The following points highlight the twenty six items of expenses. Some items are: 1. Design and Drawing Office Costs 2. Materials Carriage, Handling and Storage Expenses 3. Transport Charges 4. Royalties and Patent Fees 5. Light, Heat and Air-conditioning 6. Repairs Renewals and Maintenance 7. Material losses and Wastages 8. Inspection Charges 9. Insurance Costs 10. Canteen Expenses and Other Items.
Treatment of Items of Expenses:
- Design and Drawing Office Costs
- Materials Carriage, Handling and Storage Expenses
- Transport Charges
- Royalties and Patent Fees
- Light, Heat and Air-conditioning
- Repairs Renewals and Maintenance
- Material Losses and Wastages
- Inspection Charges
- Insurance Costs
- Canteen Expenses
- Training Costs
- Cost of Container and Packing Cases
- Cost of Small Tools
- Cost Office Expenses
- Directors’ Fees and Salaries
- Subscription and Donations
- Market Research and Development (R & D)
- Dismantling of Plant
- Installation of New Plant and Machinery
- Moving and Refaxing Existing Plant
- Set up Cost
- Cost Office Expenses
- Profit Sharing Bonus
- After-Sales Service Costs
- Interest on Capital
Item # 1. Design and Drawing Office Costs:
Where design and drawing office renders specific service to a job, the costs thereof shall be charged to job concerned directly. But where drawing office provides general service to the undertaking as a whole, its costs are treated as production overheads and apportioned on the basis of number of drawings made, chargeable man-hours etc.
Item # 2. Materials Carriage, Handling and Storage Expenses:
When the cost of carriage inward is incurred for a particular material then it is treated as a part of material cost. But where carriage inwards cover a large number of materials then it is treated as an item of production overhead. Materials handling and storage expenses may be apportioned on the basis of value, weight and value of materials or number of material requisitions handled.
Item # 3. Transport Charges:
Internal transport costs incurred for movement of materials viz., from stores to production departments, interdepartmental movement of stores, components are distributed to different products or departments on the basis of distance traversed, volume, value or weight of stores carried etc.
Cost of external transport, i.e. delivery of goods to customers is treated as distribution overhead and is apportioned on the basis of truck hours, truck kilometers, weight of the products carried etc.
Item # 4. Royalties and Patent Fees:
When Royalty is paid on the basis of a fixed percentage of output, the expenditure is charged to the cost of product. When the royalty is paid on the basis of sales it is treated as selling overheads. The expenditure incurred for registering and renewal of patents is treated as Administration Overheads.
Item # 5. Light, Heat and Air-conditioning:
The expenditure is apportioned to works administration and Selling and Distribution overheads on the basis of light points if voltage is equal, otherwise on the basis of area occupied by each department. Expenses for air-conditioning and heating may be apportioned on the basis of area occupied or on the basis of cubic capacity of the department concerned.
Item # 6. Repairs Renewals and Maintenance:
If the expense incurred is on account of normal maintenance and minor repairs, it is treated as overhead costs. The expense incurred for plant and machinery and factory building is charged to factory or works overhead costs. Expenses in connection with capital assets used in the general office, selling and distribution departments will be charged to administration, selling and distribution overheads, respectively.
Item # 7. Material Losses and Wastages:
Material losses or wastages may arise in:
(ii) Storage and
(i) Loss in transit:
In coverable losses are treated as overhead. In case of heavy loss, such loss should be charged to the Costing Profit and Loss Account.
(ii) Loss during storage:
Some materials are lost in handling. Loss may arise due to pilferage, evaporation, and shrinkage. This type of loss is sure to occur and unavoidable. Such a loss is a normal loss and is treated as a factory overhead. Losses that arise due to theft, fire, and mismanagement are known as abnormal losses and should be excluded from the cost accounts and should be charged to Costing Profit and Loss Account.
(iii) Loss during manufacturing:
The materials which are wasted during manufacturing process should be charged to the job. But if the wastage is abnormal in nature it should be transferred to Profit and Loss Account.
Item # 8. Inspection Charges:
If expenses incurred in connection with inspection of goods can be identified to a specific product, process or department, it should be charged directly to the product, process or department. Otherwise it is treated as an item of factory overhead.
Inspection charges relating to raw materials and packing materials are merged with materials handling and storage expenses. Inspection cost of finished product is treated as distribution overhead.
Item # 9. Insurance Costs:
Insurance charges paid at the time of purchase of raw materials are charged direct to cost of materials or assets purchased. Premium paid for stock of raw materials is treated as manufacturing overhead. Insurance premium paid for warehouse stock is treated as distribution overhead while premium paid against loss of profit or burglary is treated as an item of administration overhead.
Insurance premium paid to cover the risks of general loss and fire in respect of plant and machinery, factory building and equipment is treated as production overhead and apportioned to the different departments on the basis of value .insured.
Item # 10. Canteen Expenses:
Canteen expenses are apportioned to different Cost Centres on the basis of direct wages, number of employee, number of meals served etc.
Item # 11. Training Costs:
Training costs pertaining to workers are apportioned to different Cost Centres on the basis of number of trainees, direct wages. If the trainees perform productive work, a part of estimated cost is charged to the production order concerned.
Item # 12. Cost of Container and Packing Cases:
Cost of primary containers which are exhausted by one use becomes a part of production cost. Cost of secondary containers which are returnable by the customers forms a part of selling and distribution overhead.
Item # 13. Cost of Small Tools:
Generally, cost of small tools is charged to all departments on the basis of actual issues. There is a alternative treatment which is not popular. Small tools are treated as assets and depreciation thereon is charged as overhead.
Item # 14. Cost Office Expenses:
It is treated as overhead and apportioned to factory administration and selling divisions on the basis of estimated benefit obtained by each division.
Item # 15. Directors’ Fees and Salaries:
These expenses form a part of administration overhead. Sometimes directors’ remuneration may be apportioned to production, administration and selling and distribution functions on the basis of time devoted by the directors. Where there are separate directors for different functions like purchase, sales, finance etc., separate allocation can be made to different functions.
Item # 16. Subscription and Donations:
Subscriptions and donations to welfare schemes or institutions from which workers can obtain benefit are treated as an item of factory overhead. Subscriptions to mercantile agencies for obtaining different information as to the financial status of a prospective buyer should be treated as selling overhead.
Subscription and charitable donations from which no benefit is derived by the workers or the business unit are kept outside the ambit of cost accounts.
Item # 17. Market Research and Development (R & D):
“Research and Development costs have been defined by ICMA, London, as follows:
“Research cost is the Cost of seeking new or improved products, applications of materials or methods. Development cost is the cost of the process which begins with the implementation of the decision to produce a new or improved product or to employ a new or improved method, and ends with the commencement of formal production of that product or by that method.”
Research may be of two types, namely, fundamental research and applied research. Fundamental research aims at increasing the knowledge of the technicians.
Applied research aims at a achieving the following objectives:
(i) To improve the quality of the existing product;
(ii) To improve the existing method of production;
(iii) To search for new product;
(iv) To search for new method of production; and
(v) To search for new application of materials.
Treatment in Cost Accounting:
(i) Fundamental research:
Expenses incurred on fundamental research are treated as manufacturing overhead.
(ii) Applied research:
When expenses on applied research are incurred for bringing about improvement on the existing methods of production and products, such expenses incurred for a particular period should be treated as manufacturing overhead of that period. But if such expenses are earmarked for any specific product, all expenses will be charged directly to the product.
When expenses are incurred for searching new products or new methods of production, each research project should be given a specific project number and cost should be allocated accordingly. If the research project becomes a failure the cost should be debited to Costing Profit and Loss Account.
But if it becomes a success it should be debited to development cost. If the project results are relating to a particular product, it would be a direct charge to that product, but if a production method is related to any project, it should be treated as an item of manufacturing overhead:
Item # 18. Dismantling of Plant:
Where it becomes essential to dismantle the existing plant and machinery and re-erect the plant at a different place, the expenditure involved is charged to works overhead. When an asset is prematurely dismantled on being obsolete, the costs of dismantling should be charged to the account of dismantled asset, and set off against any salvage or compensation moneys or sale proceeds received.
The final gain or loss on realisation should be transferred direct to Profit and Loss Account, unless some element of any gain is considered to be a Capital Profit which ought to be properly transferred to Capital Reserve.
Item # 19. Installation of New Plant and Machinery:
The cost incurred for installation of a new machine is generally capitalized and such cost is written-off as depreciation along with the asset.
Item # 20. Moving and Refaxing Existing Plant:
The cost may be treated as production overhead as it does not add to the value of the asset.
Item # 21. Set up Cost:
Cost of setting up for a particular job order or production order is a direct charge to that job order. But when setting cost is not meant for a particular job and is high, it is treated as production overhead and is apportioned to all the jobs accordingly.
Item # 22. Depreciation:
Generally, depreciation is charged on the capitalized value of a fixed asset. Depreciation on fixed assets used in the factory is treated as an item of Factory Overhead. Depreciation on fixed assets used in the office and sales departments is treated as an item of Office and Administration and Selling and Distribution Overhead, respectively.
It is suggested that when prices are rising, the amount of depreciation should be calculated on ‘Replacement Cost’ rather than on original cost. Providing of depreciation on replacement cost is a controversial issue.
Arguments for and against it are discussed below:
Points in favour of providing depreciation:
1. After the expiry of the life of the asset, sufficient funds are made available to replace the old asset. Moreover, unless the firm provides depreciation on a replacement cost basis, it will have insufficient funds to keep its capital intact.
2. True profits are not closed under the original cost basis as depreciation is either undercharged or overcharged depending upon inflation or deflation.
3. The depreciation charge on the replacement cost in the cost accounts represents the true cost in as much as the cost so arrived at is comparable with the current selling price.
4. In case the value of the asset has gone up and depreciation is provided at the usual old rates, true price cannot be revealed.
5. Overstatement of profits in the original cost method results in higher taxation.
6. The inflated profits may be paid away in the form of dividend which may affect the financial position of the concern.
The following are arguments against providing depreciation on replacement cost of an asset:
1. Depreciation is a charge for diminution in the book value of an asset and has nothing to do with the appreciation in its value or its replacement cost.
2. The actual cost of an asset should be taken into account for costing purposes. Providing depreciation on replacement cost is misleading and is a departure from costing principles.
3. ‘Replacement Reserve’ can be created to provide sufficient funds for replacement of an asset.
4. This method is not approved by the Revenue Department. In India, the Income tax Act approves the charging of depreciation on the original cost of the asset.
5. In an inflationary economy it becomes very difficult to ascertain the true replacement cost of an asset. So, the practical application of this method also has certain difficulties.
Item # 23. Cost Office Expenses:
Expenses incurred in connection with Cost Office are treated as an item of administration overhead. Sometimes they are apportioned to factory, administration and selling divisions on the basis of estimated benefit obtained by each.
Item # 24. Profit Sharing Bonus:
In a profit sharing bonus scheme the bonus is paid out of profit and so this should be excluded in cost accounts. Since bonus is a part of wages, some accountants prefer to treat bonus as an overhead and is apportioned to different departments on the basis of wages of each department. When payment of bonus becomes obligatory it is to be apportioned to these functions.
Item # 25. After-Sales Service Costs:
After-sales service costs include salaries paid to staff engaged in after-sales service, rectification expenses during the warranty period. These costs are treated as product costs. In some cases, after-sales service costs are treated as part of selling overhead and pro-rated to different products on the basis of sales achieved.
Item # 26. Interest on Capital:
Whether interest on capital is to be treated as an element of cost is a controversial issue.