1112010_12557_F036_=_Overhead_Session_-_5-6

8/3/2019 1112010_12557_F036_=_Overhead_Session_-_5-6

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Dr. P.H.Rao, IMIS 1

Overhead

All indirect costs are collectively termedas 'overheads' and they constitute animportant component of total cost of aproduct, a job or a process.

A cost is composed of three elements -(a) material, (b) labour, and (c) expenses.

Each of these costs can be furtherclassified as (1) direct and (2) indirect.


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Dr. P.H.Rao, IMIS 2

The National Association of Accountants (USA)

defines overheads (overhead costs) as follows :

Fundamental concept : Costthathave to beincurred althoughthey have no directly measurable,observable relationship to specific activity units,

production or cost objectives. Applicationdefinition : While relatedto the

accomplishment ofthe firm's objectives, overheadcost are costs which cannot, as a practical matter,be assignedto those objectives in a direct fashion.

A consistent method of cost allocation, which bysome measure approximates the economicsacrifices incurred, must be adopted.


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Dr. P.H.Rao, IMIS 3

Classification OF Overheads

Element-wise Classification1. Indirect materials

2. Indirect labour

3. Indirect expenses

Function-wise Classification1. Production overheads

2. Administration overheads

3. Selling overheads

4. Distribution overheads

Behavior-wise Classification1. Fixed overheads

2. Variable overheads

3. Semi-variable overheads


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Dr. P.H.Rao, IMIS 4

Steps in Overhead Distribution

Collection of overheads

Allocation and apportionmentto production

and service departments

Re-apportionment of service department

costs

Absorption of overheads


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Dr. P.H.Rao, IMIS 5

ALLOCATION AND APPORTIONMENT OF

FACTORY OVERHEADS

Allocation is "the allotment of whole items of

costto cost centers or costunits".

For example, if canteen is treated as a

separate cost centre, salary paidto canteen

manager can be allocatedto canteen.

If indirect wages and salaries are paidto the

employees in eachdepartment, they can bewholly attributedto the concerned

departments and charged accordingly.


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Dr. P.H.Rao, IMIS 6

Overhead Can Be Allocated To A Cost Centre If the

Following Two Conditions Are Satisfied :

The overhead musthave been incurred

because ofthe existence ofthat particular

cost centre.

The exact amount of overhead incurred in a

cost centre must be known.


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Dr. P.H.Rao, IMIS 7

Apportionment

Apportionment refers to the distribution of common

items of costto two or more cost centers on some

appropriate basis.

Whenthe costs which are incurred forthe factory asa whole and benefittwo or more cost centers, then it

is necessary to apportionthem to different

departments that receive benefit from such costs.

For example, factory rent benefits all the

departments. Hence, it should be apportioned lo all

the departments onthe basis ofthe floor area

occupied by eachdepartment inthe factory.


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Dr. P.H.Rao, IMIS 8

The common factory overheads have to beapportioned various production and servicedepartments inthe factory on some equitable basis.

A productiondepartment is one that engages inthe

actual manufacture ofthe product. Examples of productiondepartments are weaving,

spinning, crushing, mining, grinding, etc,

A service department is one which renders a servicethat contributes indirectly inthe manufacture of a

product. It renders service to the production as wellas other service departments.

Examples of service departments are purchasing,stores, time keeping, personnel inspection, etc.


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Dr. P.H.Rao, IMIS 9

Basis of Apportionment


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Dr. P.H.Rao, IMIS 10

Apportionment of Services Centre Costs

Direct Method

Step-Down Method

Repeated Distribution Method

Simultaneous Equation Method


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ABSORPTION OF FACTORY OVERHEADS

Once the total overhead cost of various

productiondepartments is ascertained by

means of allocation, apportionment and re-

apportionment, these costs should bechargedto the costunits i.e. the products that

pass throughthese production cost centers.

As the ultimate objective is to find outthe cost

of production it is necessary to distribute the

overhead costs of production

departments/costs centers to the costunits.


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Basis of Absorption of overhead

Production Unit Method

Direct Material Method

Direct Wages Method

( Production overhead by Direct Labour Cost) multipliedby 100

Prime Cost Method

(ProductionOverhead by Prime Cost) multiplied by 100

Direct Labour Hour Method

Machine hour method


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OVER-ABSORPTION AND UNDER-ABSORPTION

OF FACTORY OVERHEADS

Overhead absorption rate may be actual rate

or pre-determined rate. Actual rate is arrived

at by dividingthe actual overheads by the

actual output or actual laborhours or actualmachine hours forthe period.

Butthe actual rate cannot be computedtill the

end ofthe accounting period resulting in

delay in computingthe cost of a product. This

causes a problem in fixingthe selling price for

quotations andtenders,


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Hence, pre-determined overhead absorption

rates are calculated by dividingthe estimated

amount of overheads by the estimated

productionunits or laborhour or machinehours.

When pre-determined rates are used, the

overheads absorbed may be more than or

less thanthe actual overheads. This will

result in over-absorption orunder-absorption

of overheads.


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In other words, ifthe absorbed amount of

overheads by the costunits is less thanthe

actual amount of overheads, it is a case, of

under-absorption, and Ifthe absorbed amount of overheads by the

costunits is more thanthe actual amount of

overheads, then it is a case of over-

absorption of overheads.


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Causes of under or Over absorption

Error in estimating overhead cost

Error in estimatingthe base i.e. quantity ofoutput or labourhour or machine hours

Unexpected changes in production capacity Unexpected changes inthe method of

production resulting in change inthe amountof overheads

Seasonal fluctuations inthe amount ofoverheads from periodto period in certainindustries


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Treatment of Special Items

Interest on Capital


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Treatment of Special Items

Interest on Capital

Depreciation

1112010_12557_F036_=_Overhead_Session_-_5-6

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