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OVERHEAD COST

Overhead costs are the operating costs of a business enterprise which can not
be traced directly to a particular unit of output.
ALLOCATION AND APPORTIONMENT OF OVERHEADS
iv)
Allocation and apportionment overheads among production & service
departments (primary distribution)
v)
Apportionment of service deptt among production deptt (secondary
distribution)
ALLOCATION
Allocation is the process of charging the full amount of overheads costs
to a particular cost centre. This is possible when the nature of expenses
is such that it can be easily identified with a particular cost centre.
APPORTIONMENT
It is the process of splitting up an item of overhead cost and charging it to
the cost centers on an equitable basis.

BASES FOR APPORTIONMENT


OVERHEAD COST

BASIS FOR APPORTIONMENT

1. Rent & other building expenses, Floor area, or volume of


Fire precaution services, Air
department
conditioning
2. Fringe benefits, Labour welfare
exp, Time keeping, Supervision

Number of workers

3. ESI and PF contribution, Fringe


benefits

Direct wages

4. Depreciation, repairs, insurance


of machinery

Capital values

5. General overhead

Direct labour hours or direct


wages, or machine hours

BASIS FOR APPORTIONMENT


OVERHEAD COST

BASIS FOR APPORTIONMENT

6. Electric power

Horse power of machines or


machine hours or both

7. Lighting expenses

No of light points or area

Primary distribution
A co. Ltd has three production deptt A, B and C and two service deptt
D and E. the following figures are extracted from the records of the
company
Rent & rates
Indirect wages
Depreciation of
Machinery

5,000
1,500
10,000

General lighting
Power
Sundry expenses

The following details are further available:

600
1,500
10,000

Total

Floor space (sq


ft)

20,000

4,000

5,000

6,000

4,000

1,000

Light points

120

20

30

40

20

10

Direct wages
(RS)

10,000

3,000

2,000

3,000

1,500

500

H.P of
machines

150

60

30

50

10

Value of
machinery

2,50,000

60,000

80,000

1,00,000

5,000

5,000

Apportion the cost to various deptt on most equitable basis and [prepare
overhead distribution summary.

RE-APPORTIONMENT OF SERVICE DEPARTMENT COSTS


(Secondary Distribution)
Apportionment of Service Department Overheads

Apportionment to
production deptt only

Apportionment of production &


other service deptt

Non reciprocal

Simultaneous
equations methods

Repeated distribution
method

Reciprocal

Trial & error method

BASIS FOR RE-APPORTIONMENT OF SERVICE DEPARTMENT COSTS


OVER DIFFERENT PRODUCTION DEPTT (Secondary Distribution)

Service deptt cost

Basis for apportionment

Maintenance deptt

Actual service utilised or hours


worked for each deptt

Payroll/Time keeping deptt

Direct labour hours, Machine


hours, Number of employees

Personnel deptt

Number of employees, rate of


labour turnover

Store keeping deptt

No of requisition, Qty or value of


materials

Purchase deptt

No of purchase orders, value of


materials purchased

Welfare deptt

No of employees

Internal transport service

Value or weight of goods


transported or distance covered

(A) Apportionment to production department only


Question.
(B) Apportionment to production as well as service deptt.
v)

Non reciprocal basis


Question
vii) Reciprocal Basis
Question

ABSORPTION OF OVERHEADS
Absorption of factory overheads refers to charging of the factory
overheads of a particular production deptt to various product
manufactured, or jobs completed or orders expected in that
department. It is basically charging of overheads to cost units.
Two steps:
v)
vii)

Computation of overhead rate :


Total overheads of cost centre/total units in base
Application of these rates to cost units:
overhead absorbed = No. of unit of base in cost unit X Overhead rate

METHOD OF ABSORPTION OF FACTORY OVERHEADS


1)
3)
3)
7)
9)

Direct material cost percentage method:


Production overhead/Direct materials *100
Direct labour cost percentage method:
Production overhead/Direct labour cost *100
Prime cost percentage method:
Production overhead/Prime Cost*100
Direct labour hour method:
Production overhead/Direct labour hour
Machine hour method:
Production overhead/No of machine hour

Q. The following are the details of costs incurred in respect of


production deptt of factory:
Direct Materials
2,000
Direct labour
3,000
Direct expenses
-----

Rs.4,000

4,000

Rs.2,000

3,000

Rs.1,000

1,000

The share of the factory overheads of the deptt comes to Rs.5,000


which is to be apportioned to different jobs on the basis of direct
material used. Find out the share of factory overheads and the cost
of each job.

Basis of apportionment of different overheads to machines


EXPENSES

BASIS

STANDING CHARGES
1. Rent & Rates

Floor area occupied by each


machine

2. Heating & Lighting

No. of light points for each


machine, or floor area occupied by
each machine

3. Supervision

Estimated time devoted by the


supervisor on each machine

4. Insurance

Insured value of each machine

5. Lubricating oil and other


consumable stores

Capital values/machine hours

6. Miscellaneous expenses

Equitable basis depending upon


the facts

Basis of apportionment of different overheads to machines


EXPENSES

BASIS

RUNNING/MACHINE CHARGES

1.

Depreciation

Machine hours or capital value or


multiple of both

1.

Power

Horse power of machines or


machine hours or both

1.

Repairs

Machine hours or capital values

Question on machine hour rate


Q.1 The following information compute a machine hour rate in

respect of machine No. 10 for the month of January:

Cost of the machine Rs.32,000


Estimated scrap value Rs.2,000
Effective working life 10,000 hours
Repair & maintenance over the life period of the machine Rs.2,500
Standing charges allocated to this machine for January Rs.400
Power consumed by the machine @ Rs.0.30 per unit, Rs.600
The machine consumes 10 units of power per hour.

The original cost of the machine used (purchased in June 2004)


was Rs. 10,000. Its estimated life is 10 years. The estimated scrap
value at the end of its life is Rs. 1,000 and the estimated working
timer per year (50 weeks of 44 hours) is 2,200 hours, of which
machine maintenance, etc. is estimated to take up 200 hours.
Setting up time of 100 hours is estimated.
Electricity used by the machine during production is 16 units per
hour at a cost of 20 paise per unit. No current is taken during
maintenance or setting up.
The machine requires a chemical solution which is replaced at
the end of each week at a cost of Rs. 20 each time.
The estimated cost of maintenance per year is Rs. 1,200.
Two attendances control the operation of the machine together
with five other identical machines. Their combined weekly
wages, insurance, and the employers contributions to holidays
pay amount to Rs. 120.
Departmental and general works overheads allocated to this
machine for the year 2003-04 amount to Rs. 2,000.
Calculate machine hour rate when
Setting up time is unproductive.
Setting up time is productive

TYPES OF OVERHEAD RATES


Actual and Pre-determined Rates
Actual Rate It is calculated by dividing the actual
overheads by actual base thus:

Actual amount of overheads


Actual overhead rate = ---------------------------------
Actual base
Limitations are:
Actual rate cannot be computed until the end of the
accounting period. This result in delay in computing cost.
When costs are used to calculate the selling prices for
quotations and tenders hare is bound to be a considerable
delay before the sales department can invoice customers
due to delay in information from costing department.

Pre-determined Rate
This rate is determined in
advance of the period in which it is to be used. It is
computed by dividing the estimated or budgeted amount
of overheads by the budgeted base.

Budgeted amount of overhead


Thus Pre-determined rate = -----------------------------------
Budgeted base
As compared to actual rate, a pre-determined rate is of
greater utility. This is because a pre-determine rate
enables prompt preparation of tenders and quotations and
fixation of selling prices. Cost control is also facilitated by
comparing the actual overheads with the pre-determined
overhead recovered.

Blanket and Multiple Rates


A blanket overhead rate is a single, overhead rate for the
entire factory. It is computed as follows:

Total overheads for the factory


Blanket rate =------------------------------------------
Total number of units of base for the factory
Blanket overhead rate should not be used except when
output is uniform. Otherwise it will result in overcastting
or undercosting of certain cost units.

Blanket rate is also know as Plant-wide or Plant wise rate.


Production department
Service department
Cost centre
Product
Fixed overhead and variable overhead

Overhead of department or cost centre


Overhead rate = -----------------------------------------------
Corresponding base
Blanket rates have a very limited application and can be usefully
employed in (i) small firms, or (ii)when one single product is
produced, or (iii) when a firm is producing more than one product and
all of these products pass through all the departments and the
incidence of overhead is uniform.
QUESTION

UNDER & OVER ABSORPTION OF OVERHEADS


Under-absorption
When the amount of overheads
absorbed it is called under-absorption or under-recovery
the cost because the overheads incurred jobs, processes
etc.
When the amount of overhead absorbed is more than it
is know as over absorption or over-recovery the cost of
jobs, processes, etc.

Example
Pre-determined overhead rate
Actual machine hours
Actual overheads
Overhead absorbed
Under-absorption

= Rs. 5 per machine hour


= 1,500
= Rs. 9,000
= 1,500 hrs. x Rs. 5 = Rs. 7,500
= Rs. 9,000-Rs. 7500 = Rs. 1,500

If the actual machine hours worked were 1,900, then:


Overhead absorbed
Overhead over-absorbed

= 1,900 hrs. x Rs. 5= Rs. 9,500


= Rs. 9,500 Rs. 9,000 = Rs. 500

Accounting Treatment of Under- and Over-absorption


3. USE OF SUPPLEMENTARY RATES: Where the amount of
under or over-absorbed overhead is significant, a
supplementary overhead absorption rate is calculated to
adjust this amount in the cost. However, adjustment is made
in the cost of (i) work-in-progress; (ii) finished stock, and (iii)
cost of sales. In the case of under-absorption, the overhead is
adjust by a plus rate since the amount is to be added, whereas
over-absorption is adjusted by a minus rate since the amount
is to be deducted.
Supplementary rate = unabsorbed overhead/total cost

Accounting Treatment of Under- and Over-absorption


Example:
A company absorbs overheads on pre-determine rates. For the
year ending 31st, Dec., 2004, factory overheads absorbed were
Rs. 3,66,250. Actual amount of overheads incurred totaled
Rs. 4,26,890. The following figures are also derived from the
trial balance.
Finished stock
Rs. 2,30,732
Cost of goods sold
Rs. 8,40,588
Work-in-progress
Rs. 1,41,480
How would you dispose of under/over-absorbed overhead
by use of supplementary rate method.

Writing off to Costing Profit and Loss Account. This


method is used when the under or over-absorbed
amount is quite negligible and it is not worthwhile to
absorb it by supplementary rate.
Carry over-to the next year. Under this method the
under or over-absorbed amount is transferred to
Overhead Reserve Account or Suspense Account for
carry over to the next accounting year.

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