Managing Financial Resources
Indirect costs are those costs which are not easily traced to the final product. Such costs tend to be so general such that they are attributable to the firm as a whole rather than the particular products. They are also known as overheads, and examples include; factory rent, depreciation of equipment, heating costs for the factory, and factory lighting costs. Because of the complexity in directly identifying such costs to a particular cost unit or cost center, methods have been devised to help account for these overheads, by sharing them out between units of production through some costing systems.
Some of the widely used systems are: absorption costing (overhead recovery), specific order costing, process costing, and uniform costing. Absorption costing (Drury, 2004) This is a method whose aim is to recover overheads in a way that fairly reflects the amount of time and effort that has gone into making a product. Absorption costing involves the following steps: i. Allocation and apportionment of overheads ii. Reapportionment of service cost center overheads iii. Absorption of overheads i. Allocation and apportionment of overheads Allocation involves charging overheads directly to specific departments (i.
e. production and service). Examples of overheads that are allocated to specific departments
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Such bases though are not normally predetermined, but the only base line is that whatever method use must be fair. Possible basis of apportionment include: – Floor area – for rent and rates overheads, and lighting expenses – NBV of fixed assets – for depreciation charges, and insurance of machinery – Number of employees – for canteen costs, personnel costs, and wages paid – Kilowatts – for power consumed – Direct – for maintenance costs etc of specific machinery or departments (Drury, Management and Cost Accounting Ed. 7, 2007)
Reapportionment of service cost centers to production cost centers applies when one service department does work for another, but not where services are reciprocated e. g. canteen does work for maintenance and maintenance does work for the canteen. Reciprocal reapportionment is instead applied where services are reciprocated. (Ernst and Young, 1992) Illustration The following information is for Q Ltd which has four departments; A, B, C and D. Departments A and B are production departments, and departments C and D are service departments.