Cost Accounting | Procedure for allocation of Indirect Cost

What is Cost Accounting

Cost accounting is a system of accounting which includes collecting, classifying, processing, analyzing and reporting of information to top management for taking quality decisions in time.

Categories of Cost Accounting

Under traditional cost accounting system, costs are divided into two categories. They are

  1. Direct cost and
  2. Indirect cost.

Direct costs are directly allocated to the specified product. Indirect costs are allocated to the specified product through cost centre.

Procedure for allocation of Indirect Cost

The allocation of direct cost to the product is very easy. But, the allocation of indirect costs involves heavy task. The following is the procedure followed in the allocation of indirect cost.

1. Selection of suitable basis of allocation.

2. Recording of indirect costs in the ledger accounts as per the selected suitable basis.

3. The ledger accounts information (indirect costs) are transferred to the respective production and service departments.

4. Then, the indirect costs of service department are reapportioned to production departments only as per the predetermined method.

5. Finally, all the indirect costs of production department are allocated to the end products.

The indirect costs are allocated and reallocated on anyone of the suitable basis. There is no hard and fast rule for the selection of suitable basis. It is left to the judgement of the cost accountant to select the most appropriate basis of allocation. Hence, the apportionment of overheads (indirect costs) may led to misleading accounting information.

Direct labour hours, machine hours, plant capacity, value of machine and the like are some of the method followed for the apportionment of overheads. If there is any wrong calculation of direct labour hours, the selection of this basis leads to wrong apportionment of overheads. In this way, each basis has its own weaknesses. Hence, there is a possibility of reporting misleading information to the top management.

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