Philips Pakistan Consumer Electronics Company – Cost Accounting Report
Philips Pakistan Consumer Electronics Company – Cost Accounting Report
COMPANY PROFILE AND OVERVIEW
Philips formed Philips Electrical Company Ltd. in Pakistan in 1949. From a humble beginning it is now a dynamically growing industry
Right from its inception Philips Pakistan has taken dynamic strides in the field of progressive manufacture of a wide range of electrical appliances. The consistent development of its product range has not only contributed to the national economy but has also created further job opportunities thereby enhancing the quality of life of the people of Pakistan.
Keeping pace with the demands of a growing quality conscious market, Philips Pakistan has consistently attempted to provide superior quality products and services to its customers. To ensure international quality standards in all its operations the ‘Philips Quality Program’ was launched in the early nineties. As a result all the factories including Light, Consumer Electronics, and Domestic Appliances and Personal Care (DAP) are ISO certified.
In all business areas, Philips Pakistan intends to follow the policy of steady growth and diversification. Based on the strength of the organization and its infrastructure, coupled with good quality products, Philips Pakistan continues to strive for continual improvement in every area of its activities, thus living up to the spirit of ‘Lets make Things Better’!
Philips Pakistan has many categories of products produced in different divisions of the factory. They are as follows:
- Consumer Electronics
- Household Appliances
- Personal Care Products etc.
CONSUMER ELECTRONICS DIVISION
Consumer electronics division is primarily concerned with consumer electronics. This division has many departments in it, which are as follows:
- General Management
- Finance & Accounting
- Human Resource
Industrial Department is mainly concerned with the production aspects of the consumer electronics. This department has further sub-departments, which are ‘General Management’, ‘Production Department’, ‘Production Engineering’, ‘Quality’ and ‘Storage’.
Commercial Department is mainly concerned with the finished goods i.e. goods that are completely produced and are ready to be sold, they are sellable. This commercial department again comprises of two sub-departments, which are ‘Marketing’ and ‘Sales’.
FINANCIALS OF CONSUMER ELECTRONICS DIVISION
The market of televisions remained stagnant due to erosion of purchasing power in general. In this sector the Company is following the policy of selected diversification to lessen the dependence on color televisions. Since the past few years’ emphasis has shifted towards entertainment market, and Audio and Video products such as VCR/VCP and portable audio systems have been introduced
Another significant addition is PC Monitors, which were introduced in 1996, and the sale of this product has shown quantum jumps due to competitive price and excellent quality. As a result, sales of this division recorded an impressive growth of 22% amounting to Rs.812 million against Rs.663 million of last year. Operating profit amounted to Rs.14 million compared to operating loss of Rs.8 million of previous year.
The improvement in profitability is mainly attributable to effective marketing strategies, strict cost controls and rationalization of tariffs by the Government.
However, imports through irregular channels are a continual threat to this activity restricting market share and future growth. Unless judiciously administered by the Government, it is the apprehension that this may result as a serious threat to the very survival of the local industry.
CONSUMER ELECTRONICS PRODUTS
This category of products called ‘Consumer Electronics’ contains a variety of products that are:
- Televisions – Projection TV, Flat TV, Large Screen TV, Real Flat TV, Conventional TV
- PC Peripheral i.e. Monitors
- Headphones & Accessories
Although Philips Pakistan sells the above mentioned consumer electronics but it only produces Televisions in Pakistan. But all the remaining consumer electronics are obtained or purchased from abroad and are resold here in Pakistan. These consumer products from abroad are at present obtained from mega factory of Philips located in China i.e. these products are China based. Previously they used to come from Philips Mother Factory where they have ‘International Production Center (IPC)’ in Holland but now they come from China.
In Philips, a proper planning and analysis is done to determine the total number of units of television sets to be manufactured in a particular period and this is done by arranging formal meeting.
Firstly, planning sessions are held which are attended by logistics, buyers and marketing people. The first decision is concerned with the ‘make or buy’ decision about the products i.e. they decide whether they are going to manufacture the products or they are going to buy from abroad and resell it here in Pakistan. For this they also keep in mind the custom duties and import duties on the products and the materials obtained from abroad. Therefore a very comprehensive cost and benefit analysis is conducted to see whether local manufacture of products is beneficial or not.
After that, second is the detailed sales plan. This mainly constitute decisions regarding the total quantities of television sets to be sold in a particular period which then leads to deciding the total units to be manufactured.
Thirdly they decide about the materials to be ordered for the manufacture of the products. They decide upon the suppliers from whom they are going to buy these materials for the production of their products. They also determine the suppliers who will be going to supply them with the packaging materials. They also discuss about the time that it takes for the materials to reach here and the level of safety stocks to be kept for unusual orders. In the end, they also determine the levels of both the Production Inventory (materials for production) as well as the Commercial Inventory (finished goods inventory) for a particular period.
PRODUCTION AND COSTING SYSTEM
Costing system is primarily concerned with the accumulation and analysis of cost information for internal use to aid management in planning, controlling and decision making.
As mentioned earlier, consumer electronics includes many products like TVs, monitors, headphones etc but the only product produced here is Television sets. These television sets are of various sizes i.e. of 14 inches to 21 inches and also of 60 inches. The production of television set of 60 inches is very limited since they are not locally bought here in Pakistan due to the low purchasing power of majority of people. The main backbone of television is the television sets of 14 inches, 21 inches till 25 inches since these sizes are usually bought.
The costing system used with respect to televisions here in Philips is ‘PROCESS COSTING SYSTEM’. It is an accounting system used when identical units are produced through a series of uniform production steps. Similar is the case with the production of televisions sets produced in Philips Pakistan. The television sets are produced by passing through similar stages and all the television sets take approximately similar time in production i.e. in the production process, each and every set of television takes same amount of time and they are produced by identical series of steps.
The stages through which the television set passes are as follows:
- Stuffing of PCBs i.e. Printing Circuit Boards
- Rectification of PCBs
- Live Testing
- Godown i.e. finished goods
The order in which the product flows through these stages is as follows:
- PACKING OF THE PRODUCT
- ALIGNMENT OF THE COMPONENTS
- SOLDERING OF PRINTING CIRCUIT BOARD
- GODOWN – FINISHED GOODS INVENTORY
- LIVE TESTING OF THE PRODUCT
- ASSEMBLING OF THE COMPONENTS
All the television sets produced in Philips pass through the same stages every time. As shown on the previous page, first and the most important and crucial stage in the production is ‘STUFFING’ of PCB (Printing Circuit Board). In this stage, all the components are stuffed on to the PCB. This work is done manually. The stage consists of 8 to 12 stations i.e. at each and every station particular components are stuffed on to the PCB. Second stage is ‘Rectifying the PCB’ where it is checked whether the components are placed correctly on the board or not and also whether these components are functioning. Third stage is ‘Soldering’; here the board is cooled for sometime. Fourth stage is ‘Assembly’ where all the components required for the television set are assembled. In the fifth stage, all the components are ‘aligned’. In the sixth stage, the television set is tested to see whether it is working properly or not, in the seventh stage it is packed using packaging materials. In the eighth and the final stage, this product is transferred to godown i.e. finished goods inventory.
In this way, television sets are manufactured in the consumer electronics factory using process-costing system because the product passes through the similar steps again and again and each item takes the same amount of time in production. The difference occurs only when different kinds of PCBs (Printing Circuit Boards) are used for different models of televisions but the remaining process is similar.
Under standard costing, all costs attached to products are based on standard or predetermined rates. Standard costs represent the ‘planned’ costs of a product and are generally established well before production begins.
The costing system used in Consumer Electronics division (Television Production) is not an integrated standard costing system i.e. it is not carried to the ledger accounts. But the costing system in Philips is “Notional Standard Costing” i.e. in this system, the total cost of each product (including materials, labor and factory overhead costs etc) is estimated beforehand but this estimated cost is not carried to the ledgers. So Philips develops standards and maintains them “off the books”. That is, they are not part of the formal accounting system. Therefore this “notional standard costing” is there to facilitate control of personnel, operations and costs. Using this standard costing system (not integrated standard costing), the management basically decides what a unit cost of the product should be. So here in Philips, the standard costs are objectives set by management which function as controls for monitoring actual costs. Standard costs do not replace actual costs in a cost accumulation system but serve as efficiency and performance indicators.
Since there is not an integrated standard costing, i.e. they are not carried into the ledgers (off the books records) but only serve to control actual costs, therefore no variances or variance accounts occur in the ledgers and accounts due to the differences between actual and budgeted costs. The degree or amount of variance also depends upon the nature of the product being manufactured. Since here in Electronics Consumers Division, only television sets are being manufactured i.e. they are not literally manufactured but they are just assembled here as all the essential components come from China. Due to this, the chances of spoilage and therefore variances are very minimal and rarely occur. Therefore
due to the nature of the product, no significant variation occurs between the estimated costs and the actual costs. But on the other hand, in lighting division, there is a greater chance of spoilage and rework costs due to the sensitive nature of the product being produced. When the wastage occurs, more materials have to be purchased and therefore more production costs occur as compared to estimated costs in the case of lighting products thus causing more variances. But this is not the case in assembling of television components and turning them into finished goods. So there are no significant variances and therefore no variance accounts in Consumer Electronics i.e. Television sets production.
Direct materials refer to those materials which are used directly in the production of products and which can be easily traced back to the product produced. Philips Pakistan only manufactures Television sets here in it local factory but the remaining consumer electronics come from China and are resold here.
The direct materials i.e. the components that are used in television production are not manufactured here but they come from China where there is a mega factory of Philips.
The components (materials) used are:
- Picture Tube
- Deflection Yoke
- Printing Circuit Board (PCB) including all the components to be stuffed on it
All the above mentioned materials come from China except Packaging Materials. These packaging materials are bought from local manufacturers here in Pakistan.
The logistics manager here determines the amount of the materials that need to be acquired. There is a complete and efficient record of the levels of materials (components for TV) present in the factory on the computers. These materials records are fed into the
computers when they are provided by the department of storage and production about the amount of materials available in the factory. The logistics manager then regularly looks at the computer records to determine material inventory level. Therefore the logistics manager caters to materials needs. If the manager sees that the materials are needed then he decides upon the amount of materials or components needed on the basis of following three things:
- Production Plan
- Kits (components) on hand
PURCHASE ORDERS AND INVOICES
When materials are needed, logistics manager issues a formal purchase order specifying the number of components required, when they are needed and so on. The components are ordered in ‘kit’ form i.e. usually components are ordered which enable the Philips to manufacture 500 complete television sets. That means 500 Picture Tubes will be ordered, 500 PCBs and 500 Deflection Yokes are ordered. But the numbers of Speakers ordered are 1000 because each television set requires 2 speakers. In this way, components come in kit form i.e. one kit will contain all necessary things for one television set and at one time 500 kits are ordered.
It takes 6 to 8 weeks for the materials to arrive at Philips from abroad. Invoices arrive at Philips when the shipment of materials is triggered. Usually the credit period for payment is 30 days i.e. Philips pays its bills in 30 days and also there are no kinds of discounts.
When the materials arrive at Philips, they are not physically examined for defects or anything because they come from China and therefore are of highest quality possible. But the packaging materials that are bought from manufacturing companies are thoroughly examined for any defects. When the complete examination is done, only then payment is made for these good materials and the bad materials are sent back to the suppliers.
ISSUANCE OF MATERIALS
There is a person who has complete charge of the storeroom that contains all the materials in it. This person is responsible for the proper storage, protection and issuance of all the components or the materials of production. Whenever the materials are issued to the production floors, the requisition forms are issued showing the quantities or the components going for the manufacture of television sets.
The issuance of materials to the production floor and their valuation is done on different basis. This means that the issuance of the materials occur on the FIFO (First-In First-Out) basis i.e. the materials that came into the storeroom first are sent to the production floor first and are used first in manufacturing television sets. Therefore materials purchased first are issued first. But this is not the case when the valuation of the materials is done. On the other hand, the valuation is done according to LIFO (Last-In First-In) method i.e. here the cost of materials issued is computed by taking the last purchase first and
therefore the materials issues are valued at the latest price. But the use of LIFO or FIFO does not make much difference in the case of production of television sets because the prices of the components or materials obtained from Philips factory in China are mostly constant and they usually do not change.
VALUATION OF MATERIALS INVENORY
In Philips, the accounting system for materials employed is PERIODIC inventory system. Here the cost of all the materials obtained is put into ‘Material’ account. In order to derive the consumption of materials (components) during a certain period, simply periodic method is followed. At the start of a period, they have a particular beginning balance of components and then they add the cost of materials obtained from suppliers this period to have the materials available for use. After that, at the end of the period, they perform a physical check of the materials available in the inventory and subtract this from the available materials to compute the consumption of the materials during that period. This procedure can be shows as follows:
Material inventory – beginning balance xxx
+ Materials purchased xxx
– Materials at the end xxx
Consumption of Materials xxx
In this way, under this method the cost of materials used is not computed directly but is indirectly computed by conducting a physical check at the end of the period.
Conversion costs are costs expended in the transformation of direct materials into finished goods products. Conversion costs include labor costs and factory overhead costs.
In Philips, manufacturing costs are mainly divided into two main categories i.e. materials costs and conversion costs. But the 90% of these total costs are material costs and the remaining 10% are conversion costs.
Direct labor is all that labor that is directly involved in the production of a finished goods, that can be easily traced to the product, and that represents a major labor cost of producing that product. The direct labor costs includes:
- medical expenses
- retirement benefits
- canteen expenses
- clothing used by employees working on the product (uniforms, gloves etc)
The direct labor costs are not allocated according to time worked by these employees but these labor costs are fixed. They get fixed amount of wages every month but they have incentive schemes packages attached when certain criteria are met. The employees’ salaries do not depend upon the units produced by them but they are fixed and if they work overtime then this overtime is tacked with the extra or overtime worked. In addition to this, the employees have incentive schemes packages which motivate them to do their job more effectively and efficiently to achieve the rewards.
As mentioned before, these labor costs are also estimated at the beginning when “notional standard costing” is done to estimate the unit cost of the television. But these estimated costing are not carried into the books or records so no variances occur in this case. But the actual costs are recorded. So in this way, estimated costs serve to control the actual costs.
Factory overhead is used to accumulate indirect materials, indirect labor, and all other indirect manufacturing costs.
Indirect labor is the labor involved in the production of a product but it is not considered to be direct labor. Indirect labor includes:
- Production engineers
Other factory overhead comprises of:
- Indirect materials in the maintenance of factory
- Essential management of administrative affairs
- Automation (Information Technology) that adds value to the product
- Organization stores
- Electricity used in offices
- Corporate sector overhead (treasury department which opens ‘letters of credit’ for consumer electronics division thus providing services)
- Finance & Accounting, logistics departments as well as Human Resource costs (their services for consumer electronics i.e. television production)
The above mentioned factory overhead costs, however, does not include the electricity needed to run the machines for the production of televisions because that is treated as direct costs and not indirect manufacturing costs.
The allocation of the factory overhead costs to the television units produced depends upon the number of television sets produced and not on the labor hours worked. The total
factory overhead costs are divided by the total units produced to allocate the overhead costs to each set of television produced. Philips does not use hours bases to allocate the factory overhead costs because, at present, all the television sets manufactured take same time in production. But next year, they intend to use ‘gross hour system’ (hours worked as the bases) for the allocation of overhead costs as they will be producing different models of television which will be taking different amounts of time.
FULL ABSORPTION COSTING
Under full absorption costing, all factory overhead, both variable as well as fixed, are treated as product costs i.e. all factory costs whether variable or fixed are part of the cost of production and should be included in the computation of unit product costs.
In Philips, the costing of the television sets is also ‘Full Absorption Costing’. All the costs i.e. materials, labor costs and factory overhead costs etc are estimated and then are allocated to the units produced thus treating all the costs as product costs.
At the beginning of the period, this division estimates all the materials costs, labor costs and all the factory overhead costs which were mentioned previously. After determining all the costs of production, then these costs are allocated to each product by dividing the total costs by the total number of units to be manufactured. In this way by treating all the costs as product costs, unit cost is derived which later helps in setting the price of the product. In this way, “notional standard costing” is used but it is not integrated and these estimated costs are not carried to the ledgers but they are estimated just to control and monitor actual costs. Since estimated costs are not carried into the ledgers, therefore no variance accounts occur.
SPOILAGE AND REWORK
The spoilage refers to the wastage that occurs during the production of television set. There is no abnormal spoilage in Consumer Electronics in the manufacture of television sets. But the percentage of normal spoilage or wastage is 0.6% of the value. This percentage of spoilage does not increase due to the nature of the product that is being produced. This 0.6% is not treated or accounted for separately because it is very minimal and it rarely exceeds this. On the other hand, this percentage of spoilage increases in other divisions like lighting division. This is due to the fact that the products produced in the lighting division like bulbs are made of filament which is very sensitive and delicate and there is greater chance of its being defective thus causing greater spoilage and wastage. But this does not happen in manufacture of television sets. The only problem that occurs is in the components of the Printing Circuit Board (PCB) during the stuffing stage of the production. When the stuffing is not done correctly or the components do not work properly when checked in the rectification of the PCB (Printing Circuit Board), then the rework is done on these PCBs. The stuffing on the PCBs and the rework is done manually. The costs of the rework are not accounted for separately but they are just ignored because the costs of the rework are very low and minimal.
DAILY PRODUCTION REPORTS
There are no cost production reports produced here in the consumer electronics division. But the ‘Profit & Loss’ accounts acts as the cost production reports for the products produced. But they do prepare daily production reports that specify the units of television sets produced every day at the end of the day. At the same time, they also prepare weekly production reports specifying the total television sets produced for that week. These reports do not specify the costs of production but they just give you the total units produced in day, week or a month. These reports basically act as the ‘performance indicators’.
In short, Consumer Electronics division in Philips Pakistan is involved in the production of television sets but the remaining products like monitors, headphones and other accessories are purchased from abroad to resell here in Pakistan. The costing system is ‘process costing’ and at the beginning of the period, through careful planning, product costs is estimated and production level is determined. The company is able to meet its target level of costs through efficient controls and therefore no significant variances occur in estimated and actual level of costs. Philips Pakistan achieves its objectives through the dedication and loyalty of its employees.