MEKELLE UNIVERSITY

COLLEGE OF BUSINESS AND ECONOMICS

DEPARTMENT OF ACCOUNTING AND FINANCE

ASSESSMENT OF PRODUCT COSTING AND PRICING PRACTICE (IN

CASE OF HUDA FLOUR FACTORY)

A RESEARCH PROPOSAL SUBMITTED IN PARTIAL FULFILLMENT OF

THE REQUIREMENTS FOR THE AWARD OF BACHELOR OF ART (BA)
DEGREE IN ACCOUNTING AND FINANCE

By:

KIFLIE BIRHAN

(ID Number: CBE/UR/165396/2006)

ADVISOR: ELIAS (MSc.)

April, 2016

Mekelle, Tigray, Ethiopia

 CHAPTER ONE

1.1. Background of the study

Cost is the sacrifice made usually measured by the resource given up to achieve a particular purpose.
There are different cost concept, classifications and measures used for external financial reporting,
setting of price purpose. Understanding these differences enable the cost management analysts to
provide appropriate cost data to the manager who need it (Hilton, 2003).Product costing is a cost
assigned to goods that were either purchased or manufactured for resale. It used to value the
inventory manufactured goods or merchandise until the goods are sold. The product cost of
manufacturing inventory includes all costs incurred in its manufacture. For example, the labor cost
of a production employee, product costs are also known as inventoriable costs (Hilton, 2003).

Pricing is the process of determining what a company will receive in exchange for its product or
service. Pricing factors are manufacturing cost, market place, competition, market condition, brand
and quality of product. Pricing is also a key variable in microeconomic price allocation theory.
Pricing is a fundamental aspect of financial modeling and is one of the four Ps of the marketing mix
(Horengren, 2004).
Product pricing is the process of determining the selling price of the product which is sufficient to
cover administrative and marketing expenses and give a reasonable percentage of profit (Hilton,
1997).
Product costing and pricing plays a vital role for the success and failure of any organization
whether they are manufacturing, merchandise or service giving organizations therefore a great deal
of emphasis should be given for product costing and pricing. An understanding of the cost concept is
absolutely critical to the cost management and setting price of product. Company cost information
provides the data required for the preparation and operation of budget, for establishing standard costs
and determination of the price the product and for analytical purpose. Any organization starts from
smaller sole proprietorship to the largest corporation acquiring know how and use of product costing
and pricing practice(Hilton,2003).
Previous study, for example, Meksud (2011) had conducted a research on the related topic i.e.
Examine the costing system and classification of cost and their respective recording that he
conducted his study. In this study deeply examine the product costing and pricing practice that Huda
Flour Factory apply (examine the bases that the industry uses in setting selling price, assess how
direct material, direct labor and manufacturing overhead are recorded, see the product costing
system use in the setting of selling price, examine the pricing and product costing practice of the
Huda Flour Factory, and assessment of the accounting treatment for spoilage and scrap).
This study will be conducted to assess the product costing and pricing practice of Huda Flour
Factory.
1.2. Statement of the problem
For any business enterprise whether they are manufacturing, merchandizing and service giving the
product costing and pricing is very important. Therefore, the improper practice of product costing
and pricing may result in the disruption of the operation, affect the profitability of the organization
and even cause bankruptcy. Due to this, the proper practice of product costing and pricing is
important for Huda Flour Factory to sustain its operation and to maintain satisfactory level of
growth. Because proper practice of product costing and pricing is crucial for the success and failure
of the business because every operating business incurs cost and setting their product price (Hilton,
2003).
Product costing and pricing practice is one of the most important factors to insure the survivals of
the organization. Cost management helps an organization management create more value at lower
cost by efficiently managing the organization value chain activities, processes and functions (Hilton,
2003).
Previous study, conducted by Meksud (2011) indicates that the purpose of cost accounting system,
the recording of production costs in accounting department and the role of costing system for
decision making. This study will be intended to assess significantly other cost accounting issues
such as bases in for setting selling price , the pricing and costing strategies ,costing methodology in
using pricing decision, product costing and pricing practice of Huda Flour Factory.
Therefore, the study will be designed to concentrate on the application of product costing and
pricing.
1.3. Objectives of the Study
1.3.1 General Objective
The general objective of this study is to assess product costing and pricing practice in case of Huda
Flour Factory.
1.3.2 Specific Objectives
The specific objectives of this study are:
1) To assess how direct material, direct labor, manufacturing overhead costs (production cost) of
product are recorded.
2) To examine the product costing and product pricing practice that Huda Flour Factory use.
3) To examine the bases that Huda Flour Factory uses in setting selling price.
4) To see the product costing practice use in the setting of selling price.

1.4. Research Questions

This study is developed to answer the following basic questions:
1. How each production cost (i.e. direct material, direct labor, manufacturing overhead cost) are
recorded in Huda Flour Factory?
2. What product costing and product pricing that Huda Flour Factory use?
3. What are the bases for setting selling price?
4. Does the product costing practice help the management in the setting of selling price?

1.5. Scope and Limitation of the Study

The scope of the study will be delimited to those areas which will tells the product costing and
pricing practice of Huda Flour Factory. The study will be emphasized on manufacturing cost
(material, labor and overhead). In addition the study will cover some important aspect which will be
considered in setting proper price in selling product and its application in Huda Flour Factory. The
study will not be wanted to detail of the other accounting aspect of the company unless it will be
related to the costing implication.
While the researcher conducting this study the researcher will face some limitation. These includes;-
absence of well developed and written document for secondary data sources in the organization,
some respondents are not willing to give the necessary information, financial constraint, lack of
internet access for searching more information and doing research in parallel with learning other
courses are some major limitation that the researcher will be encountered.
1.6. Significance of the Study
This study will go to investigate the real world application of product costing and pricing practice by
selecting Huda Flour Factory. The significance of the study is that: First, the recommendations gives
at the end will help to the organization to improve its inefficiencies. Second, the study paper will
enables to create awareness to an area about product costing and pricing. Third, the study paper will
enables to make further study on the subject matter and other related studies. Fourth, it will motivate
the researcher to conduct such and other studies by getting knowledge from the assessment. Finally,
the study paper will help to improving the way to those who are interested to undertake further
research on the same studies in the future.
1.7. Organization of the Paper
This study will be classified in to five chapters. The first chapter provides background of the study,
statement of the problem, objective of the study, scope and limitation of the study, significance of
the study, and organization of the study. The second chapter will be outlining the related literature
review of different authors about the subject matter under study. The third chapter deals about
research methodology. The fourth chapter will outline the data analysis and presentation. Finally the
fifth chapter will be summed up all points that will be raised in the paper, drawn conclusion and
sound recommendations.
 CAPTER TWO
2. Literature Review
2.1 Definitions of cost and cost accounting
Cost is a measurement of resources sacrificed or forgone to achieve a specified objective. Total
cost includes notional or imputed costs, which do not involve actual cash outlay and hence do
not find place in financial accounting records (Bhattacharyya, 2010).
Cost- is as sacrifice of resources or giving up of resources for a particular purpose frequently
measured by the monetary units that an organization must pay for goods and services. It is the
amount of expenditure incurred on or attributable to a given product or service referred to as cost
object. Cost object is anything for which decision makers desire a separate measurement of cost.
Example includes: department, product, activities and territories (Horengren, 2004).
Cost Accounting is the field of accounting that measures, recorders and reports information
about cost represented in the accounting system by outlay of cash, promise to pay cash in the
future and expiration of the value of the asset. These include the cost of inventory, the cost of
increasing sales volume and cost saved from energy efficiency equipment. Cost accounting is the
process of accounting for cost from the point at which expenditure is incurred or committed to
the establishment of its ultimate relationship with cost centered and cost unit (Arora, 1997).
2.2 classification of cost
All types of organization incur costs business, non-business, manufacturing, and retail land
service. Generally, the kind of cost that are incurred and the way in which these cost are
classified depends on the type of organization. There are different method of classifying costs
depending on the purpose in which the information is to be used, similar costs are grouped to aid
managerial decision making and to produce the analysis necessary for external financial
reporting cost item can be similar to one another in several different aspect. The particular
classification depends on the purpose of grouping cost together. Cost can be analyzed by
functions in which a case function within organization is manufacturing, administration, selling,
distribution, researched. The criteria used will be depending on the reason for which the
information is being collected (Garrison, 2006).
 A. The time period for computing costs

Time can be broadly classified in to past and future .cost can be also classified according to those
time periods (Cherrington, 1998).
Historical cost
Sunk cost is a cost that has already been incurred and that cannot be changed by any decision
made now or in the future. Sunk costs are those costs that are incurred in the past period they are
also known as historical costs (Cherrington, 1998).
Budgeted costs
Budgeted costs are those costs that are expected to incur in the future time (Cherrington,
1998).
B. Cost classification for predicting cost behavior
Cost behavior means how accost will react or respond to changes in the level of business
activity. As the activity level rises and falls, a particular cost may rise and fall as well or it may
remain constant (Garrison, 2006).Cost behavior describes how the cost changes with time or
changes in volume .Cost behavior refers how the cost will react or respond to change in the
level of business activities (Hilton, 2003). This classifies costs as variable and fixed costs, and
describes as follows;
Variable costs
A variable cost is a cost that varies in total, in direct proportion to changes in the level of
activity. The activity can be expressed in many ways, such as units produced, units sold, miles
driven, beds occupied, lines of print, hours worked, and so forth (Garrison, 2006).
Fixed costs
A fixed cost is a cost that remains constant in total, regardless of changes in the level of activity
within the relevant range (Garrison, 2006).
C. Cost classification for assigning costs to cost objects
Costs are assigned to objects for a variety of purposes including pricing, profitability studies, and
control of spending. A cost object is anything for which cost data are desired. For purposes of
assigning costs to cost objects, costs are classified as either direct or indirect cost (Garrison,
2006).
Direct cost
A direct cost is a cost that can be easily and conveniently traced to a particular cost object under
consideration (Garrison, 2006).
Indirect cost
An indirect cost is a cost that cannot be easily and conveniently traced to a particular cost object
under consideration (Garrison, 2006).

2.3 Components of product costing

Product cost is a cost assigned to goods that were either purchased or manufactured for resale .It
is used to value the inventory of manufactured goods or merchandise until the goods are sold. In
the period of sale, the product costs are recognized as expense called cost of goods sold. Since,
product costs are initially assigned to inventories, they are also known as inventor able costs.
Most manufacturing companies divided product costs in to three categories: direct material,
direct labor and manufacturing overhead (Garrison, 2006).
2.3.1. Direct material
Direct materials are those materials that are an integral part of the finished product and that can
be physically and conveniently traced in to it (Garrison, 2006).
Direct materials are resources such as raw materials, parts, components that one can feasibly
observe being used to make specific product. The term “feasibly you observe”means that the cost
of observing the use of the resource is less than the benefit which of doing so (Hilton, 2003).
Direct materials are those materials which can be conveniently identified with and allocated to
cost units. They are the acquisition costs of all materials that eventually become part of the
object and that can be traced to the cost object in an economically feasible way Acquisition costs
of direct materials include freight in charges, sales taxes and custom duties (Horngren, 2003).
Direct materials are the raw materials from which the product is made and comprise the value of
materials that are physical observable as being identified with the finished good and that may be
traced to the finished product in an economically feasible manner (Horngren, 2003).
2.3.2 Direct Labor Cost
Direct labor is reserved for those labor costs that can be easily (i.e., physically and conveniently)
traced to products. Direct labor is sometimes called touch labor, since direct labor workers
typically touch the product while it is being made (Garrison. 2006).
The term labor cost is the cost of remuneration such as wages, salaries, commissions, bonuses,
etc. Direct manufacturing labor costs include the compensation of all manufacturing labor that
can be traced to the cost object in an economically feasible way. Direct labor consists of wages
paid to workers directly engaged in converting raw materials in to finished products. These costs
can be conveniently identified with a particular job or process (Horngren, 2003).
2.3.3. Manufacturing Overhead Costs
Manufacturing overhead cost includes all costs of transferring material into finished products
other than direct material and labor costs, which one cannot be feasibly observe being used to
make specific products but they are necessary for the production process. Example; indirect
materials (repair parts, light bulbs for production plant), indirect labor (maintenance workers,
supervisor, purchase manager etc.)(Hilton, 2003).
Manufacturing overhead cost is all costs of manufacturing except direct material and direct labor
, maintenance and repairs on production equipment, heat light, property tax, depreciation, and
insurance on manufacturing facilities (Garrison, 2006).
2.4. Non-Manufacturing Costs
Non-manufacturing costs are those costs that are not incurred to manufacture a product, include
selling and administrative costs .selling costs are cost of sales personnel, data bases equipment
and facilities devote to sales activities. Administrative costs are incurred to manage the
organizations and provide staff support (Hilton, 2003)
Generally, non-manufacturing costs are sub classified in to two categories as;
1. Marketing or selling costs,
2. Administrative costs
Marketing or selling costs include all costs necessary to secure customer orders and get the
finished product or service in to the hands of the customer. The costs are often called order-
getting and order-filling costs. Marketing cost includes; advertising, shipping, sales travel, sales
commissions, sales salaries and costs associated with finished goods warehouses (Garrison,
2006).
Administrative costs include all executive, organizational and clerical costs associated with the
general management of an organization rather than associated with manufacturing, marketing or
selling (Garrison, 2006).
2.5. Product costing system
Product costing system refer to the techniques and processes employed in the ascertainment of
costs. There are different products costing system for different factories. The product costing
system to be used in a particular company depends up on the type of manufacturing and nature of
factory (D. Williamson, 1999).

Process costing Job order costing

system system

Mass of identical or similar unit of Distinct unit of product or service

Product or service
2.5.1. Process Costing System
Process costing is used in repetitive production environments, where large numbers of identical
or very similar products are manufactured in a continuous flow. Process costing treats all units
processed during a time period as the output of which costs are assigned and does not separate
and record costs for each unit produced (Hilton, 2003).
Process costing is applied in cases where the identity of individual orders is lost in the general
flow of production. In this process the cost object is masses of identical or similar units of
product or service. Industries to which process costing is applied produce uniform products
without reference to the specific requirements of customers. Example Textile, sugar, paper, shoes
plastic factories chemical industries etc (Arora, 1997).
According to M.N Arora process costing follows the following procedures;
1. The factory is divided in to a number of processes and an account is maintained for each
process.
2. Each process account is debited with material cost, labor cost, direct expenses and overhead
allocated or apportioned to the process
3. The output of a process is transferred to the next process in the sequence.
4. The finished output of the last process is transferred to the finished goods account.
A single work in process account may be used by a company that has only one producing
department or continuously produces a single product. On the other hand departmental work in
process accounts are preferable if production flow through several cost centers or departments
separate cost figures for each process might also be desirable. In a manufacturing process.
Costing setting, each unit receives the same or similar amounts of direct materials costs, directs
labor costs and indirect manufacture costs (Horngren, 2003).
According to Charles T. Horngren there are five steps in calculating unit costs in process costing
system. These steps are.

1. Summarize the flow of physical units of out put

2. Compute output in terms of equivalent units
3. Compute cost per equivalent unit
4. Summarize total costs to account for
5. Assign total costs to units completed and to unit in ending work in process.

2.5.2. Job Order Costing System

Job-order/Batch costing is used by companies with job-shop operations or batch-production
operations.
In job-order costing, each distinct batch of production is called job or job order. The cost
accounting procedures are designed to assign costs to each job. Then the costs assigned to each
job are averaged over the units of production in the job to obtain an average cost per unit. Job
order costing treats each individual job as the unit of output and assigned costs to each job as
resource are used (Hilton, 2003).
According to (Hilton, 2003) Job order cost costing is appropriate for the following type
production process.
o Each unit or batch of product is distinct and clearly distinguishable from other product.
o Each unit of relatively high value, which makes the benefits of separately assigning
production cost worth the cost of doing so.
o Each unit or batch of product is often priced different, frequently in accordance with a
bidding process.
o Each unit or batches of product can feasibly have its direct costs traced.
According to (Hilton, 2003) job order costing is useful for the following purpose.
 Identifying types of jobs
  Providing data to predict costs of future
 Managing data of current jobs
 Renegotiating job contracts
 Reporting actual financial results

2.6 Cost Recording and Cost Accumulation Procedures

A company or an organization is responsible for proper recording and accumulation of costs
especially cost department (Cherrington, 1994).
A Cost Recording
I. Accounting for material
The material account is affected by transaction such as purchase issue for use, return of unused
material spoilage and damage of obsolesce (Cherrington, 1994).
1. Purchase of Materials
Material purchase have own treatment for freights, clearing and handling cost. Such cost can be
material or manufacturing overhead cost which is charged on the basis of pre-determined price
that help to identify direct and indirect material. The cost of material includes the invoice amount
plus other costs paid to put the material in place ready for use. Costs typically include the invoice
amount, shipping cost (freight in), sales tax, costs of delivery. Etc (Cherrington, 1994).
Trade discount, purchase discount, quantity discount should not be included in the cost of
material (Cherrington, 1994).
Purchase Discount
Purchase discount refers cash discounts. It is usually profitable to pay the invoice with in
discount period. Material should be recorded at the invoice price minus the amount of purchase
discounts permitted whether they are taken or not. This procedure is known as recording
purchase discount (Cherrington, 1994).
Freight in
Freight in is an ordinary, and necessary cost of purchasing material. The journal entry for
purchase of material with freight in would be (O. Cherrington, 1994).
2. Material Issued
The direct material consumption is charged to working in process. There are three cost flows of
material assumptions that must be consistently applied for similar categories of materials
(Cherrington, 1994).
 1. First in first out
The criticism of FIFO is that it does not match the current cost of goods sold with the current
revenue; rather the oldest unit costs are matched with current sales revenue. The cost of the first
material received is assumed to be the cost of the first material issued (McGraw-Hill, 2001).
2. Last in first out
The Last in- First out method of inventory costing methods inventory valued at the most recent
unit of acquisition cost with current sales revenue. The cost of the last material received is
assumed to be the cost of the first material issued (McGraw-Hill, 2001).
3. Average method
Weighted-Average cost is used with a periodic inventory system because the physical inventory
is not counted until the end of the period, and the periods weighted-average unit cost can be
determined only at the end of the period. It uses the average cost of material purchased is
assumed to be the cost of the firm material issued (McGraw-Hill, 2001).
II Account for Labor Cost
There are two general set of journal entries required to account for labor costs. The first set
records the cost and payment of labor benefits. It includes salaries, wages and incentive plan
( Cherrington, 1994).

B. The Cost Accumulation, Assignment, Allocation

Cost Assignment

Direct Cost tracing

cost
Cost
Cost allocation
object
Indirect
cost
A) Cost Accumulation
Cost accumulation is the process of collecting cost data through an accounting system. Costs are
usually accumulated under natural classifications, such as material, labor, power, electricity, fuel,
advertising, sales commission, and fright.
B) Cost Assignment
Cost assignment is a general term that encompasses with tracing accumulated cost to cost object,
and allocating accumulated cost to cost object.
The costs that are traced to cost object are direct cost and the cost that are allocated to cost object
are indirect cost.
Cost tracing is the assigning of direct cost to the chosen cost object.
C) Cost Allocation
Cost allocation is the charging of discrete, identifiable items of cost to cost centers or cost units.
Terminology of Cost Allocation
 Cost object:- is anything for which a separate measurement of cost is desired
 Direct cost of a cost object-: Costs that are related to the particular cost object and can be
traced to it in an economically feasible way.
 Indirect cost of a cost object: - Cost that is related to particular cost object but cannot be
traced to it in an economically feasible way.
Purpose of Cost Allocation
o To provide information for economic decision
o To motivate manager and employees
o To justify cost or computer reimbursement
o To measure income and asset for reporting to external parties

Criteria to Guide Cost-Allocation Decisions

Cause-and-effect: Using this criterion, managers identify the variable or variables that cause
resources to be consumed.
Benefits-received: Using this criterion, managers identify the Beneficiaries of the outputs of the
cost object.
Fairness or equity::This criterion is often cited on government contracts when cost allocations
are the basis for establishing a price satisfactory to the government and its suppliers.
Ability to bear::This criterion advocates allocating costs in proportion to the cost object’s ability
to bear them.

2.7. Use of Cost Information

2.7.1. Cost for planning and Control
A company’s cost information system provides the data required for the preparation and
operation of a budget and for establishing standard costs.
Budget: - In many companies predetermining or estimating factory overhead constitutes the
initial step toward a budget program. The budget program lists of all members of management in
the task of creating workable and acceptable plan of action welds the plan in to homogenous
unit.
Standard cost: - Closely allied with the budget is standard cost which is predetermined cost of
direct material, direct labor and factory overhead.
2.7.2 Cost for Analytical propose
Different type of involves varying kind of consideration in managerial analysis for decision
making. For example differential analysis for decision making in different and out of pocket cost
are type of cost which attempt to envision when management in faced with the problem of
abandoning one product and substituting another decision will demand the consideration of
opportunity cost.
2.8. Pricing Models
Pricing models in manufacturing firms are based on cost relationships. Prices based on costs are
popular because they are easy to use and easy to understand. A very simple and widely used cost
based pricing model in manufacturing firms is known as cost plus pricing with a cost plus a
certain amount or percentage is added to the product cost determining it selling cost. It uses
current selling price and competitor’s price (Hilton, 1997).
Many manufacturing firms use a cost plus or what sometimes referred to as markup pricing
method to set selling price for their products. Cost plus pricing means cost plus a certain mark
up. This is sufficient to cover administrative and marketing expenses and give a reasonable
percentage of profit (Hilton, 1997).

Major Influences on Pricing Decisions

Customers: influence price through their effect on the demand for a product or service, Based on
factors such as the features of a product and its quality.
Competitors: No business operates in a vacuum. Companies must always be aware of the
actions of their competitors. At one extreme, alternative or substitute products of competitors
hurt demand and force a company to lower prices.
Costs: influence prices because they affect supply. The lower the cost of producing a product,
the greater the quantity of product the company is willing to supply. Generally, as companies
increase supply, the cost of producing an additional unit initially declines but eventually
increases. Companies supply products as long as the revenue from selling additional units
exceeds the cost of producing them. Managers who understand the cost of producing products set
prices that make the products attractive to customers while maximizing operating income
(Horengren, 2012).
Time Horizon of Pricing Decisions
A. Short-run pricing decisions

Short-run pricing decisions: typically have a time horizon of less than a year and include
decisions such as (a) pricing a one-time-only special order with no long-run implications. And (b)
adjusting product mix and output volume in a competitive market.
Two key factors affect short-run pricing.
1. Many costs are irrelevant in short-run pricing decisions. For example, most of costs in R&D,
design, manufacturing, marketing, distribution, and customer Service are irrelevant for the short-
run pricing decision. These costs will change in the long run and therefore will be relevant.
2. Short-run pricing is opportunistic. Prices are decreased when demand is weak and competition
is strong and increased when demand is strong and competition is weak. As we will see, long-run
prices need to be set to earn a reasonable return on investment
 B. Long-Run Pricing Approaches

Long run pricing decision: pricing decisions have a time horizon of a year or longer and include
pricing a product in a market where there is some leeway in setting price.
Long-run pricing is a strategic decision designed to build long-run relationships with customers
based on stable and predictable prices. A stable price reduces the need for continuous monitoring
of prices, improves planning, and builds long-run buyer–seller relationships. But to charge a
stable price and earn the target long-run return, a company must, over the long run, know and
manage its costs of supplying products to customers. As we will see, relevant costs for long-run
pricing decisions include all future fixed and variable costs (Horengren, 2012).
Two different approaches for pricing decisions are as follows:
I. Market-based pricing
II. Cost-based, which is also called cost-plus pricing
I. Market-based pricing
The market-based approach to pricing starts by asking, “Given what our customers want and
how our competitors will react to what we do, what price should we charge?” Based on this
price, managers control costs to earn a target return on investment. Companies operating in
competitive markets (for example, commodities such as steel, oil, and natural gas) use the
market-based approach. The items produced or services provided by one company are very
similar to items produced or services provided by others. Companies in these markets must
accept the prices set by the market (Horengren, 2012).
Target costing for target pricing
Market-based pricing starts with a target price. A target price is the estimated price for a
product or service that potential customers are willing to pay. This estimate is based on an
understanding of customers’ perceived value for a product or service and how competitors will
price competing products or services. This understanding of customers and competitors is
becoming increasingly important for three reasons:
1. Competition from lower-cost producers is continually restraining prices.
2. Products are on the market for shorter periods of time, leaving less time and opportunity to
recover from pricing mistakes, loss of market share, and loss of profitability.
3. Customers are becoming more knowledgeable and incessantly demanding products of higher
and higher quality at lower and lower prices.
II. Cost-based pricing
The Cost-based approach to pricing starts by asking, “Given what it costs us to make this
product, what price should we charge that will recoup our costs and achieve a target return on
investment?” Companies operating in markets that are not competitive favor cost-based
approaches. That’s because these companies do not need to respond or react to competitors’
prices. The margin they add to costs to determine price depends on the value customers place on
the product or service. The general formula for setting a cost-based price adds a markup
component to the cost base to determine a prospective selling price. Because a markup is added,
cost-based pricing is often called cost-plus pricing,
Companies operating in less competitive markets offer products or services that differ from each
other (for example, automobiles, computers, management consulting, and legal services), can use
either the market-based or cost-based approach as the starting point for pricing decisions. Some
companies first look at costs because cost information is more easily available and then consider
customers or competitors: the cost-based approach. Others start by considering customers and
competitors and then look at costs: the market-based approach. Both approaches consider
customers, competitors, and costs. Only their starting points differ. Management must always
keep in mind market forces, regardless of which pricing approach it uses. For example, building
contractors often bid on a cost-plus basis but then reduce their prices during negotiations to
respond to other lower-cost bids (Horengern, 2012).
 CAPTER THREE
3. METHODS AND RESEARCH METHODOLOGY
3.1. Description of the study area
The study area is Mekelle city which is located at northern part of Ethiopia, in Tigray regional
state. It is located in a distance of 783 kilo meters from the capital city of Ethiopia, Addis Ababa.
Mekelle is the capital city of Tigray regional state.
Specifically, this study will be conducted on Huda Flour Factory located in Tigray region,
Mekelle city, Ayder a bit distance from Ayder Referral Hospital.
3.2. Research Methodology
3.2.1. Research Design
The study will be focused on a matter that describes the product costing and pricing practice. The
research design to be employed in this study will be descriptive research design by using
diagrams and expressions to assess product costing and pricing practice of Huda Flour Factory.
The reason why the researcher will select the descriptive research design is enable to review the
past and present company’s product costing and pricing. It will be give more information for the
readers after the compilation of the research and it also enable to describe the existing problem
well.
3.2.2. Target Population
The target population of this study will be the accounting staff management of Huda Flour
Factory.
3.2.3. Data type and Sources
This study will use both primary and secondary data. Primary source of data will be collected
from accounting staff management through interview. The secondary data will include
information collected from cost manuals and journals.
The data desirable to assess the product costing and pricing will be obtained from both primary
and secondary source of data. The primary source of data will be collected by using interview for
the accounting staff management. Secondary data will be collected from the analysis of cost
manuals and journals of Huda Flour Factory.
3.2.4. Data Collection Instrument
This study will be used interview questions (close ended) as a data collection instrument. The
interview check list will be prepared to collect data from the management. And also this study
will used analysis of cost manuals and journals of Huda Flour Factory.
3.2.5. Sampling Techniques and Sample Size
Since the target population of this study is the accounting staff management of Huda Flour
Factory, there is no need of sampling technique and sample size.

3.2.6. Method of Data Analysis and Presentation

The most crucial part of the research design is the analysis and interpretation of data. After the
data will be collected this study will give full attention for the analysis and presentation. The
method of data analysis for this study will be both quantitative and qualitative data analysis. The
data will be analyzed using tabulation as well as graphic so as to arrive at effective conclusion
and possible recommendation.
 CHAPTER FOUR

4. DATA ANALYSIS AND INTERPRETATION

This chapter deals with the data analysis and presentation of the study on the data obtained from
the accounting and finance department manager and cost department managers through
structured interview.

4.1. Preliminary Review and Overview of the costing system

Cost information is essential for managers and decision makers in all types of organization
whether they are profit making or not. This importance grows when the organization is in a
competitive environment where advantage should be taken instantly. Considering these
importance, this study tries to assess the costing system used by Huda Flour Factory for its
product. The main products of Huda Flour Factory are the following:
 Flour-main product of the factory
 Cruska-by product of the factory
 Furshkello-by product of the factory
4.2. The Costing system of the factory
There are different acceptable costing systems to be used for manufacturing factories depending
on the type of products and production methods. The major one are Job-order / batch costing,
process costing and hybrid (the combination of process and job-order) costing methods.
According to the response of accounting department manager of Huda Flour Factory the factory
uses, hybrid costing system due to the factory produces mass of different products. The factory
use process costing method because of it produces very similar or identical products (i.e, flours,
cruskas, furshkello treated under process costing system.

The products which have similar feature are treated under process costing method and each unit
receives the same or similar amounts of direct materials costs, directs labor costs and indirect
manufacture costs.
4.3. How costs are classified in the factory?
Cost classification is a base for the type of information to be provided by any cost accounting
system. Proper cost classification enables decision makers to concentrate in the areas which are
critical for the factory. According to the response of accounting department manager of Huda
Flour Factory classify cost based on different bases such as based on behaviors, traceability,
presentation on financial statement etc.since we are focusing on product cost the classification
based is on the presentation in financial statement i.e. product and period costs. Product costs
are presented in balance sheets which are not closed at the end of the fiscal year. Product costs or
manufacturing costs includes direct materials, direct labor and manufacturing overheads, in
addition for price build up purpose adds non-manufacturing cost such as administration and
marketing expenses.

4.3.1. Nature of Production Costs

The cost of production is comprised of direct material, direct labor and production overhead. It is
also known as Inventoriable costs are all costs of a product that are considered as assets in the
balance sheet when they are incurred and that become cost of goods sold only when the product
is sold. For manufacturing sector factories, all manufacturing costs are inventoriable costs. Costs
of direct materials issued to production (from direct material inventory),direct manufacturing
labor costs, and manufacturing overhead costs creates new assets, starting as work in process and
becoming finished goods.
4.3.1.1. Direct material costs
Direct materials are those materials and supplies which can be easily identified with the product
or job. A material may be considered as a direct change at one time and indirect or overhead
change on another occasion on the basis, direct materials and distinguished from indirect
material such as stationary, lubricant, fuel, cleaning and other supplies etc.

On the other hand materials, such as stationary, lubricant, fuel, cleaning materials, other supplies
and all materials which cannot be traced to products are classified under indirect material with in
production overhead category.

4.3.1.2. Direct Labor Costs

Direct labor cost consists of salaries and wages of employees assigned to a particular product or
production unit of a factory. By contrast, the salaries and wages of employees who are not
directly involved in the production of goods (E.g. the salary of the production head, machinery
maintenance and repair, water and electric technicians, guards and the salaries and wages of the
workers engaged in the work shop and the like are indirect labor cost) and therefore chargeable
to production overhead costs. Thus to determine the actual cost of direct labor a proper time
attendance sheet should be maintained for each worker salaries and wages paid during a period
of a week or month be calculated and charged to specific production unit.
In the case of Huda Flour Factory labor (both permanent and sometime temporary labor) is
involved in the production operations.
4.3.1.3. Production overhead costs

These are costs which are not easily and economically identifiable with a product or a job.
Although such costs are difficult to identify with a product or a job to particular production or
service units they could be charged to these units. Any production cost not taken into account as
a direct material or direct labor is included under production overhead category. For Huda Flour
Factory these costs include indirect material (lubricant, fuel), indirect labor (electric and water
technician, guard, managers) and others include rent, utilities, insurance, power, water,
depreciation of factory building, telephone, factory supplies etc.

4.3.2. Operating Expense

These are expenses included under the general heading.
Administrative and general Expenses
These are expenses incurred in the direction, control and administration (including accounting,
general expense for examples are the expenses in running the administration of the plant such as
salaries and wages of personnel in the manager’s office, Finance and administration divisions all
legal service costs, financial costs etc.
Marketing Expense
These are expenses incurred in publicizing and delivering of products to customers such as
felling costs (salaries and wages of sales staff, consumer service costs etc.) Publicity cost
(Advertising and potion expense) and distribution cost (ware housing salable products and
delivering products to customers.

4.3.3. Cost Recording and Accumulation of Huda Flour Factory

I. Direct raw materials cost accumulation
Direct raw materials cost accumulation for direct materials in Huda Flour Factory depends on
source of supply for the item. Some materials are imported and some are bought locally.
  Imported raw materials
The cost for imported raw materials includes
- Invoice price
- Insurance cost in transit
- Freight costs etc.
 Local raw materials
Most of the times locally purchased materials delivered to the factory supplier’s truck or the
factory transportation. The factory rarely uses rented transportation for such purposes. In all
instances the costs of material includes; the invoice price charged by the supplier other material
related costs.

The cost accounting treatment follows the material flows and uses different source documents.
The cost accumulation system for the factory is in line with its cost classification. Proper
performance evaluation could be made only when the source data accurately coded, classified
and reported in time. The determination of direct material cost used by the factory is based on
generally accepted accounting principles (GAAP). The accounting treatments for raw materials
are described as follow at different stage of production.

I. Purchase of raw material

Raw materials inventory-----xxx
A/p or cash----------- xxx
II. Materials entered in to production
Work in process---------------xxx
Raw material inventory--------------xxx
III. Completion of product
Finished goods inventory----------xxx
Work in process inventory--------------xxx
This implies that the factory accumulates cost as what a cost accounting principle says about cost
accumulation.
II. Direct labor cost accumulation
There are different cost component for direct labor. These costs can be grouped in to two by
method of payment. Those directly taken from payroll and others paid through various vouchers.
Huda Flour Factory pays and prepares its payroll classified by departments. The employees are
segregated in the payroll in to direct labor manufacturing overheads and non-manufacturing
overheads which are divided by various support departments. The accounting treatment is
simplified as all the payment is made through the banking system. There is no need for
unclaimed salaries or payroll fund account.
The entries are as follows

Direct labor expense------------------xxx

Salaries and wagers payable-----------xxx

Allowance -------------------------------- xxx

Provident fund ---------------------------xxx

Non-manufacturing overheads (by department)

Salaries and wages---------------xxx

Allowance ------------------------- xxx

Provident fund -------------------xxx

Income tax payable ----------------------xxx

Cash at bank (net pay) ------------------xxx

For those items not paid through payroll but through other source documents like purchase of
uniform or settlement of medical bills the entries are as follows.

Direct labor costs by type of expense

Medical ----------------------xxx

Insurance --------------------xxx

Cash/ A/p ------------------------ xxx

This implies that the cost accumulation for direct labor cost is based on the historical cost
concept. This is an accepted treatment of costs for external reporting and internal purposes.

III. Manufacturing overhead cost accumulation

All production costs not included as direct materials and indirect labor are grouped as
manufacturing or production overheads. These costs are entered directly in to manufacturing
overhead account as they are incurred. According to the response of accounting department
manager of Huda Flour Factory, the actual costs incurred are accumulated according to the
nature of expense in the production cost section classified by chart of accounts. Indirect materials
follow the steps used for raw materials and indirect labor costs follow same step used for direct
labor costs.

The rest will be handled as follows.

 Manufacturing overheads by type of expense when incurred :

Utilities/water, power, telephone/-----------------------xxx
Rent for factory equipment -------------------------------xxx
Miscellaneous overhead cost-----------------------------xxx
Depreciation of factory building & machinery---------xxx
Cash /A/P----------------------------------------------------xxx
 Applying manufacturing overhead cost:

Manufacturing overhead costs are assigned to work in process by a means of predetermined

overhead rate the rate is established at the beginning of each year by dividing the total estimated
manufacturing overhead cost for the year the estimated total amount of the allocation base
(measured in machine hour, direct labor hour, or some other base). The predetermined overhead
rate is then used to apply overhead cost. According to the response of accounting and cost
manager of Huda Flour Factory machine hour is used as allocation base overhead cost is applied
to each job. Multiplying predetermined overhead rate by the number of machine hour charged to
the job. This implies that the factory use allocation bases which are mostly used as a base for
allocation of manufacturing overhead.

Work in process-------------------------xxx

Manufacturing overhead ---------------------xxx

4.4. What pricing model that the factory uses?

There are two time horizon about the pricing decision these are short run and long-run pricing
decision:

Short-run pricing decisions typically have a time horizon of less than a year and include
decisions such as (a) pricing a one-time-only special order with no long-run implications and (b)
adjusting product mix and output volume in a competitive market.

Long-run pricing decisions have a time horizon of a year or longer and include pricing a
product in a market where there is some leeway in setting price. Two key factors affect short-run
pricing. (1). Many costs are irrelevant in short-run pricing decisions. These costs will change in
the long run and therefore will be relevant. (2). Short-run pricing is opportunistic. Prices are
decreased when demand is weak and competition is strong and increased when demand is strong
and competition is weak. As we will see, long-run prices need to be set to earn a reasonable
return on investment. Long-run pricing is a strategic decision designed to build long-run
relationships with customers based on stable and predictable prices. A stable price reduces the
need for continuous monitoring of prices, improves planning, and builds long-run buyer–seller
relationships. But to charge a stable price and earn the target long-run return, a factory must,
over the long run, know and manage its costs of supplying products to customers. As we will see,
relevant costs for long-run pricing decisions include all future fixed and variable costs. There are
two different types of long run pricing decision, these are:

 Market-based
 Cost-based, which is also called cost-plus

According to the response of accounting department manager of Huda Flour Factory the industry
uses market based /competitive based pricing approach/model/ because it operates in competitive
market Companies operating in competitive markets use the market-based approach. The items
produced by one factory are very similar to items produced by others. Companies in these
markets must accept the prices set by the market. Because of this Huda Flour Factory uses
market (competitive based pricing model).
As we inferred from the data obtained from the accounting department manager the factory apply
what the principle of cost accounting says regarding the pricing models. The factory is operated
in competitive market it uses competitive based pricing model. This implies that the factory is
in line with generally accepted pricing system used internationally.

4.5. Bases of setting selling price of the company product

Customer, competitor and cost are the major factors that affect the pricing decision of the
factory. According to the response of accounting and cost department managers of Huda Flour
Factory, the base of setting selling price of the factory are market/competitor/, customer and
costs. Since the factory operates in the competitive market the base to set selling price is the
market/demand and supply/ to compete with its competitors, to set its selling price the factory
first see the other similar distributors selling price and then set its selling price and the other base
that the factory use as a base for setting selling price are customers purchase power influence
price through their effect on the demand for a product or service of the factory and also it
considers the purchasing power of their customers. Since the factory is a government
development organization the price of the product is lower than the other producers’
/competitors/, sometimes it sells its products with loss to attract customers. This implies that the
major factors that affect the price determination of the factory’s product is customers.

4.6. Role of cost accounting for the management for the fixation of selling
price

As the cost accounting and finance manager of Huda Flour Factory says that cost accounting
play a vital role in the management for the fixation of selling price by providing necessary data
for the management in setting selling price like cost data’s and participate in the fixation of
selling price.

CHAPTR FIVE

CONCLUSION AND RECOMMENDATION

The main objective of the study is focuses on assessing the product costing and pricing practice
of Huda Flour Factory. Based on the result of analysis and discussion issue of the research in
the previous chapter, the following conclusion and recommendation are drawn.
 5.1. Conclusion

From the analysis this study has made, the following specific conclusions:
 As the data obtained from the accounting and cost department managers of Huda Flour
Factory through structured interview the Factory uses process product costing system
because the factory produces mass of identical or similar products. Products with similar
feature treated under process costing system.
 As the data obtained from the accounting department manager through structured
interview the factory uses competitive based pricing model. Because it operates in
competitive market.
 As the data obtained from the cost and accounting department manager of Huda Flour
Factory the factory use different bases such as market/demand and supply/, purchasing power
of customers and cost even if the factory uses competitive based pricing approaches to set its
selling price the major factor that affect the selling price of the factory is customers.
 From the data obtained from the manger cost accounting department plays a vital role to
managements for the setting of selling price by providing necessary information like cost
data’s to management, even if the factory use market based pricing model.

5.2. Recommendation
In this part this study will try to give certain recommendation that can help the factory’s to improve
their product costing and pricing practices and to be strong competitors in the future business
world. From the data obtained the researchers has given the following recommendations:

o The accounting treatment used in the receipt of the items in to stores in good receiving note
debited work in process inventory as production cost for raw materials and similarly the entry
 used in direct labor cost accumulation is direct labor expense to be debited instead of cost,
the practical is different from its theoretical part of the cost accounting system in Huda Flour
Factory. Then the factory should match the practical and theoretical parts of the cost
accounting system.
o As the accounting and cost department manger says Huda Flour Factory uses process costing
system. Products with similar feature treated under process costing and product having
different feature are grouped based on their similarity are treated under job-order costing
system. The factory appropriately applies what the cost accounting system says. Therefore it
should be continue by applying these principles because identical or similar unit of products
are mass-produced, not processed as individual jobs, process costing is used to calculate an
average production cost for all units produced.
o As the data obtained from the accounting department manager through structured interview
the factory uses competitive based pricing model. The factory should differentiate his
product for pricing because the factory has competitors and the major factor that affect price
determination are customers.
o Generally, as we inferred from the data obtained from the manger of Huda Flour Factory the
factory apply the cost accounting system related to costing and pricing system, then the
factory strengthen its effort to apply appropriately cost accounting systems.
 MEKELLE University
College of Business and Economics
Department of accounting and finance
INTERVIEW:
This interview is designed by Mekelle University Student College of business and economics
department of Accounting and finance student for the purpose of the senior research project work
in the partial fulfillment of the award of bachelor degree of art in accounting and finance. The
main objective of this interview is to collect appropriate information that helps to conduct
research on the title of assessment of product costing and pricing practice of Huda Flour Factory
and to find some solutions. I would like to assume all the information that you will provide is
confidential. Therefore the success of this study depends on your careful response for each
question. Thank you in advances for cooperating and spending your precious time for this
purpose.

INTERVIEW QUESTIONS
1. What are the main products your factory produces?
2. What pricing model that the factory use? Why it select? What are the bases for select-
ing that model?
3. Which product costing system that the factory uses? Why? What are the bases for se-
lecting that costing system?
4. What bases that the factory uses to set selling price of your product?
5. How the factory set selling price of your product?
6. What are the factors that affect the selling price determination?
7. How do you classify production costs?
8. How does the product cost (material, labor and overhead costs) are recorded in the ac-
counting department?
9. How costs are accumulated and allocated?
10. What are the main raw materials that the factory used to produce the products?
11. Form where do you purchase raw materials?
12. How do you charge the labor costs?
13. What are the roles of cost accounting for the management for the fixation of selling
price?
14. What did you say about the product costing and pricing practice of the factory?(it
could be positive or negative )
 Reference
1. Arora, N (1997) “Cost Accounting” 1st edition.
2. Cherrington, O (1998) “Cost Accounting” 18th edition. San Francisco
3. Coulthrst, N, (1999) “Cost Accounting: Principles and applications” 4th edition.
4. Garrison, Noreen& Brewer, (2006) “Managerial accounting” 11th edition.
5. Hilton, Maher, Selton, (2003) “Cost management strategies for business decision” 2 nd
edition.
6. Horengren, T.foster, (2004) “Cost accounting and managerial emphasis” 14th edition.
7. Horngren, T.Foster, G.Datar, G. (2003) “Cost Accounting: A Managerial decision” 11th
edition. New York
8. Mc Graw-Hill (2001) “Intermediate Accounting” 5th edition
9. Ronald W.Hilton (2002) “Managerial Accounting” 5th edition