,000)

1,170,000

Overhead Absorption Rate =

Production

Stores

Floor area

3,000

2,000

Machinery book value

180,000

60,000

No. of employees

150

100

Budgeted Labor hours

120,000

Break-even analysis

Rs. (per unit)

Selling price

150

Direct Material

(35)

Direct Labor

(15)

Variable Production Overheads

(70)

Unit Contribution

30

Break-even point = =

Projected Income Statements

Projected Income Statement for the month ending 30th April 2019

(Marginal Costing)

Rs.

Sales

150 * 100,000

15,000,000

Less Cost of Sales:

Direct Material

35 * 100,000

(3,500,000)

Direct Labor

15 * 100,000

(1,500,000)

Variable Production Overheads

70 * 100,000

(7,000,000)

Contribution

3,000,000

Less Fixed Production Overheads:

Machinery Depreciation

150,000

Heat and Lights

320,000

Repair Costs

170,000

Machinery Insurance

310,000

Canteen

220,000

(1,170,000)

1,830,000

Less Non-Production Overheads:

Administrative Salaries

100,000

Rent & Rates

150,000

Selling Expenses

80,000

(330,000)

Profit

1,500,000

Projected Income Statement for the month ending 30th April 2019

(Absorption Costing)

Rs.

Sales

150 * 100,000

15,000,000

Less Cost of Sales:

Direct Material

35 * 100,000

(3,500,000)

Direct Labor

15 * 100,000

(1,500,000)

Variable Overheads

70 * 100,000

(7,000,000)

Fixed Production Overheads

9.75 * 100,000

(975,000)

Contribution

2,025,000

Less Non-Production Overheads:

Administrative Salaries

100,000

Rent & Rates

150,000

Selling Expenses

80,000

(330,000)

Profit

1,695,000

Projected Statement of Financial Position as at 30th April 2019

Rs. ‘000s

Rs. ‘000s

Assets

Non-Current Assets

Property, Plant and Equipment

11,500,000

Current Assets

Inventories

200,000

Trade and Other Receivables

500,000

Cash and Cash Equivalents

2,000,000

2,700,000

Total Assets

14,200,000

Equity and Liabilities

Stated Capital

500,000

Retained earnings

8,200,000

8,700,000

Non-Current Liabilities

Bank Loan

4,000,000

4,000,000

Current Liabilities

Trade and Other Payables

500,000

Bank Overdraft

1,000,000

1,500,000

Total Equity and Liabilities

14,200,000

Conclusion

In conclusion we see that various management accounting systems and reports are used by Nestlé Lanka to ensure the efficiency and effectiveness of its day-to-day operations; managers use these techniques in order to make decisions and further improve the status of Nestlé Lanka.

With the use of the management accounting systems and cost accounting methods used in this report, our team has concluded that the new product Nescafé Rapido is profitable for Nestlé Lanka and we recommend that Nestlé Lanka go ahead with the plans to launch Nescafé Rapido.

References

  1. Drury, C. (2013). Management and Cost Accounting. New York, NY: Springer.
  2. Nestlé (2019). The Nestlé company history. [online] Available at: https://www.nestle.com/aboutus/history/nestle-company-history [Accessed 2 Mar. 2019].
  3. Nestlé Lanka (2018). Nestlé introduces all new Nescafé Hazel-Ice on International Coffee Day. [online] Available at: https://www.nestle.lk/en/media/pressreleases/nestl-introduces-all-new-nescaf-hazel-ice-on-international-coffee-day [Accessed 8 Mar. 2019].
  4. Nestlé Lanka (2018). Nestlé Lanka Annual Report 2017. [online] Nestlé Lanka, pp.32, 78. Available at: https://cdn.cse.lk/cmt/upload_report_file/487_1522637656268.PDF [Accessed 4 Mar. 2019].
  5. Nestlé Lanka (2019). Key Dates & Events. [online] Available at: https://www.nestle.lk/en/aboutus/nestle-in-sri-lanka/key-dates-and-events [Accessed 2 Mar. 2019].
  6. Nestlé Lanka (n.d.). Nestlé in Sri Lanka. [online] Available at: https://www.nestle.lk/en/aboutus/nestle-in-sri-lanka [Accessed 2 Mar. 2019].
  7. Walther, L. and Skousen, C. (2009). Managerial and Cost Accounting. Ventus Publishing, pp.10, 17.

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Analytical Essay on Cost Accounting System: Case Study of Nestlé Lanka Limited. (2022, September 27). Edubirdie. Retrieved November 29, 2022, from https://edubirdie.com/examples/analytical-essay-on-cost-accounting-system-case-study-of-nestle-lanka-limited/
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