Most
of the students are point-blank when someone has asked them that indirect cost
and overheads are same? But here, no need to wonder. There are enough reasons
provided for that similarity. Here it goes, but before explaining the reasons,
one needs to understand what direct and indirect cost is? Cost which is
traceable with the product is the direct cost. To grasp the concept deeply,
take an example, suppose there are five sales offices in different cities and
managers are appointed for each separately. Say Rs. 50,000 is the total salary
that a company has to pay to their managers. Now the question is how much
salary a manager is entitled to get? It is so simple to trace the salary
directly with the number of offices. It is Rs. 10,000 which is directly
traceable with the sales offices is a direct cost. However, cost which is not
traceable with the product is an indirect cost. So let’s take an example again,
in a restaurant, where several food items are cooked and served. There is only
one man who looks after the restaurant and getting a salary of Rs. 5,000. Can
you trace the salary of man with the food items? No, it’s not possible is an
indirect cost. Indirect material, indirect labor and indirect expenses collectively
make the word overheads.
The
most crucial part of the overheads is how to charge it to the cost units
equitably as it is an indirect cost? Mainly three terms are used to equal
distribution of overheads. These are ALLOCATION, APPORTIONMENT AND REAPPORTIONMENT
of the overheads.
Before
arriving at ALLOCATION, we must understand the DEPARTMENTALIZATION. It is a
process by which we divide the whole firm into several departments. Once
departmentalization is done, we reached at ALLOCATION which means to charge the
overheads to respective cost units and cost centers directly. For clear
understanding take an example, electric charges can be allocated directly to
respective department if separate meters are installed and cost of coal which
is used for boiler is directly allocated to boiler house division. Thus,
allocation is direct process of identifying overheads to the cost units or cost
centers.
Now
we reach at another step, APPORTIONMENT, it is a process where we apportion the
overheads which are not allocated to cost units or cost objects directly.
Reconsider the above example, if meters are not installed, you will definitely
wonder that how it could be done. But, here the electricity charges are
apportioned on some suitable basis like number of light points to various
departments. This is how the apportionment takes place. It is also called a
“primary Distribution Summary” of overheads.
Now
the journey of overheads is headed towards the REAPPORTIONMENT of overheads,
here we again discuss further a bit about departmentalization. That is
classification of departments, which are broadly classified into PRODUCTION AND
SERVICE DEPARTMENTS. As we know that production department is place where
actual production takes place. And service department that renders the services
to production departments. In primary distribution summary, overheads are
allocated to departments i.e. production department and service department. But
absorption of the overheads to cost units demand that overheads of service
department should be redistributed to production department which is called
redistribution of overheads. It is also called SECONDARY DISTRIBUTION SUMMARY
of overheads. Now the question is Why the REDISTRIBUTION demanded? Because how
many units are manufactured to be traced from production departments. Once
total cost of concerned department found it is divided by number of units
produced by that department. This is how one can find the cost of one unit.
Which is also called ABSORPTION RATE.
