3. COST ACCOUNTING AND RATE DETERMINATION › 3.5 Indirect Cost Application Methods
3.5 Indirect Cost Application Methods
You must evaluate the many different types of indirect costs
individually to determine how they should be distributed and
to determine the items against which they should be
distributed. The IS organization applies a "burden rate"
against the users that represents the organization's indirect
costs. If indirect costs are not distributed on an equitable
basis, management does not have an accurate picture of the
cost of operating each load center, nor is the IS
organization able to distribute its costs to its users
equitably. The following example illustrates the evaluation
of indirect items:
The IS organization of company XYZ has three
departments: A, B, and C, each of which is considered a
load center. Load centers A and B are direct centers,
while load center C is an indirect center. Figure 3-1
illustrates a sample set of costs for load centers A, B,
and C.
DEPARTMENTAL COST BREAKDOWN
DIRECT INDIRECT TOTAL
----------------- ---------------- ----------------
Labor Material/ Labor Material/ Labor Material/
Machinery Machinery Machinery
____________________________________________________________
Dept.
A 10,000 50,000 2,000 15,000 12,000 65,000
B 32,000 0 1,000 4,000 33,000 4,000
C 6,000 0 1,000 0 7,000 0
______ ______ _____ ______ ______ ______
All 48,000 50,000 4,000 19,000 52,000 69,000
____________________________________________________________
Figure 3-1. Departmental Cost Breakdown
While there are many different methods of distributing
corporate indirect costs, this example uses a burden rate
that is a percentage applied against the labor costs of
each division. The burden rate is 110%. (It would have
been feasible to use either the number of personnel or
total costs as distribution bases.) Figure 3-2 adds the
burden rate to the total costs listed in Figure 3-1.
TOTAL BURDEN RATE APPLICATION SCHEDULE
Dept. Labor Burden Cost Material/ Total Cost
(Labor + Machinery + Burden
1.1 * Labor)
____________________________________________________________
Dept.
A 12,000 25,200 65,000 90,200
B 33,000 69,300 4,000 73,300
C 7,000 14,700 0 14,700
_______
All 178,200
____________________________________________________________
Figure 3-2. Burden Rate Application Schedule
To arrive at the final costs of the direct load centers,
A and B, the cost of load center C must be applied to the
two other load centers. Remember load center C is an
indirect cost and must be applied against direct load
center costs. It is also important to realize that even
though load center C is an indirect load center, the
burden rate was still applied to it to determine the
accurate cost of load center C.
Load center C is a support activity maintaining materials
and machinery. Therefore, it would be logical to
distribute the cost of load center C across centers A and
B based upon their material and machinery costs. The
total cost of materials and machinery for the two centers
is $69,000, with A responsible for 94.2% and B
responsible for 5.8% of the total. In distributing the
cost of load center C, the amount of $14,700 is
distributed proportionately, with $13,847 going to A and
$853 going to B. The final direct costs of the A and B
load centers are shown in Figure 3-3.
_________________________________________________________
Total
Dept. Burdened Cost Distributed Load Center
Indirect Cost Cost
_________________________________________________________
A $90,200 $13,847 $104,047
B 73,300 853 74,153
________
$178,200
_________________________________________________________
Figure 3-3. Total Load Center Costs
The object of this example is to illustrate two points:
first, that there are many different types of indirect costs;
and second, that there can be many different ways of
distributing these costs. In defining indirect costs and
distribution techniques, we strongly suggest that the cost
accounting department be brought in as consultant to the data
processing costing staff while the accounting system is being
designed. If this participation with the cost accounting
group is successful, the costing policies of the data
processing system should adhere to those of the overall
corporation. Such compliance with corporate procedures will
go a long way in winning acceptance by both user and top
management of the data processing costing procedures.
