Business – Banking – Management – Marketing & Sales

Description of an adequate indirect cost planning and distribution system



Category: Budgeting Methodology

The complexity of budgeting for overheads (i.e. indirect costs) stems from the fact that overhead costs are not connected directly to individual products, orders or services as are direct costs.

Some indirect costs, however, are still relatively close to direct cost: the salary of a workshop supervisor, certainly, cannot be related to individual work operations, as can the labour cost of direct workers. The supervisor’s cost, however, and any other indirect cost incurred by the workshop in which the direct worker works, can be attached to the productive work done by the workers, and via the productive work, to the products.

Other indirect costs are spent in departments which only carry out indirect activities, e.g. building maintenance and repair, equipment maintenance and repair, internal transport, quality control etc. These functions are referred to as auxiliary functions.

A third category of indirect cost is incurred by purely administrative functions such as marketing/sales, accounting, general administration etc.

All these indirect costs have to be put in relation to the productive work performed which can have the form of operator hours or of machine hours. The way this is done can be described schematically as follows:

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  • the cost of auxiliary activities and general administrative activities recorded in accounting by type of cost and by organizational function are distributed to the direct activities who have to carry them in accordance with the contribution they make to their work.
  • the total indirect cost identified as belonging to one productive activity (i.e. the indirect cost of the productive activity plus the distributed cost of the auxiliary activities) are then allocated to products or processes.

This is explained in more detail in the following. It is recommended to read this explanation in conjunction with the Excel sheets which have been developed to illustrate the indirect cost distribution and allocation methodology


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