Overheads - Direct, Indirect Expenses
Direct Costs/Expenses (Or) Prime-Cost
Direct Material CostCosts incurred on Materials which are purchased for the purpose of manufacture of a product or generation of a service or a cost center and charged directly to the product or service or the cost center accordingly are called direct material costs.
Direct Labour/Labor CostCosts incurred on Labour/Labor employed for the purpose of manufacture of a product or generation of a service or cost center and whose cost can be worked out using the time sheet data and the wage rates payable to them and charged directly to the product or service or the cost center accordingly are identified as direct labour/labor cost.
Direct ExpensesOther expenses which are incurred for the specific product or service or cost center and are directly charged to them are identified as Direct Expenses.
Eg : Expenses on Special Tools and Consumables purchased for the product or service or cost center specifically.
Prime-CostThe sum of all direct expenses in relation to a product or service or cost center is identified as the prime cost for that product, service or cost center.
⇒ Prime Cost
|=||Direct Materials + Direct Labour/Labor + Direct Expenses|
Indirect Expenses - Overheads
Some material costs (identified as indirect materials), some labour/labor costs (identified as indirect labour/labor), rents, depreciation costs, salaries of staff, warehousing costs etc. are of such a nature.
These costs are collectively called overheads.
Some directly attributable costs are identified as overheadsAlthough some costs can normally be identified with cost centers, they are not directly attributed to cost units.
Eg : Selling and Distribution expenses relating to a product. Although they may be attributed to a product, we do not treat is as a direct cost as it is a set ‘overhead’ and not a general manufacturing cost.
Manufacturing CostsCosts that are incurred in the process of manufacture of a product. These do not generally include costs that are identified as administrative and selling costs.
Attributing Overheads to Products/Services/Cost-Centers
IllustrationA, B and C are 3 products manufactured in the organisation.
Materials, Labour/Labor and other direct expenses which are used up separately for each product form the direct costs for the products.
Other expenses like factory rent, depreciation of machinery, consumable material, wages of helpers, office salaries, administrative expenses, warehouse rent, salesmen salaries etc., incurred in the organisation cannot be directly attributed to a particular product or service as the benefit of these expenses accrues to more than one product or service.
Since we have to recover the total cost incurred, these costs (which together we call overheads) are also to be attributed to products or services in deciding the total cost of each product. The total cost arrived at would be considered for deciding the sale price of the product or service.
The process of attributing the total cost among the various products or services is done by choosing a reasonable basis for apportionment of the overheads over each product or service.
- The rent of the factory premises is apportioned based on the area of the factory utilised for manufacturing each product.
- Depreciation of machinery is apportioned based on the number of hours the machine is used for each product.
Allocation - Apportionment
Allocation - Allocated/Allocable CostWhere the total overhead cost incurred under a particular head is attributable in total to a product or service or cost center, the cost is said to be an allocable cost and the process of such attribution is called allocation of overhead.
Apportionment - Apportioned CostWhere the total overhead cost incurred under a particular head is not attributable in total to a product or service or cost center it is an apportioned cost and the process of such attribution is called apportionment of overhead.
Where an overhead cost is not allocable on account of the benefit of the cost/expenditure accruing to two or more products or services or cost centers combined, it is to be attributed to each of the products or services or cost centers by apportioning the total cost among the products or services or cost centers in an appropriate manner.
The apportionment among the products or services or cost centers is to be done on the basis of some rational basis.
In brief, allocation is allotment of cost in total and apportionment is allotment of a part of the cost to a product or service or cost center.
All Direct Costs are allocated Costs but all allocable costs need not be Direct Costs
Direct Costs involve only manufacturing costs and as such all allocable manufacturing costs form direct costs i.e. a part of the prime cost.
The total cost of a product or service or cost center would also include administrative and selling expenses. Costs which are capable of being allocated but fall under these categories cannot be treated as direct costs.
Thus we can say that all direct costs are allocable costs, but all allocable costs need not be direct costs.