Scribd
Upload
14 views52 pages

Overheads

The document provides an overview of overhead costs, defining them as expenses not directly traceable to a product or service, and categorizing them into production, administration, and selling/distribution. It discusses methods of overhead allocation, apportionment, and absorption costing, emphasizing the importance of accurately distributing these costs to determine the full cost of production. Additionally, it addresses the concepts of under and over absorption of overheads, along with factors influencing these discrepancies.

Uploaded by

alexvadar
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PDF, TXT or read online on Scribd
14 views52 pages

Overheads

The document provides an overview of overhead costs, defining them as expenses not directly traceable to a product or service, and categorizing them into production, administration, and selling/distribution. It discusses methods of overhead allocation, apportionment, and absorption costing, emphasizing the importance of accurately distributing these costs to determine the full cost of production. Additionally, it addresses the concepts of under and over absorption of overheads, along with factors influencing these discrepancies.

Uploaded by

alexvadar
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PDF, TXT or read online on Scribd
You are on page 1/ 52

Dr.

Anushka Verma
Email: [email protected]
Phone: +91 8700485037 (WhatsApp Only)
 Overhead is the cost incurred in the course of making a product, providing a
service or running a department, but which cannot be traced directly and in full to
the product, service or department.
 In other words, any expenditure over and above prime cost is known as overhead.
Overhead is actually the total of the following:
 Indirect material (e.g., Glue, Lubricants)
 Indirect labour (e.g., Supervisor’s Salary)
 Indirect expenses (e.g., Rent, Electricity, Water)
Overheads could be split into the following categories
 Production
 Administration
 Selling and distribution
 Absorption costing is a method for sharing overheads between different products
on a fair basis.
 The objective of absorption costing is to include in the total cost of a product an
appropriate share of organization’s total overhead
Aim – To find the full
cost of one unit
1. Allocation
 Allocation is the process by which whole cost items are charged direct to a cost
unit or a cost centre
2. Apportionment
 It is a process by which indirect costs are spread fairly between cost centers.

3. Absorption
 Overhead absorption is a process whereby costs allocated and apportioned to
production cost centers are added to unit, job or batch costs.
 Overhead absorption is sometimes called overhead recovery
Allocation is used when the cost can be clearly identified with a single department
or product. Apportionment divides a cost among multiple departments or products
based on a suitable criterion.

Allocation directly departmentalizes overheads, while apportionment requires a


basis for sub-division of cost.

Whether to allocate or apportion an expense depends its relation to the cost center
or unit, not its nature.
PRODUCTION DEPT SERVICE DEPT

Items Basis A B C D Total Cost


Indirect Material Allocation 950 1200 200 1500 3850
Indirect Wages Allocation 900 1100 300 1000 3300
Rent Area(Sq.ft.) 750 550 450 250 2000
Repairs Plant Value 480 360 240 120 1200
Depreciation Plant Value 360 270 180 90 900
Light Area(Sq.ft.) 75 55 45 25 200
Supervision No. of workers 1200 800 600 400 3000
Insurance Value of Stock 500 300 200 0 1000
Employee Insurance Wages 120 90 60 30 300
Power Plant Value 720 540 360 180 1800
Total 6055 5265 2635 3595 17550
 The reassignment or reapportionment of
REAPPORTIONMENT service departments overhead to
(SECONDARY producing departments or centres is
termed as secondary distribution.
DISTRIBUTION)
 Reapportionment is the process of redistributing the costs of service departments
(also known as support departments) to production departments or other service
departments.

 This is typically done after the initial allocation and apportionment of overhead
costs.

 This is due to the reason that service departments do not themselves manufacture
anything and it is the production departments or cost centres which are involved in
manufacturing activities.
To reapportion service cost centre overheads to Production cost centres there
are 3 methods
1. Algebraic or Simultaneous equation
Method
3. RECIPROCAL 2. Repeated/Continuous Distribution
Method
METHOD
Let X= total amount of overhead of department 1
Let Y= total overhead of department 2
X=234+0.2Y
Y= 300 + 0.10X

Two unknown in two equation, solving that


X= 300, Y = 330

Particulars Total (₹) A B C


Distribution Summary 5000 1800 1700 1500
Service Dept 1 (90% of ₹300) 270 60 120 90
Service Dept 2 (80% of ₹330) 264 132 66 66
ILLUSTRATION
(SIMULTANEOUS EQUATION
METHOD)
Particulars Total (₹) A B C
Distribution Summary 8250 3150 3700 1400

Service Dept P (90% of 2500) 2250 1000 750 500

Service Dept Q (80% of 1250) 1000 375 375 250

Total 11500 4525 4825 2150


STEPS FOR
OVERHEAD
DISTRIBUTION
 The final step is to charge these overheads to cost units. This is called absorption.
• ICMA (U.K.) define overhead absorption as the allotment of overhead to cost units.

• The term absorption implies that expenses pertaining to a producing department


or cost centre are, finally charged to or absorbed in the cost of products, jobs, etc.
passing through it.

• As a result of absorption, the cost of each unit of product of the producing


departments includes an equitable share of the total overhead of that department.
1. Direct Material Cost Method 4. Direct Labour Hour Method

2. Direct Labour Cost Method 5. Machine Hour Rate

No. of Machine hours

3. Prime Cost Method 6. Output Method


SOLUTION
Absorption of Absorption of Selling &
Administration Overheads Distribution Overheads
Percentage of works cost A rate per unit of sale
𝐴𝑑𝑚𝑛.𝑂𝑣𝑒𝑟ℎ𝑒𝑎𝑑
• Overhead rate= X100 Overhead rate=
𝑆 & 𝐷 𝑂𝐻𝑠
X100
𝑊𝑜𝑟𝑘𝑠 𝐶𝑜𝑠𝑡 𝑁𝑜 𝑜𝑓 𝑢𝑛𝑖𝑡𝑠 𝑠𝑜𝑙𝑑

Percentage of sales A percentage of Selling Price


𝐴𝑑𝑚𝑛 𝑂𝑣𝑒𝑟ℎ𝑒𝑎𝑑 𝑆 & 𝐷 𝑂𝐻𝑠
Overhead rate= X100 Overhead rate= X100
𝑆𝑎𝑙𝑒𝑠 𝑆𝑎𝑙𝑒𝑠

Percentage of conversion cost Percentage of conversion cost


𝐴𝑑𝑚𝑛 𝑂𝑣𝑒𝑟ℎ𝑒𝑎𝑑 𝑆&𝐷 𝑂𝐻𝑠
Overhead rate= X100 Overhead rate = X100
𝑇𝑜𝑡𝑎𝑙 𝐶𝑜𝑛𝑣𝑒𝑟𝑠𝑖𝑜𝑛 𝑐𝑜𝑠𝑡 𝑇𝑜𝑡𝑎𝑙 𝑊𝑜𝑟𝑘𝑠 𝐶𝑜𝑠𝑡

39
Overhead costs are fully recovered from production, if actual
rate method of absorption is adopted.

But if a predetermined rate is used, the actual expense may be


different from the charged or budgeted overhead expenses.

If the overheads absorbed are less than the overheads incurred,


it is under absorption of overheads.

On the other hand, if the amount of overhead absorbed is more


than the actual overheads incurred it is overabsorption of
overheads.
Over or Under Absorption = Actual Overhead Costs - Absorbed Overhead Costs

Factors responsible for under/over absorption of overheads:


• Error in estimating overhead expenses
• Unexpected changes in the methods of production affecting the amount of overhead
• Unanticipated changes in the production capacity
• Seasonal fluctuations in the overhead expenses from period to period
• Actual working hours may be more or less than the hours anticipated
Let’s assume a company estimates its overhead costs to be ₹500,000 for the year, and it plans to
produce 10,000 units. The overhead absorption rate would be:

Now, let’s say the company actually produced 9,500 units during the year. The absorbed overhead
cost would be:

If the actual overhead costs for the year turned out to be ₹460,000, the over or under absorption
would be calculated as:

Since the result is negative, it indicates under-absorption of ₹15,000.

You might also like