Overheads Costing

Basics

Meaning • Overheads are the expenditure which cannot be conveniently traced to or

identified with any cost object under consideration
• Expenses on services that facilitate or make possible the carrying out of the
production process
• By themselves, these services are not of any use
Functional Factory/ • All expenditures from procurement of materials
Classification Manufacturing/ to completion of Finished Goods.
of Overheads Production Overhead • Example: repair / dep. of factory building, primary
packing, repair/ insurance of P&M, Indirect
Labour, Admin of factory etc.
Office and • Expenditures incurred on all activities relating to
Administrative General management and admin of organization.
Overheads • Example: salary to office staff, repair/ dep of
office building, postage, stationery, lease rental,
accounting and audit expense etc.
Selling and • Selling: expenses related to sales of products and
Distribution include all indirect expenses in sales management
Overheads for the organization.
Example: Salesman Commission, Advertisement
Cost, Sales office Expense etc.
• Distribution: Cost incurred for making product
available in the market.
Example: delivery van expenses, transit
insurance, warehouse, cold storage, secondary
packing etc.

Accounting of Factory Overheads

Flow of
Overheads
Distribution
Methods of Direct re- • Service department costs under this method are
Reapportionment distribution apportioned over the production departments only.
method • This method is applicable only when service
departments render services to production department
only and not the other Service Department
Non- • In this method, services rendered by one service to
Reciprocal other service department are also considered.
Method • The sequence here begins with the department that
renders maximum number of services to the other
service department(s)
• Also called as Step Ladder Method
Reciprocal • This method is applicable when service departments
Method render services to each other.
 Reciprocal Simultaneous • this is similar to solving linear equation in two
Methods Equation variables.
Method
Trial and • According to this method the cost of one service cost
Error centre is apportioned to another service cost centre.
Method • The cost of another service centre plus the share
received from the first cost centre is again
apportioned to the first cost centre.
• This process is repeated till the amount to be
apportioned becomes negligible.
Repeated • In this all overheads cost of service departments are
Distribution apportioned to production department in the agree
Method ratio.
• This process is continued till the balance of service
dept. cost gets exhausted.

Example

Suppose the expenses of two production departments A and B and two service departments X and Y are
as under:

Dept. Amount Apportionment Basis

X Y A B

Dept X 200000 NA 25% 40% 35%

Dept Y 150000 10% NA 40% 50%

Dept A 300000

Dept B 320000

PREPARE a statement apportioning the costs of service departments over the production departments
using all reciprocal methods.
Illustration 4 - Page 4.22
Exercise Que 3 - Page 4.63 | Step Ladder
Absorption of Factory Overheads

Methods

Machine Hour Direct Machine • When each machine or group of machines is

Rate Hour Rate: treated as a cost centre, overheads apportioned to
a production department are further apportioned
to machines or group of machines.
• These apportioned costs are divided by the
estimated productive machine hour of that
machine to get machine hour rate
• Formula -
Cost apportioned to machine
Estimated Productive machine hours of that machine

Comprehensive • When a single rate is used for entire dept/ cost

Machine Hour Rate centre
• here estimated overheads of department are
divided by entire machine hours of department
• Formula –
Estimated overheads of Department/ Cost Centre
Estimated Productive machine hours of department
Illustration 6 - Page 4.35
Exercise Que 5 - Page 4.65
Exercise Que 4 - Page 4.64
Types of Overheads Normal Rate/ Not useful as we require overhead recovery rates at
Rate Actual Rate the beginning of the period
Actual amount of overheads
Actual Base
Pre-determined The budgeting can be done in various ways like – use
Rate previous period data as base, use anticipated volume,
use fix as per normal business
Budgeted amount of overheads
Budgeted Base
Blanket No department wise split, only one rate for entire
Overhead Rate factory. Useful only when either only one department
or only one product is produced
Total Estimated overheads of the Factory
Total number of units of base for the factory
Departmental Used when there are multiple production
Overhead Rate departments
Estimated overheads of the Dept.
Corresponding base
Under / Over Overheads Recovered – Overheads Incurred
Recovery
 Treatment of Under/
Over Recovery

Supplementary Rate Under/ Overabsorbed OH to be charged to cost accounts

Units Produced

Exercise Que 11 - Page 4.68

Accounting of Other Overheads

Administrative Apportioning Admin • administrative overheads lose

Overheads Overheads between their identity and get merged
Production and Sales with production and selling and
Department distribution overheads.
• Difficult to find suitable base for
apportionment
• Not Suitable
Charging to Profit and Loss • Cost of products is understated as
Account administrative overheads are not
charged to costs.
• The exclusion of administrative
overheads from cost of products
is against sound accounting
principle
• Not suitable
Treating Administrative • This method considers
Overheads as a separate administration as a separate
addition to Cost of function like production and sales
Production/ Sales • This method is mostly used
Selling and Different Bases Sales Value, COGS, Gross Profit, etc.
Distribution Best Approach The best method for absorbing selling and distributing
Overheads expenses over various products is to separate fixed
expenses from variable expenses.
• Fixed Expenses: Apportion the fixed expenses
according to the benefit derived by each
product and thus ascertaining the fixed
expenses per unit.
 • Variable Expenses: These are expenses which
are variable per unit of sale so it can be directly
charged (similar to direct cost) Examples:
Packaging, freight outwards, insurance in
transit, commission to salesman, discount/
rebate to customers etc.
Concept of Capacity Installed/ • Maximum capacity of producing goods or
Rated providing services.
• This capacity is unachievable practically hence
called as theoretical capacity
Practical • This capacity takes into account loss of time due
to repairs, maintenance, minor breakdown, idle
time, set up time, normal delays, Sundays and
holidays, stock taking etc.
• Generally it is 80 to 90% of installed capacity.
Normal • Volume of production or services achieved or
achievable on an average over a period under
normal circumstances taking into account the
reduction in capacity resulting from planned
maintenance.
Actual • It is the capacity actually achieved during a
given period. It is presented as a percentage of
installed capacity.
Idle • It is that part of the capacity of a plant, machine
or equipment which cannot be effectively
utilized in production
Normal Idle • It is the difference between Installed capacity
Capacity and Normal capacity
Abnormal Idle • It is the difference between Normal capacity
Capacity and Actual capacity utilization where the actual
capacity is lower than the normal capacity

Illustration 9 - Page 4.45

Illustration 10 - Page 4.51