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COST AND MANAGEMENT ACCOUNTING
Lecture 3 &4
Accounting for Overheads
Activity Based Costing (ABC)
Classification of Overheads
Direct & Indirect costs.
Direct costs are those costs which can be directly identified with a
product or service, e.g direct materials or direct labour. The total of direct
costs is known as Prime costs.
Overheads are those costs which cannet be economically attributed
directly to a cost unit. Overheads may be defined as the aggregate of
indirect material cost, indirect wages and indirect wages and indirect
expenses. Overheads may alternatively be termed indirect costs.
Overheads can be analysed as follows:
Production Overhead
Administrative Overhead
Selling Overhead
Distribution Overhead
, 2
Accounting for Overheads
Production Overheads
Also known as factory overhead or works overhead. Examples of factory rent
& rates, factory light & power, depreciation of plant and buildings, etc
Administrative Overheads
Examples are office rent and rates, office light and heat, executives salaries,
stationery, postages and telephone.
Selling Overhead
Examples are cost of advertising, sales promotion, sales staff salaries and
research and development.
Distribution Overhead
These include warehouse costs, packaging, transport and depreciation of
delivery vans
Activity Based Costing
Activity-Based Costing (ABC) is a costing model that identifies activities
in an organization and assigns the cost of each activity resource to all products
and services according to the actual consumption by each: it assigns more
indirect costs (overhead) into direct costs. In this way an organization can
establish the true cost of its individual products and services for the purposes
of identifying and eliminating those which are unprofitable and lowering the
prices of those which are overpriced. Activity based costing is an attempt to
reflect more accurately in product costs those activities which influence the level
of support overheads.
This technique re-examines the problem that has faced accountants and
accounting technicians for decades – that of the allocation and absorption of
overhead.
, 3
Activity Based Costing
Traditional costing systems were designed years ago, when most company
were manufacturing a narrow range of products and when labour & materials were
dominant factory cost. Overheads were relatively small and basically overheads
allocation was not most critical.
However nowadays most company produce a wide range of products and direct
labour cost represent only a small proportion of total cost. As overheads are of
considerable importance it will be unfair to absorb them using unrealistic
diminishing labour rate. In addition traditional system were link to volume related
resources such as labour, material and other machine related costs.
Activity Based Costing
Activity Based Costing.
Absorbs costs on the basis of the activities that drive them.
Costs are incurred by activities
Each activity has a cost driver
Costs are grouped into pools
Some important aspects of ABC are as follows:
Cost Centres
A cost centre is an area of responsibility, such as a department, to which
costs can be related for control purposes.
Cost centres can be of two types:
- Production cost centre: They are directly involved in production, e.g
machining dept.
- Service cost centre: They exist to facilitate production, e.g maintenance
and canteen
COST AND MANAGEMENT ACCOUNTING
Lecture 3 &4
Accounting for Overheads
Activity Based Costing (ABC)
Classification of Overheads
Direct & Indirect costs.
Direct costs are those costs which can be directly identified with a
product or service, e.g direct materials or direct labour. The total of direct
costs is known as Prime costs.
Overheads are those costs which cannet be economically attributed
directly to a cost unit. Overheads may be defined as the aggregate of
indirect material cost, indirect wages and indirect wages and indirect
expenses. Overheads may alternatively be termed indirect costs.
Overheads can be analysed as follows:
Production Overhead
Administrative Overhead
Selling Overhead
Distribution Overhead
, 2
Accounting for Overheads
Production Overheads
Also known as factory overhead or works overhead. Examples of factory rent
& rates, factory light & power, depreciation of plant and buildings, etc
Administrative Overheads
Examples are office rent and rates, office light and heat, executives salaries,
stationery, postages and telephone.
Selling Overhead
Examples are cost of advertising, sales promotion, sales staff salaries and
research and development.
Distribution Overhead
These include warehouse costs, packaging, transport and depreciation of
delivery vans
Activity Based Costing
Activity-Based Costing (ABC) is a costing model that identifies activities
in an organization and assigns the cost of each activity resource to all products
and services according to the actual consumption by each: it assigns more
indirect costs (overhead) into direct costs. In this way an organization can
establish the true cost of its individual products and services for the purposes
of identifying and eliminating those which are unprofitable and lowering the
prices of those which are overpriced. Activity based costing is an attempt to
reflect more accurately in product costs those activities which influence the level
of support overheads.
This technique re-examines the problem that has faced accountants and
accounting technicians for decades – that of the allocation and absorption of
overhead.
, 3
Activity Based Costing
Traditional costing systems were designed years ago, when most company
were manufacturing a narrow range of products and when labour & materials were
dominant factory cost. Overheads were relatively small and basically overheads
allocation was not most critical.
However nowadays most company produce a wide range of products and direct
labour cost represent only a small proportion of total cost. As overheads are of
considerable importance it will be unfair to absorb them using unrealistic
diminishing labour rate. In addition traditional system were link to volume related
resources such as labour, material and other machine related costs.
Activity Based Costing
Activity Based Costing.
Absorbs costs on the basis of the activities that drive them.
Costs are incurred by activities
Each activity has a cost driver
Costs are grouped into pools
Some important aspects of ABC are as follows:
Cost Centres
A cost centre is an area of responsibility, such as a department, to which
costs can be related for control purposes.
Cost centres can be of two types:
- Production cost centre: They are directly involved in production, e.g
machining dept.
- Service cost centre: They exist to facilitate production, e.g maintenance
and canteen
