Methods and Systems for Allocating and Reporting Indirect Costs in Management Accounting
One of the main issues in management accounting, which has always been topical, and for which solutions are sought in its theory and practice, refers to the allocation and reporting of indirect costs. Indirect costs are an important element of cost under the current conditions. The paper discusses t...
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irk-123456789-1093202016-11-25T03:02:29Z Methods and Systems for Allocating and Reporting Indirect Costs in Management Accounting Simeonova, R. Finance One of the main issues in management accounting, which has always been topical, and for which solutions are sought in its theory and practice, refers to the allocation and reporting of indirect costs. Indirect costs are an important element of cost under the current conditions. The paper discusses the importance of cost both in financial and management accounting - especially regarding cost management in different directions. Under the present conditions, there is an increase in the share of indirect costs in the cost of manufactured goods and services. This is inevitably associated with their allocation, which as a rule is provisional. The current paper studies the various methods and models of allocating indirect costs: the method of coefficients; the method of cost analysis centres and “Direct costing” system. The search for opportunities to improve the allocation of these costs is related to the Activity-based costing method (ABC). The paper studies the conceptual foundations and guidelines for its application. Одна з головних проблем у бухгалтерському та управлінському обліку, яка завжди була актуальною, і для якої рішення знаходяться в теорії і практиці, посилається на розподіл і повідомлення про постійні витрати. Постійні витрати - важливий елемент вартості за поточних умов. У статті обговорюється важливість вартості як у фінансовому, так і бухгалтерському та управлінському обліку - особливо відносно управління витратами. У сучасних умовах, має місце зростання частки постійних витрат у вартості промислових товарів і послуг. Це неминуче асоційоване з їх розміщенням, яке як правило тимчасове. У статті надано різні методи і моделі розподілу постійних витрат: метод коефіцієнтів, метод аналізу центрів витрат і "директ-кост" система. Пошук можливостей поліпшити розподіл прямих витрат є в сполученні з грунтованим на методі (АВС). Стаття вивчає концептуальні принципи і директиви для його застосування. Одна из главных проблем в бухгалтерском и управленческом учете, которая всегда была актуальной, и для которой решения ищутся в теории и практике, ссылается на распределение и сообщение о постоянных расходах. Постоянные расходы - важный элемент стоимости при текущих условиях. В статье обсуждается важность стоимости как в финансовом, так и бухгалтерском и управленческом учете - особенно относительно управления затратами. В современных условиях, имеет место рост доли постоянных расходов в стоимости промышленных товаров и услуг. Это неминуемо ассоциируется с их размещением, которое как правило временное. В статье приведены разные методы и модели распределения постоянных расходов: метод коэффициентов; метод анализа центров расходов и "директ-кост" систему. Поиск возможностей улучшить распределение прямых расходов состоит в сообщении с основанным на методе (АВС). Рассмотрены концептуальные принципы и директивы для его применения. 2015 Article Methods and Systems for Allocating and Reporting Indirect Costs in Management Accounting / R. Simeonova // Економічний вісник Донбасу. — 2015. — № 4 (42). — С. 71-75. — Бібліогр.: 7 назв. — англ. 1817-3772 http://dspace.nbuv.gov.ua/handle/123456789/109320 657.47 en Економічний вісник Донбасу Інститут економіки промисловості НАН України |
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Finance Finance Simeonova, R. Methods and Systems for Allocating and Reporting Indirect Costs in Management Accounting Економічний вісник Донбасу |
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One of the main issues in management accounting, which has always been topical, and for which solutions are sought in its theory and practice, refers to the allocation and reporting of indirect costs. Indirect costs are an important element of cost under the current conditions. The paper discusses the importance of cost both in financial and management accounting - especially regarding cost management in different directions. Under the present conditions, there is an increase in the share of indirect costs in the cost of manufactured goods and services. This is inevitably associated with their allocation, which as a rule is provisional. The current paper studies the various methods and models of allocating indirect costs: the method of coefficients; the method of cost analysis centres and “Direct costing” system. The search for opportunities to improve the allocation of these costs is related to the Activity-based costing method (ABC). The paper studies the conceptual foundations and guidelines for its application. |
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Article |
| author |
Simeonova, R. |
| author_facet |
Simeonova, R. |
| author_sort |
Simeonova, R. |
| title |
Methods and Systems for Allocating and Reporting Indirect Costs in Management Accounting |
| title_short |
Methods and Systems for Allocating and Reporting Indirect Costs in Management Accounting |
| title_full |
Methods and Systems for Allocating and Reporting Indirect Costs in Management Accounting |
| title_fullStr |
Methods and Systems for Allocating and Reporting Indirect Costs in Management Accounting |
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Methods and Systems for Allocating and Reporting Indirect Costs in Management Accounting |
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methods and systems for allocating and reporting indirect costs in management accounting |
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Інститут економіки промисловості НАН України |
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2015 |
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Finance |
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http://dspace.nbuv.gov.ua/handle/123456789/109320 |
| citation_txt |
Methods and Systems for Allocating and Reporting Indirect Costs in Management Accounting / R. Simeonova // Економічний вісник Донбасу. — 2015. — № 4 (42). — С. 71-75. — Бібліогр.: 7 назв. — англ. |
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Економічний вісник Донбасу |
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| fulltext |
R. Simeonova
71
Економічний вісник Донбасу № 4(42), 2015
UDC 657.47
R. Simeonova,
PhD (Economics),
D. A. Tsenov Academy of Economics, Svishtov, Bulgaria
METHODS AND SYSTEMS FOR ALLOCATING AND REPORTING
INDIRECT COSTS IN MANAGEMENT ACCOUNTING
While performing their activities enterprises aim at
achieving financial results that allow their normal oper-
ation under market conditions.
Costs are one of the elements that are directly re-
lated to the formation of the financial result. Cost ac-
counting is one of the most important sectors in account-
ing, having various functional dimensions as an infor-
mation system. Thus, accounting should create infor-
mation for measuring the performance or efficiency of
an enterprise. This is achieved by reporting the flows as-
sociated with the movement and changes of resources
(material, labour and financial). Revenues and expendi-
tures are the factors related to the measurement of effi-
ciency. The reporting of operating expenses is not only
related to the creation of information on efficiency, but
it is also relevant to calculating the cost of products and
services provided by the enterprise. The relevance of
cost information is expressed as follows:
First, cost is used to measure the elements of finan-
cial statements. For example, in the balance sheet the
tangible fixed and intangible assets and inventories are
shown by their cost. The information on the actual cost
is used for the preparation of the statement of revenue
and expenditure, in which the operating costs are classi-
fied based on their function.
Second, the information on the actual cost is used
to analyze the profitability of the products manufactured
and services rendered.
Third, the information on the actual cost is used in
pricing. This applies primarily to products and services
whose prices are subject to regulation. Some contracts
are concluded on a “cost-plus” basis. Construction en-
terprises enter into a contract with investors for con-
struction, in which the contractor is reimbursed for the
allowable or otherwise defined costs plus a percentage
on these costs or a fixed fee. In this case, accounting in-
formation about the cost of the accounting product (con-
struction works) according to construction contracts,
construction sites, contract stages and calculation ob-
jects is used.
Cost information is also used for the purposes of
tax legislation.
The creation of accounting information about costs
should be oriented to the needs of management in the
following areas:
examining and studying the costs and cost prices
that are formed on this basis for the various activities;
1 See ДРУРИ. К. Введение в управленческий и производственный учет. – Москва, Аудит. ЮНИТИ, 1997. – С. 31-
32.
determining the bases for assessing certain ele-
ments of the assets of an enterprise;
using the information on the cost of production
and the services rendered to compare with the sale prices
and to find out the results;
forecasting and planning of expenditures and
revenues (a pre-established cost, production budgets,
etc.);
identifying the differences (deviations) between
the actual costs and the pre-established ones, etc.
The process of making tactical and strategic mana-
gerial decisions is based on information about costs, sys-
tematized according to different classification signs.
It should be noted, however, that the cost of prod-
ucts and services include various costs. In order to solve
relevant problems in the reporting process they are
grouped in different ways.
According to one of the renowned authors in the
theory of management accounting – C. Drury, account-
ing primarily accumulates information about three cate-
gories of costs: materials, labour and overheads. Costs
are summarized in the following areas: 1) for calculating
and evaluating the production cost; 2) for planning and
making managerial decisions; 3) for carrying out a con-
trol and regulation process. Moreover, in each of these
three areas, in turn, the costs are further elaborated de-
pending on the purpose of management1.
Traditionally accounting practice in our country
classifies costs according to the way they relate to the
cost of products and services rendered. According to this
feature, costs are classified into direct and indirect. Di-
rect costs are directly related to the manufacturing of a
specific type of product or service. They relate directly
to the cost based on the relevant primary documents.
They include the costs related to raw materials, wages
of workers directly employed in manufacturing, insur-
ance accrued on these wages, etc. Indirect costs are as-
sociated with the manufacturing of several products, re-
spectively activities, objects, etc. Examples of such
costs include depreciation of machinery and equipment,
maintenance and operation of machinery and equip-
ment, etc.
Indirect costs are allocated and charged to account
by specific objects in proportion to a pre-selected basis,
i.e. there are two aspects, two successive operations: al-
location of costs and their inclusion in the cost (See fig-
ure 1).
R. Simeonova
72
Економічний вісник Донбасу № 4(42), 2015
Fig. 1. Allocating and charging indirect costs to account by objects of reporting
The bases for allocating indirect costs by types of
production and activities and the criteria for their selec-
tion are quite different. The choice of one or another ba-
sis is often subjective. As a rule, the allocation of indi-
rect costs is provisional. Despite some inaccuracies in
the allocation of costs, it appears necessary and topical
under the modern conditions, as well.
The problem of indirect costs has been solved dif-
ferently in the practice of the developed countries.
One of the oldest methods used for the allocation
of costs in calculating the cost of production is the
method of coefficients. The aim of its application is to
determine the full cost and margin (result) of the pro-
duction output.
The essence of this method is expressed in the fol-
lowing:
The direct costs are reported and charged to ac-
count by purpose;
The indirect costs are reported in total and then
are allocated by means of coefficients and are charged
to account by the types of production.
In this respect the method of cost analysis centres1
is interesting. This method is currently used by French
companies. The process of cost accounting relates to the
registration of costs, their preliminary accumulation and
allocation and charging them to account by purpose as
direct and indirect costs by types of products manufac-
tured and services rendered.
The essence of this method is expressed in the fol-
lowing:
Formation of cost analysis centres, which facili-
tates the allocation of indirect costs. In terms of their
significance, these cost analysis centres correspond to
the organizational-production structure of the enter-
prise.
1 In earlier works in the field of management accounting this method is known as the method of homogenious sections
(Methode des sections homogenes). See LASSEGUES, P. Gestion de l`enterprise et comptabilite. – Paris, Dalloz, 1972, p. 474;
LAUSEL, P. Comptabilite analytique. – Paris, Sirey, 1971, p. 43.
The production costs are grouped on the basis of
their charging to account by purpose – as direct costs,
and on the basis of their inclusion in the product cost –
as indirect costs.
As a rule, the cost analysis centres meet the struc-
tural subdivisions of the enterprise, which carry out a
certain activity and respectively the costs of implement-
ing it. It is possible to create centres to meet specific in-
formation needs. There are two types of centres – pri-
mary and ancillary cost analysis centres.
The costs incurred in the primary centres are allo-
cated and included in the cost of products manufactured
and services rendered.
The costs incurred in the ancillary centres are allo-
cated and charged to the primary centres. These cost al-
locations are called primary and secondary allocation of
costs, respectively.
In search of a solution to the problem of indirect
costs, the USA developed the Direct costing system.
The ‘Direct costing’ concept was promoted by the Na-
tional Association of Cost Accountants (later National
Association of Accountants) in April 1954. This docu-
ment, intended for practice, also defines the fixed costs
that should be excluded when calculating the cost of
each product. Fixed costs are associated with the
maintenance and operation of the enterprise and do not
depend on the volume of its production and sales. They
also relate to the organization and management of the
enterprise. They include the costs of development and
expansion of enterprises. The majority of these costs are
indirect. They are not included in the cost of the output.
This system of calculation is suitable in cases where the
proportion of the total production costs is not high.
Therefore, it has two versions: simplified and improved.
Indirect costs
Allocation
Allocation bases Allocation co-efficients
Charging to account (inclusion) by objects of reporting
R. Simeonova
73
Економічний вісник Донбасу № 4(42), 2015
In the improved version, the algorithm includes the al-
location of indirect costs.
A number of enterprises use high-tech equipment,
which reduces the relative share of direct costs – for ma-
terials and labour, and increases the indirect costs – de-
preciation of equipment, expenses for salaries and insur-
ance of the personnel employed in the operation and
maintenance of this equipment, etc. R. Kaplan, one of
the prominent researchers in the field of management
accounting, states that the industrial cost structure
changes in the course of time and this is a historical fact.
And if at the beginning of the century the general (indi-
rect) costs accounted for 50-60% of the direct labour
costs, today the percentage of the general (indirect) costs
compared to the direct labour costs is significantly
higher – most often from 400 to 500%, and in some
complex productions it exceeds 1000%1.
Often in performing their activities enterprises
need to attract resources for a long period in the produc-
tion, marketing, supply and so on. Therefore, notwith-
standing the fact that according to estimates the equality
of marginal costs and earnings carries a maximum in-
come, the application of the Direct costing system is jus-
tified in certain conditions: enterprises in which variable
(direct) costs make up a significant part of the costs; the
range of products manufactured is small.
If these conditions are not present, it is believed
that the cost indicator is distorted to some extent.
Traditional systems of calculation assume that the
allocation of indirect costs is linked to factors which re-
flect the quantitative aspects of the work done – man-
hours, machine-hours, quantity of processed products,
etc.
The development of new forms of production or-
ganization has changed these ideas. As noted by P. Mev-
ellec,2 in modern enterprises there is a growing im-
portance of the diversity of the products that enterprises
manufacture with a view to satisfy market demand.
Companies incur costs, which are indirect, they are not
determined by the volume of production, but rather by
the need to maintain a variety of products manufactured.
For this purpose, they expend resources, which are not
dependent on the size of the production series (batch).
These are the costs that are made for: setting and adjust-
ing the machines; controlling the quality of the series
that manufacture new products; supply activities; cus-
tomer service, etc.
1 See Kaplan, R. Cost accounting: a revolution in the making. – Corporate accounting, printings 1985. Quoted after EV-
RAERT. Set P. Mevellec. Calcul des couts: il faut depasser les methods traditionnelles. – R e v u e francaise de gestion, 1990,
mars – avril – mai, p. 18.
2 See MEVELLEC, P. Systems de calcul de couts de revient et subventionnement croises. – R e v u e francaise de compta-
bilite, 1993, №241, p. 59.
3 The drawbacks and inefficiency of the traditional systems of costing are subject of study in the works of Eiler and Goletz
in 1982, ad in a number of publications by Kaplan and Johnson in 1987. The technique of applying the ABC method is described
in a book jointly by Johnson and Kaplan. Along with that the method is practically applied by R. Cooper in enterprises of
Hewlett-Packard, Siemens, as well as in some other enterprises of Tektronic, Scovill, General Electric, etc.
4 See MORRARD B. Comptabilite analitique et controle de gestion. www.gestion.unige.ch. The grouping of activities in
Anglo-Saxon literature is presented in a similar way.
The weaknesses and inaccuracies in the allocation
of indirect costs (mainly based on direct labour costs) in
the classical systems of calculation lead to the emer-
gence of a method for calculating the cost based on ac-
tivities – Activity-based costing (ABC). It is based on
hypotheses and methods of allocating and charging the
costs to the cost price, which are considered more ap-
propriate than those that existed before. This new cost-
ing approach is based on the idea concerning the activi-
ties - products interrelation.
The concept underlying the ABC method suggests
management control based on knowledge about pro-
cesses. The ABC method allows measuring of costs not
only by activities but also by functions, centres, etc., as
well as determining the contribution of the activities in
the value creation by the enterprise. This is not just a
system for monitoring but also a system oriented to
management actions.3
The application of the ABC method is related to the
use of certain terms:
An activity, which is defined as a set of works or
activities carried out by a person or a machine. It breaks
down into separate simple operations and at the same
time defines the consumption of resources for their im-
plementation. For the purposes of applying the method,
the enterprise breaks down by activities rather than by
functions.
The activities can be divided into two broad
groups: activities relating to the existence of the enter-
prise and priority activities.
The grouping of activities in manufacturing is of
particular interest:
Activities at an individual product level. The
costs for these activities include: raw materials, wages,
insurance of those directly employed in manufacturing,
electricity, maintenance and operation of the equipment,
etc.;
Activities at a series (batch) level. The costs for
these activities involve assembling the goods, the move-
ment of materials, orders for deliveries, inspection and
control of deliveries, etc.
Activities at a product maintenance level. These
include the costs for engineering designs and technical
documentation (product characteristics), changes in pro-
duction technology, product upgrades, etc.
Activities relating to the organization and man-
agement of the enterprise as a whole.4
R. Simeonova
74
Економічний вісник Донбасу № 4(42), 2015
Cost driver. The French authors use the term
“inducteur”.
The ABC method is characterized by tracing the
transfer of direct costs by objects of costing. This is done
by using cost drivers. Their application explains the con-
sumption of activity costs and the consumption of prod-
uct activities. They are used to link the activities to the
objects of costing.
Similarity may be sought in the application of the
factors and allocation of indirect costs, which is known
from our practice.
The most commonly used cost drivers in the indus-
trial sector can be grouped as follows:
Cost drivers relating to the volume of output:
the area occupied by workshops and other sub-
divisions;
number of installed machines;
the average number of workers;
direct labour costs;
cost of the basic materials;
number of man hours;
number of machine hours;
amount of manufactured products, etc.;
Cost drivers that have a complex nature and ex-
press the characteristics of
the activities performed are not related to the
volume of production:
number of series (batches) of a given product;
number of sellers;
number of customers;
length of a production cycle;
number of the orders fulfilled per month;
number of requisitions;
number of readjustments of machines etc.
The term ‘processes’ is used in relation to the ap-
plication of the ABC method. Following the logic of ac-
tivities, they express the content of manufacturing prod-
ucts.
As already stated, this method is characterized by
tracing the costs and causality in the formation of the
cost. There arises the question of the liability for incur-
ring the costs, which leads to the problem of budgets de-
velopment. As a rule, their design is based on the idea
of centres of responsibility. They do not overlap with
activities. The French author M. Lebas, who along with
P. Mevellec is one of the most prominent researchers in
the field of activity costing presents a matrix model, in
which the enterprise is seen as a network of activities
(see figure 2).1
Functions
Processes
Deliveries
Workshop –
mechanical
processing
Workshop –
assembling
Control Sales Administration
Accepting orders ● ● ●
Management of
product changes
● ● ● ● ●
Invoicing ● ● ● ●
Quality control ● ● ● ●
…….
Fig 2. Matrix structure of an enterprise, presented as a network of activities
As can be seen in Chart 2, the enterprise is shown
as a grid, in which the functions and processes intersect
in the squares. According to the author, not every inter-
section of columns and rows can be identified as an ac-
tivity (in this figure these are the cells with the black
dots). This way of interpreting the structure of the enter-
prise allows easily to identify the activities, which are
determined on the one hand by the functions (centres of
responsibility), and on the other – by the processes that
generate costs (causality).
In this situation, budgets should be developed ac-
cording to activities. On this basis, the resources that
will be needed for each activity are identified and its
contribution in the general plan of activities is evaluated.
The application of the ABC method passes through
the following stages:
1 See LEBAS M. Du cout de revient au management par les activites. – R e v u e francaise de comptabilite, 1994, №259,
p. 48.
First, identifying and classifying activities. There
are several approaches:
• The “Top down” approach. The enterprise man-
agement prepares an activity classifier;
• Processing and re-using documents relating to
processes;
• Conducting interviews with the staff in order to
gather information about the activities.
Second, identifying activity costs. At this stage, in-
formation should be ‘produced’ regarding the costs as-
sociated with the activities.
Third, determining the cost of the cost driver. For
this purpose we need information about the activity
costs and the volume of the activity.
R. Simeonova
75
Економічний вісник Донбасу № 4(42), 2015
Fourth, including the activity costs in the cost of
products manufactured and services rendered. This
stage involves:
• identifying all activities that relate to the manu-
facturing of a product (providing a service);
• identifying the amount of units of each activity
used for manufacturing a unit of production (service);
• charging to account and including the costs by
products and applying the cost of the cost driver for each
activity.
Regardless of the advantages, this method also has
disadvantages: it is hard and expensive to implement; it
is based on subjectivity when including the costs by
products; there is a danger of the desire to minimize
costs at any cost; the hypothesis of a linear relationship
between the activities and resources consumed.
In conclusion, it can be said that the approaches
and methods for allocating indirect costs that exist in
management accounting reflect the tendency to bring
more accuracy and precision in this regard, but also that
this issue remains currently controversial and open.
Симеонова Р. Методи і системи для розпо-
ділу і повідомлення постійних витрат у бухгал-
терському та управлінському обліку
Одна з головних проблем у бухгалтерському та
управлінському обліку, яка завжди була актуаль-
ною, і для якої рішення знаходяться в теорії і прак-
тиці, посилається на розподіл і повідомлення про
постійні витрати.
Постійні витрати – важливий елемент вартості
за поточних умов. У статті обговорюється важли-
вість вартості як у фінансовому, так і бухгалтерсь-
кому та управлінському обліку – особливо відносно
управління витратами. У сучасних умовах, має міс-
це зростання частки постійних витрат у вартості
промислових товарів і послуг. Це неминуче асоційо-
ване з їх розміщенням, яке як правило тимчасове.
У статті надано різні методи і моделі розподілу
постійних витрат: метод коефіцієнтів, метод аналізу
центрів витрат і "директ-кост" система. Пошук мож-
ливостей поліпшити розподіл прямих витрат є в спо-
лученні з грунтованим на методі (АВС). Стаття ви-
вчає концептуальні принципи і директиви для його
застосування.
Ключові слова: бухгалтерський та управлінсь-
кий облік, вартість, умови, розміщення.
Симеонова Р. Методы и системы для распре-
деления и сообщения постоянных расходов в бух-
галтерском и управленческом учете
Одна из главных проблем в бухгалтерском и
управленческом учете, которая всегда была актуаль-
ной, и для которой решения ищутся в теории и прак-
тике, ссылается на распределение и сообщение о по-
стоянных расходах.
Постоянные расходы – важный элемент стои-
мости при текущих условиях. В статье обсуждается
важность стоимости как в финансовом, так и бухгал-
терском и управленческом учете – особенно относи-
тельно управления затратами. В современных усло-
виях, имеет место рост доли постоянных расходов в
стоимости промышленных товаров и услуг. Это
неминуемо ассоциируется с их размещением, кото-
рое как правило временное.
В статье приведены разные методы и модели
распределения постоянных расходов: метод коэф-
фициентов; метод анализа центров расходов и "ди-
рект-кост" систему. Поиск возможностей улучшить
распределение прямых расходов состоит в сообще-
нии с основанным на методе (АВС). Рассмотрены
концептуальные принципы и директивы для его
применения.
Ключевые слова: бухгалтерский и управленче-
ский учет, стоимость, условия, размещения.
Simeonova R. Methods and Systems for Allocat-
ing and Reporting Indirect Costs in Management
Accounting
One of the main issues in management accounting,
which has always been topical, and for which solutions
are sought in its theory and practice, refers to the alloca-
tion and reporting of indirect costs.
Indirect costs are an important element of cost un-
der the current conditions. The paper discusses the im-
portance of cost both in financial and management ac-
counting – especially regarding cost management in dif-
ferent directions. Under the present conditions, there is
an increase in the share of indirect costs in the cost of
manufactured goods and services. This is inevitably as-
sociated with their allocation, which as a rule is provi-
sional.
The current paper studies the various methods and
models of allocating indirect costs: the method of coef-
ficients; the method of cost analysis centres and “Direct
costing” system. The search for opportunities to im-
prove the allocation of these costs is related to the Ac-
tivity-based costing method (ABC). The paper studies
the conceptual foundations and guidelines for its appli-
cation.
Keywords: management accounting, cost, condi-
tions, allocation.
Received by the editors: 03.12.2015
and final form 28.12.2015
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