BoC Gases – A Cost Accounting Study
PREFACE
This report covers the cost accounting system of BOC Gases, Pakistan, a subsidiary of The BOC Group. It puts forth the practices and policies followed by the company when accounting for the costs of various elements and processes and tracing them to the products.
The company has a Finance Department that has been divided into the following three sections:
- Financial Accounting
- Management Accounting
- Treasury Section
The Management Accounting section is responsible for handling all the responsibilities with regards to the cost accounting activities.
The company has also implemented SAP, an Enterprise Resource Planning System in its effort to computerize the whole system and bring it up to the standards of its parent company.
The report also gives the format and some samples of various documents listing the comprehensive cost information.
Hence, this report gives a comprehensive summary of the methods used for the costing of the products by the company and their analyses.
THE BOC GROUP PLC
The BOC Group has an international portfolio of companies grouped for management control and reporting into three business segments. These are Gases & Related Products, Health Care, and Vacuum Technology & Distribution Services.
BOC adds value to a diverse range of industries and organizations world-wide: from electronics to food; from water treatment plants to chemical processes; from pharmaceuticals to sophisticated anesthesia equipment for hospitals and clinics; from coating most of the world’s high-performance glass to distributing food, clothes and other consumables.
PRODUCTS
The BOC Group is one of the world’s leading producers of industrial gases. Its major products include the atmospheric gases (oxygen, nitrogen, argon and the noble gases, neon, krypton and xenon) produced by the separation of air by plants chiefly of its own design and manufacture. BOC also markets carbon dioxide, helium, hydrogen and liquefied petroleum gas.
In addition, BOC markets dissolved acetylene and a wide range of specialty gases, medical gases, gas mixtures, and gaseous chemicals.
BOC Gases operates in more than 50 countries around the world, including the UK, the United States, South Africa, Australia and many Pacific rim countries, supplying customers with over 20,000 different gases and mixtures.
BOC PAKISTAN LIMITED
LEGAL STATUS:
The company was incorporated in Pakistan under the Companies Act, 1913 (now Companies Ordinance, 1984), as a private limited Company in 1949 and converted into a public limited Company in 1958. Its shares are quoted on all the stock exchanges of Pakistan.
NATURE OF BUSINESS
The company is principally engaged in the manufacture of industrial and medical gases, welding electrodes and marketing of medical equipment.
The main business areas of the company are:
- Industrial Gases
- Specialty Gases
- Health Care – Medical Gases and Equipment
- Welding Products
HOLDING COMPANY
The company’s holding company is The BOC Group plc, which is incorporated in the U.K. and holds 60% of the company’s shares. This includes The BOC Group PLC nominee shareholders. Other foreign shareholding in the company is about 1.62%.
MARKET SHARE:
The company enjoys the highest market share among its competitors. It has a market share of around 70%. However, the market share of the company has been on the decline. Efforts are being made to maintain the high market share of the company.
CUSTOMERS:
The company has no authorized retailers. Mostly the company has direct contact with its customers. The retailers who buy from the company are also considered as independent customers. Discounts are offered to them but no legal agreement exists between the company and its retailers.
The biggest customer of the company is ICI. A plant facility has been established at Port Qasim to meet the requirements of ICI.
Another plant has been set up at Mehmood Kot solely for PARCO.
COMPUTER SYSTEM:
The company is using the SAP system, which integrates all the functions and the branches. Previously, the company used a very outdated system known as Insight. Keeping in view the current requirements and shortcomings of the old system, the company switched to the SAP system in May 1999. However, till September 1999 both the systems were running parallel to each other. From October 1, 1999 the old system has been eliminated.
SAP has five modules in all. Out of these, three modules have been implemented in the company: Financial Information, Materials Management and Sales & Distribution. The two other modules; Human Resources and Manufacturing/Production; have not yet been implemented.
The implementation of SAP has not been fully successful so far. Work is still being done on it and efforts are being made to utilize the full potential of the system.
ORGANIZATIONAL STRUCTURE:
Business strategy determines the structure of the organization. The structure is also influenced by the culture prevalent in the company.
STEP 1
Initially the strategy is ‘accumulation of resources’. The sole power rests with the entrepreneur and thus the power culture prevails. The structure is not formal. The authority lies with the entrepreneur and each employee reports directly to the entrepreneur. The structure is bureaucratic with the entrepreneur dictating orders to the employees.
STEP 2
As the organization grows, the strategy changes to that of ‘rationalization of resources’. The culture now changes to role culture where the authority and responsibility are delegated to the functional heads. The structure is therefore, functional in nature.
STEP 3
The organization now feels the need to diversify and hence the strategy is ‘diversification of resources’. The structure is divisional in nature.
Structure at BOC
At BOC, the structure is a matrix structure, which is both functional and divisional in nature. For example, the finance department looks over the finances of all the three divisions i.e., Industrial Gases, Health Care and Welding.
THE FINANCE DEPARTMENT
The Finance Department of the company is located at the Head Office in Karachi. It handles the financial operations of all the branches. The Finance Department has been divided into three main sections:
- Financial Accounting
- Management Accounting
- Treasury Section
The Financial Accounting has been further divided into sub sections:
- Bookkeeping
- Sales and Stores Accounting
- Accounts Payable
This report mentions the working of all these sections and sub sections.
FINANCIAL ACCOUNTING SECTION:
BOOKKEEPING
The bookkeeping section is responsible for maintaining the general ledger of the company. This is the section that generates monthly reports to be submitted to the senior management. These reports mention the performance of the company during the month as compared to the budgeted performance.
SALES AND STORES ACCOUNTING
The sales and stores section is responsible for the inventory management, management of Accounts receivables and the daily cash reciept documents. In short, it is responsible for inventory and collections from customers.
ACCOUNTS PAYABLE
the Accounts Payable section is responsible for authorizing all payments made through checks. The payment advice prepared by the accounts payable section
is given to the cashier for typing the check.
TREASURY SECTION:
The main functions of the treasury section relate to the payroll, insurances, management of workers’ funds and banking procedures. The treasury section is also responsible for the reimbursement of petty cash funds. This section also deals with the income tax and other taxes. In short, the treasury section is a public dealing section.
It has the following responsibilities:
§ Workers’ Funds
§ Banking Procedures
§ Insurance
§ Payroll
MANAGEMENT ACCOUNTING SECTION:
The Management Accounting section at BOC was established 10 years back. It comes under the finance department along with two other sections: Financial Accounting and Treasury. This section comprises of a team of four members: management accountant, accounts officer, accounting analyst and assistant accountant.
There are 11 branches of BOC Pakistan that are distributed among three regions: South (Karachi, Hyderabad, Sukkur and Quetta), North (Lahore, Multan, Gujranwala and Faisalabad) and North West (Taxila, Peshawar and Rawalpindi). The production plants are set up at Karachi, Lahore and Taxila and these three sites provide gases to the other branches in their respective regions. The other branches are only sale depots.
The 11 branches of BOC Pakistan send their monthly gases reconciliation statements to the management accounting section at Karachi so as to reach this section by the 2nd of each month. The management accounting section then confirms these statements and prepares a consolidated reconciliation statement for all these branches.
THE WORK FLOW
The main raw material for BOC Gases is air, which is decomposed into its various components and then sold. Hence, the air is passed through various departments where it is first treated so that it breaks into the different gases it composes of. Then these gases are passed through several other departments to treat each gas individually to meet the specifications of the customers.
The costs flow along with the gases through the various departments, with the decomposition department yielding many joint products, the allocation of which will be discussed later. The most important of these costs is the power cost to run the machinery for various functions. All the processes at BOC are mechanized and hence, the quality of the end products is consistent.
Since the gases need to be transmitted from the factories and plants to various other places like the end consumer, the main loss is from transmission, due to the highly mobile nature of gas molecules. This will also be discussed later in detail.
COST ACCUMULATION SYSTEM
The company uses the perpetual cost accumulation system since it uses the computerized enterprise resource planning system SAP. This enables the company to continuously keep the inventory accounts up-to-date. The materials inventory accounts are debited whenever merchandise (the chemicals or other raw materials) is purchased. The air is processed through various departments, and the company maintains an up-to-date record of the various work-in-process accounts as well. Whenever these gases are sold, sales revenue and cost of goods sold are recorded, and finished goods are reduced. Hence, the company has up-to-date information about the inventory accounts and the cost of goods sold on hand all the time. Thus, the perpetual system gives the benefits of detailed and timely information, while the costs of time and money have been reduced by the implementation of SAP. The inventory account balances are shown on the balance sheet under the stock-in-trade item.
Since the gases are processed in batches with similar outputs, the company uses the process cost accumulation system for allocating costs to these gases. Further, the company uses weighted moving average method for inventory costing, having different weights every period. The company also prepares cost sheets every month; these list the consumption quantities of the various direct materials used in production, and the values of the raw materials, fixed and variable power, labor, depreciation, repair and maintenance, and allocation for the month. Not only this, these values are also compared with the budgeted values and the variance is calculated. This serves as one of the bases for performance evaluation.
COSTING METHOD
The company uses standard costing for its variable, fixed, and allocated costs. Hence, it uses a predetermined rate for all these types of expenses, and allocates the costs on the basis of these rates. The base used for each element of cost is the same, that is, quantity. The rates for each element are calculated by dividing the estimated costs of that element by the expected 100 cubic meters to be produced. Total costs are estimated for each of the elements of cost (listed in the next section) to arrive at the total estimated cost for each type of expenses. Then, the per 100 cubic meter rate is determined for the total material costs, total variable power costs, total variable costs, fixed power costs, total employee costs, total maintenance costs, depreciation costs, total fixed costs, each head under the allocated cost, total allocated costs, and finally, total costs. These rates are used to allocate costs during the month to the gases for the pricing purposes.
Then, at the end of each month, SAP is used to generate cost sheets that lists and compares the actual and budgeted usage, price, and total and per 100 meter cube cost of each of these elements. A third column gives the variance in these factors between the actual and budgeted values. This variance is adjusted into the cost of sales calculated every month.
This enables the company to have access to timely information, though it may not be very accurate due to fluctuations in the costs of materials and labor. To overcome this efficiency, the rates are revised every quarter based on past trends.
THE ELEMENTS OF COST
The manufacturing costs at BOC come under the following headings:
- VARIABLE EXPENSES:
- RAW MATERIALS
- Caustic Soda
- Alumina Pallets
- Slica Gel
- C. E.
- Lubricating Oil
- Calcium Carbide
- Acetone
- Rregenetal
- Calcium Choloride
- Ammonium Nitrate
- Direct Chemicals
- Other Materials
- Water Purchased
- Natural Gas
- Purchase Gases
- Argon for Lamp Mixture
- Nitrogen for Lamp Mixture
- Nitrogen
- Argon
- VARIABLE POWER
- Energy Charges
- Duty
- FAC (Fuel Adjustment Charges)
- Economizer Power
- FIXED EXPENSES:
- FIXED POWER
- EMPLOYEE COST
- Salary, Wages & Benefits
- Temporary Wages
- Overtime
- REPAIR & MAINTENANCE
- Slag Wool
- Maintenance Material Building
- Maintenance Material P/M
- N2 Internal Consumption
- Purchase Repair Building
- Purchase Repair P/M
- DEPRECIATION
- ALLOCATED COSTS:
- MAINTENANCE GASES
- FACTORY OVERHEAD
- HO ENGINEERING COST
These material and conversion costs are added to the gases as they are incurred in the various departments based on their functions. The materials and labor are added throughout the process with the labor costs being quite low due to the mechanization of the processes. The largest expense, thus, is that of fuel and power to run these machines.
The variable materials included are not exactly the direct materials. The per unit usage for these materials is not a fixed amount i.e. their usage is not directly affected by the production volume. This is the reason why their usage is not specified in the budget as well as in the actual figures. The only major raw material for the production is air, which is available free of cost. The materials considered as variable, are those required to keep the plant running. By their nature they should have been classified under repair and maintenance or factory overheads. They have been termed as variable due to the fact that their usage is affected by the production volume to some extent e.g., when the production volume is increased by a large amount, the usage of these materials also increases. However, the lubricating oil classified as variable material in the operating cost sheet is included under the repair and maintenance in the production cost report generated by SAP.
The power costs are direct costs, which are in direct proportion with the production volume. The power costs have also been classified as the variable and fixed power costs. In fact, power costs constitute the major part of the total costs (more than 50%).
The allocated costs are the portion of the maintenance gases, factory overhead and HO engineering costs that are allocated to a particular cost center. It is a fixed percentage that is revised every two years. For example, 80 % of the maintenance gases expense for Lahore is allocated to the ASU production, Lahore. The allocated costs are included in the operating cost sheet but not in the production cost report generated by SAP.
COST ALLOCATION TO DEPARTMENTS
The company uses departmental allocation for allocating overhead of the service departments. It allocates these costs using the reciprocal method of allocation. This method, though, is more time-consuming and more detailed, is easily put into practice with the use of SAP. The costs of service departments like Finance and Human Resources (HR) are allocated to each other and to the manufacturing departments on the basis of resources consumed. These costs are included under the element of factory overhead in allocated costs.
COSTING FOR PERFORMANCE EVALUATION
With the help of SAP, the company generates variable costing income statements for each type of product every quarter to see the contribution made by each product toward the coverage of fixed expenses. This serves as critical information for decision-making as well as for performance evaluation. Even the cost sheets separate the fixed and variable costs to give a clear picture of the total costs. And this has been possible only through the implementation of SAP.
ALLOCATING JOINT COSTS
Many departments and processes at BOC lead to joint products, especially the decomposition plant, which has several joint products. The costs of these processes are allocated on the basis of the estimated net realizable value. The reason for not using the physical quantities method is that the values of the gases are inversely proportional to their physical quantities at the split-off point.
This is due to the following reason:
The composition of air is such that it comprises of 78% Nitrogen, 21% Oxygen and other gases like Hydrogen, Argon, Helium, Carbon dioxide, Krypton and Xenon make up only 1% of air. Subsequently, the price of Nitrogen and Oxygen falls between Rs. 20 and 30 per m3 while that of Hydrogen and Argon goes up to as much as Rs. 200 per m3.
Hence, the company uses the estimated net realizable value for the allocation of joint costs. Again, though the method can be cumbersome due to the subtraction of additional processing costs at each split-off point from the sales value, the company faces no problems in doing so due to the implementation of SAP.
BUDGETING
The budget is prepared every year for every month. There is a flexible budget for the variable costs and a fixed budget for the fixed costs. The flexible budget includes usage, unit price (Average Selling Price – ASP) and total cost for the variable expenses and the cost of the fixed expenses. The fixed budget includes only the budgeted cost for the fixed expenses. The budget or the AP (Annual Plan) is prepared by the management accounting section by mid of August for the next financial year (Oct. – Sep.) and is sent to the BOC UK for approval. The key figures such as sales, operating profits, etc are reforecast approximately once every quarter to account for the price fluctuations etc. The cost budget is just prepared once and is not reforecast. The average selling price is used because the company sells to the government (Karachi Shipyard and Engineering Works) at low prices and to the northern areas at higher prices. So the average selling price is used for reporting to the senior management.
VARIANCE:
The price variance is calculated as:
Price Variance = UA (PA – PB)
The usage variance is calculated as:
Usage Variance = (UA – UB) PB
Where:
UA = Actual Usage
UB = Budgeted Usage
PA = Actual Price
PB = Budgeted Price
A SAMPLE OF QUARTERLY REFORECAST
| BOC PAKISTAN LTD | |||||
| 2nd REFORECAST 1999/2000 & ANNUAL PLAN 2000/2001 | |||||
| DETAILS OF COST ELEMENTS | |||||
| ANNUAL | Cum. Expenditure | Expected | TOTAL | ANNUAL | |
| PLAN | Upto | May-Sep | 2nd RF | PLAN | |
| 1999/00 | Apr. 2000 | 2000 | 1999/00 | 2000/01 | |
| Raw Materials | |||||
| Caustic Soda | |||||
| Alumina Pallets | |||||
| Slica Gel | |||||
| T. C. E. | |||||
| Lubricating Oil | |||||
| Calcium Carbide | |||||
| Acetone | |||||
| Rregenetal | |||||
| Calcium Choloride | |||||
| Ammonium Nitrate | |||||
| Direct Chemicals | |||||
| Other Materials | |||||
| Water Purchased | |||||
| Natural Gas | |||||
| Purchase Gases | |||||
| Argon for Lamp Mixture | |||||
| Nitrogen for Lamp Mixture | |||||
| Nitrogen . | |||||
| Argon | |||||
| Variable power | |||||
| Energy Charges | |||||
| Duty | |||||
| FAC | |||||
| Economizer Power | |||||
| Fixed Power | |||||
| Employee Cost | |||||
| Salary,Wages & Benefits | |||||
| Temporary Wages | |||||
| Over Time | |||||
| Repair & Maintenance | |||||
| Slag Wool | |||||
| Maint.Material Building | |||||
| Maint. Material P/M | |||||
| N2 Internal Consumption | |||||
| Purchase Repair Building | |||||
| Purchase Repair P/M | |||||
| Depreciation | |||||
| Maintenance Gases | |||||
| Factory Overhead | |||||
| HO Engineering Cost | |||||
| Total | |||||
SPOILAGE AND QUALITY MANAGEMENT
The only inspection point lies at the beginning when the materials entering the process are checked to assure that they are up to the required quality standards. After that, since the processes are mechanized, it is assumed that the quality is consistent and is up to the levels that the company maintains. The only source of feedback on quality of the final product is the end consumer.
However, the major losses occur while the gases are in transit. These losses are expensed and shown as losses. The company is all the time trying to minimize these transmission losses but has not yet been able to eliminate them completely due to the highly mobile nature of gas molecules.
PRODUCTION COST REPORTS
The Finance Department, with the help of SAP generates monthly cost sheets and submits them to the senior management. These sheets show neither the flow of costs, nor the flow of units. Instead, they list all the actual and budgeted costs along with the variances for the month.
A sample cost sheet is presented below:
| COST SHEET | |||||||||||||
| ASU PRODUCTION KARACHI 07-200 | |||||||||||||
| April 2000 | |||||||||||||
| Volume | Actual | Budget | Var% | ||||||||||
| VARIABLEEXPENSES | |||||||||||||
| Raw Materials | |||||||||||||
| Caustic Soda | |||||||||||||
| Alumina Pallets | |||||||||||||
| Slica Gel | |||||||||||||
| T. C. E. | |||||||||||||
| Lubricating Oil | |||||||||||||
| Calcium Carbide | |||||||||||||
| Acetone | |||||||||||||
| Rregenetal | |||||||||||||
| Calcium Choloride | |||||||||||||
| Ammonium Nitrate | |||||||||||||
| Direct Chemicals | |||||||||||||
| Other Materials | |||||||||||||
| Water Purchased | |||||||||||||
| Natural Gas | |||||||||||||
| Purchase Gases | |||||||||||||
| Argon for Lamp Mixture | |||||||||||||
| Nitrogen for Lamp Mixture | |||||||||||||
| Nitrogen . | |||||||||||||
| Argon | |||||||||||||
| TOTAL MATERIALS | |||||||||||||
| Per 100 M3 | |||||||||||||
| Variable power | |||||||||||||
| Energy Charges | |||||||||||||
| Duty | |||||||||||||
| FAC | |||||||||||||
| Economizer Power | |||||||||||||
| TOTAL VARIABLE POWER | |||||||||||||
| Per 100 M3 | |||||||||||||
| TOTAL VARIABLE COST | |||||||||||||
| Per 100 M3 | |||||||||||||
| FIXED EXPENSES | |||||||||||||
| Fixed Power | |||||||||||||
| Per 100 M3 | |||||||||||||
| Employee Cost | |||||||||||||
| Salary,Wages & Benefits | |||||||||||||
| Temporary Wages | |||||||||||||
| Over Time | |||||||||||||
| TOTAL EMPLOYEE COST | |||||||||||||
| Per 100 M3 | |||||||||||||
| Repair & Maintenance | |||||||||||||
| Slag Wool | |||||||||||||
| Maint.Material Building | |||||||||||||
| Maint. Material P/M | |||||||||||||
| N2 Internal Consumption | |||||||||||||
| Purchase Repair Building | |||||||||||||
| Purchase Repair P/M | |||||||||||||
| TOTAL MAINTEN. COST | |||||||||||||
| Per 100 M3 | |||||||||||||
| Depreciation | |||||||||||||
| Per 100 M3 | |||||||||||||
| TOTAL FIXED COST | |||||||||||||
| Per 100 M3 | |||||||||||||
| ALLOCATED COST | |||||||||||||
| Maintenance Gases | |||||||||||||
| Per 100 M3 | |||||||||||||
| Factory Overhead | |||||||||||||
| Per 100 M3 | |||||||||||||
| HO Engineering Cost | |||||||||||||
| Per 100 M3 | |||||||||||||
| TOTAL ALLOCATED COST | |||||||||||||
| Per 100 M3 | |||||||||||||
| TOTAL COST | |||||||||||||
| Per 100 M3 | |||||||||||||
SYSTEM APPLICATION PROGRAM (SAP)
The company is using the SAP system, which integrates all the functions and the branches. Previously, the company used a very outdated system known as Insight. Keeping in view the current requirements and shortcomings of the old system, the company switched to the SAP system in May 1999. However, till September 1999 both the systems were running parallel to each other. From October 1, 1999 the old system has been eliminated.
SAP has five modules in all. Out of these, three modules have been implemented in the company: Financial Information, Materials Management and Sales & Distribution. The two other modules; Human Resources and Manufacturing/Production, have not yet been implemented. Each time an application module changes, the system automatically updates the data in the other application modules that are affected.
SAP is an Enterprise Resource Planning (ERP) system. One of its greatest benefits is the technical integration of logistics, accounting, and information flow features. It also eliminates a lot of duplication of effort, and helps to ensure information flow to the correct place at the correct time. process time is reduced through concurrent, instead of consecutive, processes, and missing and erroneous data are minimized.
Revenues and expenses from the components of all the modules are posted via cost and revenue elements in the Cost Accounting components. The costs that cannot be assigned to an individual cost object are allocated to cost centers in Overhead Cost Controlling. Finished products for sales orders are debited in Product Cost Controlling with material costs, production activities, and overhead costs.
CONCLUSION
The implementation of SAP has made it easy for BOC Gases to use the most sophisticated and detailed methods of cost accounting. However, two modules of SAP have not been implemented so far since they have failed to pass the cost-benefit analysis test. Besides, its potential for maximizing the efficiency of the cost accounting practices is not being fully tapped. The reason is that people still feel more comfortable with the older system and some activities are even being done manually. Hence, BOC should look into this matter and try to remove the barriers to maximum efficiency.
A lot of resources are also going waste. For example, the finance department is overstaffed and a lot of employee costs are being incurred due to idle time. Hence, the company should also try to check this issue.
One emerging and very popular concept in cost accounting today is activity-based costing. It lets you identify non-value-added activities, and hence potential cost saving areas. BOC should conduct a cost-benefit analysis of implementing this costing and management system, and if the benefits outweigh the costs, it should try implementing this system for greater profitability.
Overall, the practices and policies of the management accounting department, also responsible for capital expenditure decisions, are clear-cut and the ones most beneficial to the company. Another criterion that they must satisfy is the conformance with the standards maintained by the international BOC Group.
