Overheads :: Direct, Indirect Expenses

Direct Costs/Expenses (Or) Prime-Cost  
 
All those costs/expenses which are capable of being attributed/allocated directly to a particular product or service or cost center are called direct expenses.

• Direct Material

Materials which are purchased for a product or service or a cost center and charged directly to the product or service or a cost center are called direct materials.

• Direct Labour/Labor

Labour/Labor who are employed for the product or service or cost center and whose cost can be worked out using the time sheet data and the wage rates payable to them are identified as direct labour.

• Direct Expenses

Other 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-Cost

The sum of all the direct expenses is what we call prime cost.
⇒ Prime Cost = Direct Materials + Direct Labour/Labor + Direct Expenses

Indirect Expenses » Overheads  
 
All those costs/expenses which are not capable of being attributed directly to a particular product or service or cost center are called indirect costs/expenses.

We generally see that 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 overheads

Although 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 Costs

Costs 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  
 
Overheads are to be attributed (added up) to production costs by apportioning the total overhead among the various products or services that are generated and sold in the organisation.

Illustration

"A", "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 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.
Eg: A. The rent of the factory premises is apportioned based on the area of the factory utilised for manufacturing each product.
B. Depreciation of machinery is apportioned based on the number of hours the machine is used for each product.

Allocation » Apportionment  
 

• Allocation » Allocated/Allocable Cost

Where 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.

• Apportionment » Apportioned Cost

Where 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.

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, 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 means.

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  
 
Since direct expenses are those which can be attributed to a product or service or cost center directly, they are all costs which can be called allocated costs. However, all costs which are capable of being allocated do not form 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 also. Therefore, 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.

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