Direct Expenses | CMA Inter Syllabus

Direct Expenses

Definitions and Examples

All expenditures other than those incurred for procurement of material and labour are termed as ‘expenses’. Expenses can be classified direct expense or indirect expense. This classification is based on whether the expense is traceable to cost centre or cost unit. Expenses or costs which can be allocated to a cost centre or cost unit are referred as direct expense. Cost Accounting Standard (CAS) 10 issued by issued by the Council of the Institute of Cost Accountants of India deliberates various provisions for treatment of direct expenses in cost accounting. Indirect expenses, on the other, are those that are not traceable to the cost centre or cost unit. These are to be apportioned to a cost centre or cost unit.

Paragraph 4.4 of CAS 10 defines direct expenses as expenses relating to manufacture of a product or rendering a service, which can be identified or linked with the cost object other than direct material cost and direct employee cost.

Paragraph 5.1 of CAS 10 states that identification of Direct Expenses shall be based on traceability in an economically feasible manner.

Examples of direct expenses are royalties charged on production, job charges, hire charges for use of specific equipment for a specific job, cost of special designs or drawing for a job, software services specifically required for a job, travelling expenses for a specific job.

Nature of Direct Expenses or Chargeable Expenses

A direct expense in relation to a product forms part of the prime cost. Indirect expenses are treated as overheads. In relation to products, direct material is a material that becomes a part of it and can be physically traced in some form in the finished products, whereas the direct expenses are cost providing services or other kinds of special charges, but no trace of them can be obtained in the finished product like raw material. Both the direct material and direct expenses forms part of the prime cost.

Principles of Measurement as per CAS – 10 (Para 5)

1. Direct expenses incurred for the use of bought out resources shall be determined at invoice or agreed price including duties and taxes, and other expenditure directly attributable thereto net of trade discounts, rebates, taxes and duties refundable or to be credited.
2. In the case of research and development cost, the amount traceable to the cost object for development and improvement of the process for the existing product shall be included in direct expenses.
3. Direct expenses paid or incurred in lump-sum or which are in the nature of ‘one – time’ payment, shall be amortized on the basis of the estimated output or benefit to be derived from such direct expenses.
4. Examples: royalty or technical know-how fees, or drawing designing fees, are paid for which the benefit is ensured in the future period. In such case, the production / service volumes shall be estimated for the effective period and based on volume achieved during the cost accounting period, the charge for amortization be determined.
5. If an item of direct expenses does not meet the test of materiality, it can be treated as part of overheads.
6. Finance costs incurred in connection with the self - generated or procured resources shall not form part of direct expenses.
7. Direct expenses shall not include imputed costs. In case of goods produced for captive consumption, treatment of imputed cost shall be in accordance with CAS – 4.
8. Where direct expenses are accounted at standard cost, variances due to normal reasons shall be treated as part of the direct expenses. Variances due to abnormal reasons shall not form part of the direct expenses.
9. Any subsidy / grant / incentive or any such payment received / receivable with respect to any direct expenses shall be reduced for ascertainment of the cost of the cost object to which such amounts are related.
10. Any abnormal portion of the direct expenses where it is material and quantifiable shall not form part of the direct expenses.
11. Penalties, damages paid to statutory authorities or other third parties shall not form part of the direct expenses.
12. Credit / recoveries relating to the direct expenses, material and quantifiable, shall be deducted to arrive at the net direct expenses.
13. Any change in the cost accounting principles applied for the measurement of the direct expenses should be made only if, it is required by law or for compliance with the requirements of a cost accounting standard, or a change would result in a more appropriate preparation or presentation of cost statements of an organisation.

Disclosures

Paragraph 8 of CAS -10 states that disclosures shall be made only where material, significant and quantifiable and such disclosures shall be made in the body of the cost statement or as a foot note or as a separate schedule. The following points are stated as important aspects of the disclosure of direct expenses in cost statements.

1. The basis of distribution of Direct Expenses to the cost objects/ cost units.
2. Quantity and rates of items of Direct Expenses, as applicable.
3. Where Direct Expenses are accounted at standard cost, the price and usage variances.
4. Direct expenses representing procurement of resources and expenses incurred in connection with resources generated.
5. Direct Expenses paid/ payable to related parties (Related party as per the applicable legal requirements relating to the cost statement as on the date of the statement).
6. Direct Expenses incurred in foreign exchange.
7. Any Subsidy/Grant/Incentive and any such payment reduced from Direct Expenses.
8. Credits/recoveries relating to the Direct Expenses.
9. Any abnormal portion of the Direct Expenses.
10. Penalties and damages excluded from the Direct Expenses

Direct vs. Indirect Expense

Illustration 46

Royalty paid on sales ₹30,000; Royalty paid on units produced ₹20,000, hire charges of equipment used for production ₹2,000, Design charges ₹15,000, Software development charges related to production ₹22,000. Compute the Direct Expenses.

Solution:

Computation of Direct Expenses

Note:

(i) Expenses are related to either manufacturing of the product or rendering of service

(ii) These costs are directly identifiable and can be linked with the cost object and are not related to direct material cost or direct employee cost. Hence, these are considered as Direct Expenses.

Illustration 47

A manufacturing unit produces two products X and Y. The following information is furnished:

Royalty paid on sales ₹54,000 [@ ₹2 per unit sold, for both the products]; Royalty paid on units produced ₹35,000 [@ ₹1 per unit purchased, for both the products], Hire charges of equipment used in manufacturing process of Product X only ₹5,000. Compute the Direct Expenses for product X and Y

Solution:

Computation of Direct Expenses

Note:

(i) Royalty on production and royalty on sales are allocated on the basis of units produced and units sold respectively. These are directly identifiable and traceable to the number of units produced and units sold. Hence, this is not an apportionment.

(ii) No adjustments are made related to units held, i.e. closing stock.