Indirect Cost

1. Definitions

• Direct Costs

  • Traceable to a specific product
  • Examples: wood, plywood, laminations

• Indirect Costs (Overhead)

  • Cannot be traced to a single product
  • Examples:
    • Supervisor’s salary
    • Factory rent
    • Equipment depreciation

2. Allocation Challenge

• Scenario: 10 different furniture products
• Key issue: How to allocate total overhead among 10 products

2.1 Possible Allocation Bases

1. Equal distribution
   • Simple but often inaccurate
2. Material cost
3. Labor cost
4. Machine‑hours
5. Other activity drivers

• Accuracy depends on:
  • Relative size of overhead vs. direct costs
  • Degree of automation (higher automation → higher overhead share)

3. Impact of Automation & Flexible Manufacturing

• Flexible Manufacturing Systems

  • Same machines produce multiple products simultaneously
  • Reduces capital investment
  • Increases shared (indirect) costs

• Industry Examples:

  • Hindustan Unilever
    • Raw material: ₹13,000 cr
    • Other expenses: ₹12,000 cr
  • Infosys (service industry)
    • Salary: ₹25,000 cr
    • Administrative & other: ₹9,000 cr

4. Implications for Costing Accuracy

• Large Overhead Pool → small errors in allocation can significantly distort product cost
• Selecting Allocation Base
  • Choose driver(s) closely related to how overhead is incurred
  • Consider multiple pools & drivers if needed