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The problem of indirect cost distribution — relating indirect functions to the productive tasks performed

Category: Budgeting Methodology

Indirect costs, independent from the purpose they serve, are incurred as types of cost i.e. salaries, salary related contributions, energy, communication, amortisation, utilities, purchased services etc. In total, 58 are listed as lines on the.

All these costs, simultaneously, are associated with activities and functions adding up to 17 — 4 productive activities, 10 auxiliary functions, other costs, sales/marketing, and administration — listed in the columns of the/

Through the function to which they are related (e.g. UAH 376,000 are related to auxiliary function 2), the indirect cost can be budgeted by assessing the contribution which the auxiliary function has to make in order to realise the production plan.

In the case of mechanical repairs, for instance, this analysis would consist of an assessment of the number and kind of repair jobs which the repair manager deems necessary to keep production at the budgeted activity level of 36,000 machine hours in production activity 1, of 9,000 machine hours in production activity 2, of 180,000 m in production activity 3, and of 18,000 operator hours in production activity 4 during the budget period. The total budgeted mechanical repair cost (i.e. repair material, repair labour and the repair department overheads) would then be distributed in accordance with the material and labour cost planned to be spent for the four productive activities. The distribution base in this case is the sum of direct repair material cost and direct repair labour cost. In applying this method, 199UAH are distributed to activity 1, 120 to activity 2, 49 to activity 3 and 8 to activity 4.

It has to be noted that this methodology can only be used if the mechanical repair cost structure for the different production activities is similar. Should the mechanical repair activity be characterised by the situation that repairs for one production activity consist primarily of unproblematic replacement of expensive material, whereas the other production activities require complex manual repair work using insignificant and inexpensive material, such a distribution methodology could not be applied because it would overly burden the material intensive repairs with indirect repair cost. Another distribution method would have to be selected in this case.

The general message is that there is no simple and uniform way for distributing indirect costs to production activities. The correct distribution method is the one which distributes the indirect cost in a way which most closely reflects the effective use caused by the production process. Here are some examples of frequently used distribution bases:

Dispatching department: Time spent by dispatching dept.-employees
Energy/energy repairs: Consumed electrical energy
Steam production: Consumed steam
Internal transport Tonnes of material conveyed
Building repairs: Repair orders
Equipment repairs: Repair orders
Quality control: Effective quality control efforts as estimated by the quality manager
Purchasing % Material value, or different
%-ages for different value classes
Sales/marketing: Effective sales/marketing efforts as estimated by the marketing manager
Administration/Other cost: Mark — up on all other cost

Auxiliary services performed within the assisting functions area should be consolidated and only the services leaving the assisting functions area should be distributed.

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