Module 9.

Cost Accumulation

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Cost Accumulation
Direct /Indirect Cost
Cost Allocation

Cost Apportionment

Cost Driver

Cost Absorbtion

Treatment of Over/Under

absorbed overheads
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 Elements of Cost

Material Labour Expenses

Direct Direct Direct

Material Labour Expenses

Indirect Indirect Indirect

Material Labour Expenses

Direct Indirect
Cost Cost 3
Direct Costs
A cost that can be directly
traced to a particular department
or other subunit of an
organization is called a direct
cost.
e.g.: The cost of materials
required for a particular product
is a direct cost because it can be
directly traced to the product.
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Direct Material Cost Direct Labour Cost
Includes the cost of Consists the cost of
materials and the labour that is
reasonable used in the actual
allowances for scrap manufacture of the
and defective units. product or that is
The cost considered used to provide the
for material include service.
freight and related It also includes the
charges but exclude cost associated with
purchase discounts. the nonproductive
time that is
considered
unavoidable and
normal.
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Direct Expenses

It includes all expenses other

than direct material or direct
labour which are specially
incurred for a particular cost
object and can be identified in
an economically feasible way.
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 Indirect Costs
An indirect cost has no
convenient or economical trace
from the cost to the cost pool
(the meaningful groups into
which the jobs are often
collected) or from the cost pool
to the cost object (any product,
service, customer, activity or
organizational unit to which
costs are assigned for some
management purpose).
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Indirect Material Cost
Refers to the cost of materials used in
manufacturing that are not physically a
part of finished good.
E.g.: supplies used by manufacturing
employees, materials required by
machines such as lubricants.

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Indirect Labour cost
Includes the costs associated with
quality control, supervision, support cost
associated with manufacturing,
inspection, purchase and receiving costs.

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Indirect Expenses
Other Indirect Expenses include
depreciation on machines and
plant, property taxes, utilities,
carriage outward, etc.

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 Cost Centres
Enable a
business to
identify where
costs are arising

To manage those
costs more
effectively.
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Cost Centres

Cost centre means a location,

person or an equipment for which
cost may be ascertained,
accumulated and accounted for.
The main objective is to account
and control the cost.

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Cost Centres

Example, In rent a cab

system cost centre can be a
particular cab, for a
carpentry workshop activities
like crafting, assembling,
polishing & finishing etc. can
be cost centres.

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Manufacturing
Overheads

All indirect factory costs are

commonly combined into a single
cost pool called manufacturing
overhead.
In a manufacturing firm, it is also
called factory overhead.

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 Manufactu
ring
Overheads

Indirect Indirect Indirect

Material Labour Expenses

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MANUFACTURING COST FLOW
Direct Material

Direct Labour Work in

Process
Direct
Inventory
Expenses
Cost of
Prime Cost

Finished Goods
Manufactu Sold
ring Goods
Overhead Inventory
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 Cost Allocation
Cost allocation is the process of
assigning direct costs to a cost centre.
All direct costs are traced to cost
centres through allocation.
Indirect costs(overheads) have to be
assigned to cost centers through cost
apportionment.
The basis on which costs are
apportioned to cost centers is called
cost driver.
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Cost
Apportionment
At this stage, those items of
estimated overheads which
cannot be directly allocated to
various cost centers or
departments are apportioned.
Apportionment implies the
allotment of proportions of items
of cost to cost centers or
departments. It implies that
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 unallocable expenses are to be
spread over the cost centers or
departments on an equitable
basis.
After this stage, all the overhead
costs would have been either
allocated to or apportioned over
various departments.
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COST DRIVER

A cost driver is a factor such as

the level of activity or volume,
that casually affects costs. That
is, a cause and effect relationship
exists between a change in level
of activity or volume and a
change in the level of total costs
of that cost object.
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Example
Activities Cost Driver
Machining Machine Hours
operations

Setup Setup Hours

Inspection Pieces Inspected
Order Cost Purchase Orders
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Methods of Absorbing
Overheads

Percentage of direct material

Percentage of prime cost
Percentage of direct labour cost
Labour hour rate
Machine hour rate

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Pre-determined overhead rate
Pre-determined Overhead rate
is a rate, based on budgeted
factory overhead cost and
budgeted activity, which is
calculated before a period begins.

A pre-determined overhead rate

normally applies for a a single,
plant-wide base to calculate and 23
 apply overhead.
Overhead is then applied by
multiplying the pre-determined
overhead rate by
the actual driver units.

Predetermined Budgeted yearly

Overhead Factory Overheads
Rate Budgeted Yearly
Activity (direct
labor-hours, etc.)
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 Steps for calculating Pre-
determined overhead rate

Step 1: Estimate the amount of

the activity base will be required
to support operations in the
coming period.

Step 2: Estimate the total

manufacturing cost at that level of
activity.
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Step 3: Compute the
predetermined overhead rate by
dividing the estimated total
manufacturing overhead costs by
the estimated total amount of
cost driver or activity base.
(Note: Common activity bases
used in the calculation include
direct labour costs, direct labour
hours, or machine hours) 26
Over and Under Application of
Overheads
Through the use of pre-
determined overhead rate,
overheads are applied into actual
production throughout accounting
period.
Since the pre-determined rates
are based on expected overheads
to be incurred and estimated
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production, usually the overheads
absorbed into the production cost
may not fully agree with actual
overheads.
If the overheads absorbed are
higher than actual incurred then
it is called Over Application.
If the overheads absorbed are
lesser than actual incurred for the
accounting period, it is called
Under Application.
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Reasons
The actual hours worked can be
more or less than the estimated
hours
The actual overhead costs are
different from budgeted overhead.
The application method used may
not be correct.
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Both actual overhead costs and
actual activity levels are different
from the budgeted costs and level
Extra-ordinary expenses might
have been incurred during the
accounting period.
Seasonal variations in the
overhead expenses from period to
period.
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Major changes might have taken
place for example replacement of
manual labour with machines,
replacement of general purpose
machine with automatic high
speed machine etc.

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 Treatment of over/under
absorbed overheads in cost
accounting

Application of supplementary
rate: The supplementary rate is
calculated by dividing the under
or over application amount by
the actual base.
In case of under application, by
applying the supplementary rate 32
the uncovered amount will be
adjusted and vice versa.

Write off to costing profit and

loss account: If the under or
over absorbed overheads is
small, the it will be written off by
transferring it to the costing P&L
Account.

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Carry forward to subsequent
year: By treating the under or
over absorbed as seasonal
fluctuations, we can carry
forward it to subsequent
accounting year.
This may be transferred to
Overhead Suspense A/c or
Overhead Reserve A/c.

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