Direct materials used in production of food products, which are produced in the factory are wheat flour, rice flour, and food flavors. Noodles produced at Nongshim factory are mainly made of flour. Flour constitutes the biggest percentage of ingredients used in production of these noodles. Some noodles are made of a combination of wheat flour and rice flour. Therefore, rice and wheat flour are used as a direct materials. Besides, the factory produces rice: haepssal steamed rice, which is freshly steamed rice. Nongshim uses homegrown rice, specifically sourced from Korea. The rice is steamed using spring water and then it is packed in sterilized food containers. Given that rice is one of the main products of Nongshim factory, raw rice is therefore a direct material in the factory. All of the Nongshim products have different food flavors. Flavors used in the factory include beef, vegetables, and fruits flavors. Therefore, flavors form part of direct materials since they constitute the ingredients used in production of Nongshim products.
Indirect materials used in the factory include packaging items used to pack the processed food products. Usually, the factory uses sterilized plastic containers, to pack their food products. These containers are not part of what the factory produces, but are necessary for completion of the factory’s processes. They are therefore categorized as indirect materials. Apart from indirect labor and materials, the factory has other forms of overheads. These overheads include power used to run the processing machines in the factory, and water. All machines used in the factory utilize electricity. The production process of noodles and rice requires a lot of water. Therefore, both power and water form part of the factory’s overheads. Other overheads include the cost of repairing and maintaining the factory’s equipments and buildings. Variable overheads observed in the factory are utilities costs for power and water, while maintenance cost of the factory’s equipments (depreciation) forms part of fixed overhead resources.
The Production Activity
The production activity, which can be termed as value adding activity in the factory is the one, which involves conversion of raw rice into noodles. It is a value adding activity because raw rice is first converted into flour, and then the rice flour is converted into noodles. The process of converting raw rice into ready-to-eat rice (freshly steamed rice) can also be termed as a value adding activity. Nongshim factory controls the quality of its production process by constantly testing the quality of the products, to ensure they meet the factory’s standards. In addition, the factory conducts routine checks on the processing machines, to ensure they are free from any mishaps.
To design a product costing system for Nongshim factory, one may have to evaluate the biggest cost driver in the factory. Since direct materials and labor account for the biggest proportion of the factory’s cost, then a simple product costing system can be based on direct costs. A product costing system based on direct costs involves pricing a product based on the amount of direct costs used in its production. Nongshim factory utilizes the same facilities to produce its products. For instance, it uses the same processing plant to produce different types of noodles. The factory also utilizes the same machine to covert wheat and rice into flour.
Given that the factory uses the same facilities to produce a wide range of products, it may not require using more than one cost pool. Utilizing many cost pools may be unmanageable and time consuming. Cost drivers that the factory can use may include direct labor (wages paid to individuals involved in the production process), cost of raw materials (wheat, rice, and flavors), and depreciation of machineries and equipments. The factory can use activity based cost pool, whereby costs incurred in the production activities are combined together to form a basis of pricing the final products (cost pool). These may include a combination of costs previously identified as cost drivers.
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