Application of Cost Accouting in Small Business

African Training and Research Centre in Administration for Development

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Centre Africain de Formation et de Recherche Administratives pour le Developpement

C.A.F.R.A.D. African Training and Research Centre in Administration for Development

Cost Accounting Practice in the informal Sector of Nigeria : A Survey of Eastern business Zone
By : Lawyer C. OBARA and Ndukwe A. UKPAI Tangier Morocco – 2001

Bd. Mohammed V, Pavillon International P.O. Box 310, Tangier, 90001 Morocco

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Bd. Mohammed V, Pavillon International B.P. 310 Tanger, 90001 Maroc

Cost Accounting Practice in the Informal Sector of Nigeria

Cost accounting is a veritable tool in the management of any organization including those in the informal sector. Analyzed data from the respondents to our research instruments, indicated the maintenance of improper and inadequate records coupled with the fact that costing methods used, though sometimes effective, were unconventional. The informal businesses will approach profit maximization levels if effective cost control procedures are established and appropriate books of accounts installed. We suggest therefore that since these artisans may not be able to afford the employment of qualified and experienced accountants, they can still benefit from the services of such professionals through consultancy or part-time arrangements.

It is axiomatic that continuous existence of all business concerns depends on the efficient and effective practice of cost accounting. The principal objective of cost accounting is the provision of detailed information for planning, control and decision making. There is the recognition that the cost accounting practice in the informal sector of Nigeria is not without criticism. The current state of cost accounting practice in the informal business in Nigeria appears inappropriate and therefore ineffectual. There seem to be no relationship between the costing system and the activities or operations of the entities. Besides, the information provided by the costing system tend to be doubtful and inaccurate for the intended purpose. Preparation of exception reports and position statements are not considered necessary. But where they are prepared, they are not produced at appropriate intervals and early enough to be valid.

An accounting system is a formal means of gathering and communicating data to aid and coordinate collective decisions in the light of overall goals or objectives of an organization. The accounting system is the major quantitative information system in almost every organization (Horngren and Sundem, 1987). Cost accounting is a formal means of gathering, measuring, analysing, and reporting cost data to aid management in coordinating collective decisions in the achievement of the overall goals of an organisation. An effective cost accounting system provides information for two broad purposes: 1. The accumulation of cost data for external reporting. 2. The collection of quantitative data for internal use by management in carrying out its functions of planning, control, decision making and the formulation of overall policies. Cost accounting system of an organisation is the foundation of the internal financial information system. Biggs (1972) realized the importance of cost accounting and stated that without a system of cost accounts, it is doubtful whether a business of any size can survive in the intensely competitive conditions of today, but it must be emphasized that just as no two businesses are alike, even in the same industry, so no ready-made system of cost accounts can be provided to suit each and every business. The underlying principles, conventions and objects of all costing systems are the same, but the application of these principles and methods by which the objects are to be achieved must vary with circumstances. A good cost accounting system should aim at accomplishing the following purposes : 1. To arrive at the cost of production every unit, job, operation, process, department or service and develop cost standards. 2. To indicate to the management any inefficiencies and the extent of various forms of waste, whether of materials, time, expense or in the use of machine equipment and tools. 2 CAFRAD ??“ African Training and Research Centre in Administration for Development.

Cost Accounting Practice in the Informal Sector of Nigeria

3. 4. 5. 6. 7.

Analysis of the causes of unsatisfactory results may indicate remedial action. To reveal sources of economies in production, having regards to methods, types of equipment, design, output and layout, daily, weekly, monthly or quarterly information (reports) may be necessary to ensure prompt corrective action; To provide actual figures of cost for comparison with estimates, and to serve as a guide for future estimates, or quotations, and to assist the management in their price-fixing policy. To present comparative cost data for different periods and various volumes of production output, and to provide guidance in the development of the business. To indicate whether the cost of certain parts or components made in the factory is such that it would be more economical to buy from outside sources. To record the relative production results of each unit of plant and machinery in use as a basis for examining its efficiency. (Owler and Brown, 1984).

Generally speaking, there is no consensus on the definition or nature of small-scale business world wide. Considerable fuzziness persists about what the term denotes. Different countries, institutions and individuals have put forwards various descriptions of a small business based on some parameters. The economist??™s definition of small firms attempted to provide the size of what should be a small business thus ???a small business is one that has only a share of its market, is managed in a personalized way by its owners or part-owners and not enough medium of an elaborate management structure and which is not sufficiently large to have access to the capital market for the public issue or placing of severity???. The American Small Business Administration (SMA) according to Pickles and Abrahamson (1976), defined small business as ???one which is independently owned and operated and not dominated in its field of operation???. Davies (1982) quoted the American Committee for Economic Development (CED) as defining small business as a form having at least two of the following four key factors: – Management of the firm must be independent and usually the managers are the proprietors. – The area of operation must be mainly local with workers and owners living in one home or community. – Owners supplied capitals. – The relative size of the firm with its industry must be small when compared with the biggest units in the field. These measures can be in terms of sales volume, number of employees and so on. The parameters adopted by any country or institution also vary from period to period. In Nigeria, the situation is not different. Various criteria have also been used for the definition of small scale business. Asechemie (1992) in trying to define the informal sector wrote that the market traders, the hawkers on the street, the road side mechanic, the road side barber, and the village farmer are examples of businesses in the informal sector-different theorists have characterized it differently, depending on their mode of analysis and the emphasis given to particular element of the sector. Oshagbemi (1985) argued that; the main criteria used throughout the world to describe small scale enterprise include: (a) Number of employees (b) Sales volume (c) Financial strength (d) Relative size (e) Initial capital outlay
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Cost Accounting Practice in the Informal Sector of Nigeria

(f) Independent ownership What is common to the wide range of information available is that the operations in the sector are usually in small scale; that production technique is labour intensive and that ownership is usually private. In most cases the workers in this sector are family members, apprentices and few paid employees. However, whatever definition or criteria that may be used to define the informal sector, the informal sector as a concept and economic reality has come to stay. The interest of academics and policy makers in the informal sector arises from the perceived potential ot the sector to: (a) Generate a large volume of employment at low capital cost. (b) Develop rural Nigeria, and (c) Contribute to gross domestic product. The importance of accounting records and information (here accounting records include costing records) to the survival of these business organizations cannot be overstressed. Nwachukwu (1990) in this regard wrote that ???for an entrepreneur, the most important aspect of his information comes from financial accounting. This in brief is the score card that consists of balance sheet, income statement and other supporting documents. They are indicators of growth potentials, earning ability, liquidity and stability. This points out the important role played by accounting records in any business organisation no matter the size. There is no conventional approach to accounting practice by the informal business operators. On cost accounting, previous studies indicated that, the artisans apply cost to their product based on discretion, common sense, and sometimes associated with the way of carrying out their business. Ukpai (1997) in the analysis of cost accounting techniques and the benefits in costing of products and services of large scale business as well as small scale business, maintained that, for any business to be a success, there has to be a group of people or persons who should be responsible for the achievement of the goals of the business. The entrepreneur is the person responsible for the achievement of the small scale business. He stressed that cost accounting is the basis of decision making and planning in order to make profit. According to Lasser (1967) ???Half of the small business failure studied are due to poor and inadequate method of costing of their raw material, labour and overhead to their product, bad record keeping and too much overhead???. He went on to stress that poor costing of product and services hinders management form achieving their goals. He noted that one of the factors responsible for the inadequate costing approach among small scale business, is inadequate knowledge of the entrepreneur on various management facets. He further explained that poor decision making by the entrepreneurs on cost control is the bane of the small business. There is a need for standardised accounting practice in the informal sector. Effort also should be made to convince the participants of the utility and cost effectiveness of the system.

For the purpose of this study, the country is divided into three (3) industrial zones, namely: Eastern zone, Western zone and Northern zone. This is to ensure reliability. Therefore, the target population of this study consists of all the artisans in the Eastern industrial zone. This is the population to whom the findings of the study are held to be applicable. The accessible population on the other hand consists of all artisans in Nnewi, Aba and Port Harcourt, engaged in : 1) Motor Vehicle Maintenance (Mechanics) 2) Furniture making 3) Welding 4) Block Moulding 5) Tailoring (Dress making) 6) Refrigeration and Air-conditioning maintenance
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Cost Accounting Practice in the Informal Sector of Nigeria

7) Glazing (Aluminum Fabrication and Glazing) 8) Shoe making 9) Leather Bag making and 10) Panel Beating Business. Nnewi, Aba and Port Harcourt represent the industrial centres of the Eastern zone, where artisans tend to cluster. From the above mentioned accessible population, a sample of 150 artisans were selected using nonprobability sampling method. The rationale behind the choice of this sample method is to ease questionnaire administration and to facilitate collection for the purpose of data analysis.

The study revealed that most of the artisans did not keep explicit record of any kind as indicated in table 1 below. Table 1: Maintenance of Costing Records Industry Furniture Makers Mechanics Welders Dress Makers Block Moulders Aluminium Fabrication/Glaziers Refrigeration/Air-Conditioning Panel Beaters Shoe Makers Leather Bag Makers total % Source: Field Work, 1998. Table 1: Shows that the option ???no??? 137 or 91 per cent responses. Through discussions, it was discovered that some did not keep record because they were illiterates; others because they did not think the size of the business was large enough to warrant explicit record keeping. Those who kept records did so on job orders, debts owed and owing, sales, accessories (inventory), and cash. None of them, however, kept this full range of records. On the costing method adopted by the artisans, this study revealed that the practice of the artisans conformed with the conventional cost accounting practice, in which each industry adopted a system peculiar to the industry. Most of the artisans interview adopted the method which conformed to the practices of the industry; This is indicated in table 2 below: Yes 5 2 3 3 13 9 OPTION No 15 15 15 10 15 13 15 15 12 12 137 91 Total 15 15 15 15 15 15 15 15 15 15 150 100

CAFRAD ??“ African Training and Research Centre in Administration for Development.


Cost Accounting Practice in the Informal Sector of Nigeria

Table 2: Cost Accounting Method(s) Industry Furniture Makers Mechanics Welders Dress Makers Block Moulders Aluminum Fabrication Refrigeration/Air Conditioning Panel Beaters Shoe Makers Leather Bag Makers Total % Job Costing 8 10 7 9 8 10 12 5 5 74 49.33 Batch Costing 3 3 4 2 3 9 8 32 21.33 OPTION Contract Process Costing Costing 4 5 2 1 12 4 16 10.67 1 2 15 10 Services Costing 5 5 3 13 8.67 Total 15 15 15 15 15 15 15 15 15 15 150 100

Source: Field work, 1998. Furniture makers, welders, dress makers, glaziers and shoe makers adopted job order, batch and contract costing method. While mechanics, refrigeration/air-conditioning, and panel beaters adopted a combination of job order and service costing method. Block moulders, and few numbers of shoe makers and leather bag makers adopted process costing method and other combinations. Tables 3 and 4 below indicate our finding with respect to material stocking and the reasons for stocking or not stocking: Table 3: Material Stoking Industry Furniture Makers Mechanics Welders Dress Makers Block Moulders Aluminium Fabrication Refrigeration/Air-Conditioning Panel Beaters Shoe Makers Leather Bag Makers Total % Source: Field work, 1998. Yes 8 5 3 2 9 9 36 24 OPTION No. 15 15 15 7 10 12 15 13 6 6 114 76 Total 15 15 15 15 15 15 15 15 15 15 150 100

CAFRAD ??“ African Training and Research Centre in Administration for Development.


Cost Accounting Practice in the Informal Sector of Nigeria

Table 4: Reasons for Material Stocking Industry Furniture Makers Mechanics Welders Dress Makers Block Moulders Glaziers Refrigeration/Air Conditioning Panel Beaters Shoe Makers Leather Bag Makers Total % Source: Field work, 1998. Table 3 indicates that less than 25% of all artisans stock materials while Table 4 shows the various reasons why they do not stock materials used in production. As much as 59 or 39.33 percent confirmed the la ck of capital limited them from stocking materials. In the area of labour, this study revealed that much of the artisans workforce largely depended on apprenticeship. Over 50 percent of the labour requirements of the artisans is provided by apprenticeship. This is shown in table 5 below. Table 5: Distribution of workers Industry Furniture Makers Mechanics Welders Dress Makers Block Moulders Glaziers Refrigeration/Air Conditioning Panel Beaters Shoe Makers Leather Bag Makers Total Percentage Source: Field work, 1998.
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Lack of Storage 5 4 6 1 5 4 3 7 5 6 46 30.67

Lack of Capital 8 6 5 8 5 6 8 6 4 3 59 39.3

OPTION Fear of Theft 1 3 2 5 3 3 3 1 4 3 28 18.67

Others 1 2 2 1 2 2 1 1 2 3 11 11.33

Total 15 15 15 15 15 15 15 15 15 15 150 100

Apprentice s 10 11 9 9 4 15 11 5 8 82 55

Join-Men 2 3 3 5 1 3 3 20 13

OPTION Employees 3 1 2 6 2 5 7 7 23 22

COowners 8 5 1 15 10

Total 15 15 15 15 15 15 15 15 15 15 150 100


Cost Accounting Practice in the Informal Sector of Nigeria

These apprentices were not paid, rather they were provided with lunch allowance. The allowance was provided whenever they worked. On the techniques adopted by the artisans to control costs the study found that there is no formal technique employed. Generally, purchases are made from studying the market at the least possible price and for the right quality and quantity of materials. Exercising firm control over workers/apprentices to minimise idle time and materials wastage, and prudent check on the production incidental expenses also help to control costs.

There are a good number of control systems within an entity. But, cost accounting system is relative, and monitors all other control systems. Cost accounting system is fundamental. It is the foundation of the internal information system. Thus, the cost accounting practice in the informal sector in Nigeria can be assessed under the following major areas.

It is well observed in Nigeria that the informal business concerns lack specific inventory control method. The rate of determination of store items naturally varies with materials concerned. The fact however, remains that the longer an item is held in stock the more risk there is of deterioration. For this singular reason, it is an elementary rule of good costing system that stock should be issued on the basis on first-in first-out. The oldest stock is disposed off first. Our investigation revealed that the informal business sector did not adhere to this principle; probably, due to lack of professional knowledge. This principle though simple in theory, is difficult to enforce in practice without adequate professional knowledge. Investigations further reveal that when new consignments of goods arrive, the easiest thing the artisans do is to put them on top of items already in stock. Consequently, when issues are to be made, they simply take required quantities from the top of the pile. The practice has resulted in some inventory items becoming obsolete hence, loss of contribution.

It is observed that the role of cost accounting in the area of material management has been despised by the artisans in Nigeria. Our investigation reveals that a vast amount of inventories are ruined in every fiscal year because of bad storage. The storage of materials involves the physical custody as well as the preservation. It is well observed that some entities expose items to hazardous climatic conditions. This negative attitude has resulted in the wastage, rusting and evaporation. On further investigation, we found out that the storage problems of some of the entities studied were caused by wrong planning, misapplication of materials management principles, alteration of material management procedures and lack of professional advise. Caravans are used as stores by some artisans. These caravans are not well ventilated as they lack windows and air -conditioners. In most cases there are no humidity and temperature control devices, worst still, most of these caravans were found to have holes in them at the sides and also on top. These holes allow pest and damp to enter. It is the requirement of a good cost accounting practice that unauthorised entry or movement in the store should be disallowed. It is the contention of the researchers that such ???no entry??? measures should also be applicable to pests as they can cause a great deal of damage to inventories. 8

CAFRAD ??“ African Training and Research Centre in Administration for Development.

Cost Accounting Practice in the Informal Sector of Nigeria

Improper system is at variant with good principle of cost accounting practice. The output is very low and should be avoided as much as possible. Materials should be arranged well in the store so that there is a specific location to enhance retrieval when necessary. In our investigation, we found it difficult to define the location system in use in the sector. Some artisans can neither be said to be operating random, fixed or a combination of fixed and random location system. To employ properly accepted system of stock location is a must if the information sector must increase productivity. The importance of knowing quickly where to find every single item of stock the moment it is required cannot be overstressed.

In the area of decision making, cost accounting if adequately and properly applied should provide information regarding which products to produce among alternatives. Decision affecting pricing, selling a product at separation point or processed further, delegating a product line and make or buy decisions are all output of good cost accounting practice. Contrary to the above, the artisans make business decisions by intuition, using a ???trial and error??? approach. It is the practice among the artisans to always apply subjective means of making decisions. They avoid quantitative and analytical means of decision making. All efforts are always directed towards immediate maximisation of profit without considering the variables that bear on such objective functions. They hardly achieve this objective because of the said fundamental constraints. It is worthy of note that this constraint if not properly checked could lead to a company??™s ultimate collapse. Some of the arguments of the artisans are that to produce reliable information for better business judgement is costly in terms of money and time. They went further to assert that only big corporations, governmental entities and other formal outfits can afford to take care of such necessities. However, keen observers of the sector know too well that these excuses are as frivolous as they are flimsy. It is an indisputable fact that the objective of all business undertakings is to generate income which is greater than the associated cost of production. But the fact remains that the effect of lack of well articulated information and proper procedure for analysing information variables for effective decision making can ruin the corporate existence of an entity. In other words, these constraints can stop or reduce the normal business activities so that the anticipated income will either cease or curtail because the earning capacity of the entity has been impaired.

The current state of cost accounting practice in the informal business in Nigeria is very poor and this has caused obsolescence and deterioration of inventories. The situation is further worsened by doubtful and inaccurate cost data which are not only erroneous but misleading following misapplication of costing principles. In view of these facts, the following suggestions are advanced with a view to reversing the situation at a minimal cost. 1. The entities should try to increase the number of qualified accountants and professional managers currently with them. The output of these people is always rewarding. 2. It is important that inventories requiring similar conditions be stored together to concentrate the efforts and resources required to protect them from the hazards of the environment. 9

CAFRAD ??“ African Training and Research Centre in Administration for Development.

Cost Accounting Practice in the Informal Sector of Nigeria

3. 4.

Strict adherence to professional??™s instructions especially in respect of inventories controls. There is a need for timely and regular preparation of ad-hoc reports, schedule reports and of course, exception reports in situations which do not conform with previously defined parameters or norm. At operational and tactical management level, there is a need for staff to undergo training in the use of computer for a new orientation as to how to apply computer to decision making, for enhanced productivity.


CAFRAD ??“ African Training and Research Centre in Administration for Development.