Documentary Credit Concept

Documentary Credit Concept

Documentary credit that is also known is letter of credit is a guaranteed payment method to exporter. Letter of credit is a risk free payment arrangement.

1.    Risk Free Payment

Letter of Credit ensures risk free payment to exporters against his export. This method may also be used for short term financing by exporter by entering in into a discounting arrangement.

2.    Issued before Trade

Documentary credit is opened by importer before the trade i.e. before sales take place. Documentary credit is widely used in international trade.

3.    Issued at request of Importer

Documentary Credit is issued by bank at the request of importer. The bank issue the documentary credit is known as issuing bank.

4.    Issuing Bank Guarantees the Payment

Issuing bank Guarantees the payment to the export. This guarantees come into existence once the letter of credit is issued by the issuing bank at the request of importers.

5.    Information to Exporter

Issuing bank ask advising bank (a bank in country of exporter) to inform Exporter about the opening of letter credit and advising bank inform the exporter about letter of credit issuance/opening.

6.    Advising Bank may also Guaranteed payment

Advising bank may also add its guarantee for payment, in such cases the advising bank is called confirming bank.

Forfaiting Concept

Forfaiting Concept

Forfaiting primarily is discounting facility offered by bank to the export for discounting the promissory notes issued by the importer/buyer. Forfaiting is used as medium term financing provided by some bank for exports. The process of forfaiting arrangement has been explained below

1.    Some Price is paid Now

Buyer pays some percentage of total prices now, and remaining amount shall be paid by the importer in future, typically in three to five years.

2.    Promissory Notes are Issued

Buyer shall issue promissory notes against future balance payment. Usually these promissory notes are of same amount maturing at different dates. The maturity period vary from 3 month to 1 Year.

3.    Bank Guarantee is Required

Buyer promissory notes are required to be guaranteed by some banks. Some international bank offers such services. In some cases bank guarantee may not be required for reputable importer.

4.    Export will Find forfaiter

Forfaiter is a bank, who is ready to discount the promissory notes of the buyer/import. These promissory notes are discounted using a fixed rate, and export gets the future payment now.

5.    Risk is bear by Forfaiter

Forfaiter is responsible for future risk associated with payment i.e. political risk, foreign exchange risk, collection from availing bank.

Advantages of Internal Job Costing

Advantages of Internal Job Costing

In internal job costing the cost of service department charged on the bases of specific job performed by the service department instead of apportionment. This method has several advantages

1.    Logical & Realistic Apportionment

This method of apportionment is more logical and rational than other general apportionment methods. The costs are charged to department, which has actually used the services.

2.    Promote Responsibility Culture

This method promotes culture of responsibility within organization, and service receiving department feel responsibility of cost.

3.    Cost Control

Internal job costing can be helpful for cost saving for the organization. Services will be carefully used by the production /user department, because these services are being directly charged to user department.

4.    Control Action

Internal job costing provides useful information to the management to take appropriate control action to control the costs.

Characteristics of Job Costing

Characteristics of Job Costing

1.    Each Job distinguishable

Each job can be clearly distinguishable from other jobs. Each job is given a unique Job number, which clearly distinguish that job from other jobs performed by the organization.

2.    Customer Specific

Job costing is used, where job is performed at the request of the customer. Each job is performed as per specific requirement of customer.

3.    Job Price

Job price is agreed with customer on the bases of cost estimation. An appropriate percentage is added to the cost for quoting a price to the customer.

4.    Separate Record

Separate record is kept for each job. This record is handy for calculating the profit from the job.

5.    Job Cost Sheet

All cost related to job are collected on jobs cost sheet or job card. These costs are then charged to job work in progress account.

6.    Job Account

All cost are transferred / recorded for job cost sheet to the job account, factor overheads are also charged to the job in job account. On completion selling and other administrative expenditure also charged to job account to calculate full cost of jobs.

Cost plus Pricing Formula

Cost plus Pricing Formula

In cost plus pricing method a standard percentage of profit margins are added to the cost of the product or project. There are two methods of adding cost i.e. % profit of sales or % Profit margin on cost.

Cost Plus pricing = Cost + Profit Margin on cost

Cost Plus Pricing = Cost + profit Margin on selling Price

Example (Cost Profit Margin)

Cost = 120,000

Profit Margin on cost = 25%

Calculate the selling Price

Solution

= 120,000 x .25

= 30,000

Cost Plus pricing = Cost + Profit Margin on cost

= 120,000 + 30,000

= 150,000

Example (Selling Price Profit Margin)

Cost = 120,000

Profit Margin on Selling Price = 25%

Calculate the selling Price

Solution

Cost Plus pricing = Cost + Profit Margin on cost

= 120,000 / (1-Profit Margin)

= 120,000/.75

= 160,000

Over Absorption Formula

Over Absorption Formula

Over absorption result because absorption rate used by the organization due to technical reason i.e. actual information about cost is not available at time of production.

The use of predetermined rate may result in over or under absorption. When absorbed overhead are more than actual overheads, this is over absorption situation or case.

Over Absorption = Absorbed overhead – Actual Overheads

Over Absorption Formula Example

A product takes 5000 hr machine hour. The absorption rate was $ 5 per machine hour. Actual production overheads were $ 22,000. Calculate over or under absorption.

Absorbed overhead

(5000 hr x 5 per hour) =     $ 25,000

Less: Actual overheard    = $ 22,000

Over absorbed =                 $ 3,000

Product Absorption Rate Formula

Product Absorption Rate Formula

An absorption rate is calculated on the bases of number of unit produced is known as Product absorption rate or absorption rate based on Product. This absorption rate may be calculated by dividing production overheads with total number of units produced (units of different product).

Absorption Rate (Labour Hr) = Production Overhead/Total Products

Product Absorption Rate Formula Example

Total overhead expenditure is $ 300,000 for two products (A, B). Total production of both products is (50,000 units). Calculate Product Absorption Rate

Solution

Absorption Rate (Labour Hr) = Production overhead/Total units Produced

= $ 300,000 (production overhead)/ 50,000 Total Products

= $ 300,000/ 50,000

= $ 6 (product absorption Rate)