Direct Costing

[awaisaftab]

Under the method of absorption costing the fixed overhead cost becomes the part of profit. There are some other costing methods which are also used by the cost accountant. But absorption costing method is allowed for the purpose of determining the tax liability of a business in many countries . Other methods of costing are Direct Costing and Activity Based Costing (ABC). ABC is very rarely used but direct costing is used many countries for effective costing but the profit is adjusted as per absorption method.

In Pakistan CO,1984 is sielent about the method of costing. However legal provisions are available in ITO,2001 about costing method.
Under section 32 of ITO,2001 the companies are restricted to use only accrual basis of accounting and under sub section 5 of section 35 of the ordinance the persons (Here person means as defined in the ordinance) using accrual basis of accounting shall use the Absorption costing method for costing stock in trade.


Regards,

Awais Aftab

[danishayub_76]

Dear Awais.

Though The companies Ordinance 1984 is silent about the method of Costing to be used either direct or Absorption Method. But i need to learn about whether International Accounting STandards/IFRS give any guidlines in this regard?

Best wishes

[Star]

Awais,

There is no mention in the Companies Ordinance about costing methods. IASs are notified under companies ordinance Section 234.

IAS - 2 "Inventories" guides about the adoption of costing method. Please read the paragraphs of conversion cost in IAS-2.

Some understanding of the paragraphs about conversion cost is given below;

Entities engaged in manufacturing goods must assign costs to inventory. The costs of inventories should include all costs of purchase, costs of conversion and other costs incurred in bringing the inventories to their present location and condition. IFRS do not permit direct costing methods, where all overheads are expensed. Such costs are allocated to inventory, regardless of their classification by the entity.

Regards,

*

[awaisaftab]

Dear Danish


Unfortunately ISA do not permit direct costing methods, where all overheads are expensed but Local Standards of some countries allow the use direct costing for financial reporting only but I think no country allow direct costing for assessing income of business.
Extracts from ISA-2 are following

The allocation of fixed production overheads to the costs of conversion is based on the normal capacity of the production facilities. Normal capacity is the production expected to be achieved on average over a number of periods or seasons under normal circumstances, taking into account the loss of capacity resulting from planned maintenance. The actual level of production may be used if it approximates normal capacity. The amount of fixed overhead allocated to each unit of production is not increased as a consequence of low production or idle plant. Unallocated overheads are recognised as an expense in the period in which they are incurred. In periods of abnormally high production, the amount of fixed overhead allocated to each unit of production is decreased so that inventories are not measured above cost. Variable production overheads are allocated to each unit of production on the basis of the actual use of the production facilities.


Regards,

Awais

[shahid amin]

Direct Costing
A costing method that includes only variable manufacturing costs-direct materials, direct labor, and variable overhead- in the cost of a unit or product. It is also called Marginal Costing and Variable costing.

Moreover........
Method in which the cost of a product or operation is determined by allocating to it an appropriate portion of the variable (direct) costs. Direct costing treats fixed costs (overheads such as administrative and selling costs) as period costs (associated with time and not output). Also called contribution costing or variable costing. See also absorption costing and marginal costing.
Absorption Costing
A costing method that includes all manufacturing costs- direct materials, direct labor, and both variable and fixed manufacturing overhead- in the cost of a unit of product. Absorption costing is also referred to as the full cost method.

[tariq aziz]

good shahid i was confused about direct costing....

[shahid amin]

<blockquote id="quote"><font size="1" face="Verdana, Arial, Helvetica, san" id="quote">quote<hr height="1" noshade id="quote"><i>Originally posted by tariq aziz</i>
<br />good shahid i was confused about direct costing....
<hr height="1" noshade id="quote"></font id="quote"></blockquote id="quote">
Thanks Tariq!
you can also share your knowledge about accounting.