Assignment of overheads to cost units, that is each unit of products or service produced, is a complex issue. It is complex particularly for organisations, which produce variety of products using the same facility or has assets and other resources located in different geographical locations. By definition overheads cannot be tracked directly to cost units. Therefore, they are aggregated and averaged using some equitable basis and then assigned to cost units. Overheads, which are not attributable to current production activities, are not included in the product cost. Administrative and marketing overhead are not included in the product cost. Similarly costs, which can be assigned to cost units only arbitrarily, are also excluded from product cost. Managers choose the method for overheads accounting based on the degree of accuracy required in determining the product cost, which is used for decision-making. Such discretion is not available in determining product cost for use by regulators. Cost accounting standards are valuable to regulators and give them comfort only if they achieve the objective of bringing uniformity in cost accounting practices across entities operating in the same industry.
Accounting standards codify acceptable accounting practices. One of the objectives of accounting standards for the preparation and presentation of financial statements is to bring uniformity in accounting policy of different entities to ensure comparability. However, because entities operate in different business environments and use different business models, flexibility should be provided to entities in applying the accounting principles and methods. Therefore, principle-based accounting standards are preferred over rule-based accounting standards. However, accounting standards, which set out broad principles, are not useful because they fail to bring uniformity in accounting practices. Accounting standards explain principles in detail and provide implementation guidance. Consequently, accounting standards (IFRS), which are issued by IASB, are not purely principle-based accounting standards. They are some where between principle-based accounting standards and rule-based accounting standards.
The task of the Cost Accounting Standards Board (CASB) of the Institute of Cost and Works Accountants of India (ICWAI) is more challenging than the task of IASB. Entities operating in the same industry use different business models and organize their operations differently. A method of assigning overheads to cost units, which is appropriate for one entity, may not be appropriate for another entity. Therefore, it is a great challenge for the CASB to formulate the cost accounting principles and to ensure their implementation without prescribing rules for every situation. Conceptual issues identified by CASB reflect its predicament.
It appears that CASB wants to prescribe four-step conventional method for assigning overheads to cost units. The four step method involves allocation of overheads, which can be identified with specific cost centres to different cost centres; apportionment of overheads, which are common to different cost centres, to different cost centres; re-apportionment of overheads collected against support service cost centres to production cost centres, which are in the chain of the production process; and to assign overheads collected against production cost centres to cost units. This poses another challenge before the CASB. This method may not be appropriate for complex business models and organisations with complex organisation structure.
One of the conceptual issues identified by CASB is the allocation of corporate overheads to different functions. This issue has emerged as a complex issue in product costing because the functions of the corporate office are not restricted to general management and ‘providing future direction to the company’. Therefore, corporate overheads are not necessarily administrative overheads. A part of the total corporate office costs might include production overheads if, the corporate office supports production function. It is appropriate to include the same in the product cost. In a complex situation, it is difficult to assign production overheads incurred at the corporate office to cost centres. Therefore, the four-step model for assigning overheads to cost units is not appropriate. Perhaps activity based costing (ABC) method is the most appropriate method for accounting for corporate overheads.
The CASB should extensively deliberate whether it should prescribe contemporary methods, as an alternative, for overhead accounting. Another issue that should be debated is whether CASB should move towards rule-based cost accounting standards rather than principle based accounting standards to bring uniformity in the implementation of cost accounting principles and methods.
