Define Overhead in Cost Accounting

 

Define Overhead in Cost Accounting

OVERVIEW 

Before we define cost accounting with examples it is quite necessary to know in detail what is cost, and the applicable method of costing in different businesses. For that, we should know that cost accounting can be a genuine drag.  

You don’t see prompt outcomes, and the push to hit the nail on the head can appear to be Herculean now and again, however great cost bookkeeping systems are extremely valuable.  

Cost accounting also plays an important role in financial statements like balance sheets and others to understand the investors which costing method the company has adopted and how far it is in reducing the cost of production and increasing profit. 

The consequences of mistaken cost bookkeeping systems can be seeking after product lines or clients that are either hardly gainful or more awful yet, are unrewarding. Numerous producers have grown overhead rates that are being utilized long after their “best whenever utilized by” dates.  

The explanations behind this incorporate the possibility that expansion isn’t too noteworthy, so how vastly different can the rate be from a year ago, what’s more, it’s such a great amount of work to refresh the rate. Sooner or later, you discover the rate hasn’t been refreshed in a couple of years and afterwards your costing system has slid into ineffectualness. Likewise, cost drivers keep an eye on not being analyzed regularly.  

A few producers have constantly utilized work hours as cost drivers, so they don’t considerably think that the huge capital consumptions they have made in the business make the more conceivable cost driver machine hours.  

In standard costing systems, standards are now and again not refreshed as frequently as they ought to be for a portion of similar reasons. Do you have an underutilized limit in your plant? On the off chance that truly, has this been caught in your overhead rate and your standards?  

On the off chance that not, at that point you may have a critical issue. Have overhead rates and standards not been refreshed as frequently as they ought to be a result of limitations inside your bookkeeping and the board staff?  

Is it true that you are having issues figuring out which product lines and clients are generally gainful? Here is a short update on the fundamentals of cost accounting, and a portion of the traps to undertake to stay away from. The parts of goods costs are direct materials, direct work, and manufacturing overhead.  

Cost accounting systems can be separated into basically two sorts, occupation and standard. Employment costing systems undertake to apply genuine direct material and genuine direct work costs to a fabricated product.  

Manufacturing overhead is connected and dependent on a rate for every cost driver. Standard costing systems apply direct materials, direct work, and manufacturing overhead to the cost of a made product dependent on standards determined by the board.

Define Cost Accounting with Examples

Cost accounting is the process of material accounting which includes analysis, reporting and recording of the cost of a company. This is an internal procedure used by any company to find out different ways to reduce the company’s expenses.  

It helps the company to know the area in which the company is making expenditures, what are its earnings and also the area where the money of the company is lost or wasted. It also helps a business in fixing the price of a product and keeping in view the prevailing market competition by concentrating the gross costs plus profit margin.  

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Cost of Direct and Indirect Materials in Cost Accounting

What is Direct Material Cost in Cost Accounting

Direct material cost is the cost incurred for the purchase of material used directly as a prime substance for manufacturing a product. 

For example: leather is used for manufacturing shoes and clothes are used for manufacturing pants. materials are the crude materials a maker uses to deliver a product. In an occupation costing system, there is an endeavour to relegate the real cost of the direct materials to the product being delivered. 

In a standard costing system, a standard is created and the cost to deliver the fabricated product is allocated to the product at standard. The standard material cost is resolved depending on experience concerning how much material is utilized to create the product, including recompense for scrap, increased by the cost that the maker is paying for the material.  

In a standard costing system, if there are physical issues with materials or new production techniques that are causing startling piece issues, the standard may be reassessed more frequently than is typical. The equivalent goes for huge value changes for direct materials.

Meaning of Indirect Cost in Cost Accounting

Indirect cost is the cost that is an incidental expenditure incurred for manufacturing a product and not directly involved in the finished product.

For example, clothes-cutting machines are used for manufacturing clothes. A gas cylinder is used for cooking food in a hotel.

Labour Cost (Direct and Indirect) in Cost Accounting

Direct Labor Cost is the expenditure incurred on payment of labour cost and other incidental expenditure on labour directly involved in the manufacturing of a product.  

For example, expenditure incurred on labour is directly involved in the production of goods.

Indirect Labour Cost 

Indirect labour cost is a cost not directly charged in manufacturing of goods like expenditure incurred on sale, advertising of payment of employees of operations department.

Direct work

Direct work costs are identified with the representatives who fabricate your products. These costs incorporate wages, yet in addition finance expenses and incidental advantages. In the work costing system, there is an endeavour to relegate the genuine cost of the direct work to the product being delivered.  

The standard work cost is resolved dependent on experience concerning how much time is utilized to deliver the product increased by the compensation that the maker is paying for the work. In a standard costing system, if there are new production strategies or workforce that are causing startling piece issues, the standard may be reassessed more regularly than is typical.

Manufacturing overhead cost Accounting

Manufacturing overhead comprises those costs that are required to create a product, yet are not detectable to the product directly. These costs incorporate utilities, lease, property charges, indirect materials, and indirect work.  

In a vocation costing system, there is an endeavour to allow the real cost of the manufacturing overhead, potentially dependent on planned sums, to the product being delivered using a standard rate increased by a cost driver, with complete cost driver units perhaps dependent on a financial plan.  

The standard manufacturing overhead cost is resolved dependent on planned manufacturing costs separated by planned production amounts. The assurance of overhead rates can be convoluted in either costing system.  These costs involve expenditure on factory overheads, office and administration overheads and selling and distribution overheads.

Factory overheads include payment of factory light, factory rent, and factory insurance. Office and administration overheads include expenditures on office stationery, rent, computers and other office equipment whereas selling and distribution costs involve the expenditure on product advertisement, levelling of goods, and getting orders for sale. 


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Different Methods of Cost Accounting

1. Standard Costing Method

Standard Costing includes the pre-established costs of labour and material. This method of costing is very simple to use and therefore generally adopted by most manufacturing companies.  

Under this Costing Method, the cost of goods is determined on historical experience and pre-established costs while keeping into consideration the material changes in the business environment and economic situations.

2. Process Costing Method 

Process Costing is a cost charged at each stage of processing of the product and is useful for a large number of manufacturers who bear a very narrow difference in tracking the product’s cost.

For example, the first stage of cutting the clothes for making shirts and the second stage is for sewing them.

3. Activity-Based Costing Method

Activity Based Costing (ABC) is the most advanced form of costing. This Costing is the determination of a particular cost unit out of mass production based on an activity involved in its production. Under this method, the overheads are changed to an activity instead of a product.  

The cost is first charged as the Indirect cost to cost pools (related cost groups that are incurred at the time of doing a particular activity). 

For example, the costs of installing a production line will be charged to the cost pool. Thereafter the total cost of that cost pool will be divided into units number activity.

4. Job Costing Method

Different projects are operated by a company. In that situation, it’s very important to allocate a portion of job Costing to each product. This job cost is allocated on a proportional basis to the job done for each product. The job Costing Method includes both Direct and Indirect costs. Under this system, the project has to first charge Direct and therefore charge indirect costs based on resources utilized for that project.

Example of cost Accounting

If a project job uses 50% of light in a month out of the total light consumed in the factory during that month then that job will bear 50% of the total factory light bill of that month. Likewise, if a job uses 25% of office space on a particular day then that job will be charged 25% of the total factory rent divided by 30 (total factory rent/one-fourth/30).

5. Target Costing Method

This is a customer-based costing method. Under this method, the quality, cost and design of the product are set as per customers’ needs. By this method of costing the management can keep in mind the selling price of the product and work accordingly by fixing the production and other gross cost of the product and profit margin.

This method of costing, no doubt, helps management to make a balance between the cost of the product and the acceptable market price.

6. Direct Costing Method

Direct costing also known as variable costing is a method in which only variable production costs are included. This cost (variable cost) varies with each production level like labour and raw material. Under this method fixed costs like insurance and rent are not included.  

By this costing method, the production house will be able to get the best costs chargeable to fixed and variable costs. It is also very useful in making decisions because any change in production level in the costs is very important.

To Sum Up

Cost accounting is the process of material accounting which includes analysis, reporting and recording of the cost of a company. This is an internal procedure used by any company to find out different ways to reduce the company’s expenses. 

It helps the company to know the area in which the company is making expenditures, what are its earnings and also the area where the money of the company is lost or wasted. Direct material cost is the cost incurred for the purchase of material used directly as a prime substance for manufacturing a product. 

Indirect cost is the cost that is an incidental expenditure incurred for manufacturing a product and not directly involved in the finished product. Different Methods of Cost Accounting viz, Standard Costing Method, Process Costing Method, Activity-Based Costing Method, Job Costing Method, Target Costing Method, and Direct Costing Method. 

A certified CPA group can examine your present system and help with extending your costing systems’ capacities and precision to enable you to settle on better administration choices and amplify benefits.

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