Management Accounting

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MANAGEMENT ACCOUNTING

The Role of Indirect Costs in Costing Systems



The Role of Indirect Costs in Costing Systems

Introduction

The indirect costs corresponds to the expenses of conducting and operating business, which are not identified with a specific contract, grant, activity or function of the project, but are essential component in the operating of an organization and performance of its activities. According to the theory, costs like light, heat, personnel and accounting may be accounted for directly if small meters were able to record minutes in a cross cutting way. However, certain and significant practical complexities are major hindrances in using that approach. Hence, plans related to cost allocation or cost rates (i.e. indirect) are utilized to allocate such costs to benefit revenue supplies. Indirect costs are not related or attributable to an identifiable product with it or in some contexts, to any unit or project of the organization, in turn can be classified as:

Specific: There are those that occur only on the basis of the work. If this is not performed specific indirect costs would not exist.

General: Those who are relatively independent of the work. An example would be the cost of maintaining the central office of the contractor.The paper discusses what the role of indirect costs is in different costing systems.

Discussion

The costs that are allocated to different cost objects can be separated in two distinct categories, direct and indirect costs. Typically, the term 'overheads' is also used alternatively for indirect costs. The cost that is traced properly and accurately to cost objects is known as direct cost. In comparison, it is impossible to trace indirect costs to a cost object, as many cost objects have similar and common indirect costs (Gering, 1999, 24-26). So as a general rule, the indirect costs are allocated to different cost objects through cost allocations. Different systems of costing have varied approaches in their treatment of various costs. The treatment involves different costs allocated to different cost objects and their complexity level. Generally, there are three costing systems, which are listed below

System of Direct costing;

System of Traditional Absorption Costing;

System of Activity based costing system.

In the case of direct costing systems, direct costs are only allocated/assigned to cost objects, because the system do not allocate indirect costs directly to cost objects; the systems only account contributions to the indirect costs. The loophole in the direct costing system is that it does not contain any processes or systems to assign and measure indirect costs in relation to cost objects. This type of costing system, direct costing system, can only be recommended to an organization where indirect costs have very less contribution in organization's accumulated costs. On the contrary, both activities based costing systems and traditional costing systems allocate indirect costs to cost objects.

Direct Costing system and the indirect costs

The "direct costing", also known under the names "variable costing" or "marginal costing" posits a different approach to define the cost of manufacture. Direct costing is based on the existence of two types of costs associated with ...
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