Overheads

Overheads: Apportionment and Absorption

07/09/09

Chandrakant@SOM,KIIT University

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Overhe admore names few •Overhead expenses •Overhead Cost •Overhead Charges •Overhead expenditure •On cost •Supplementary costs •Non-productive costs •Burden Costs •Loading Costs •Indirect Cost 07/09/09

Chandrakant@SOM,KIIT University

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OVERHEAD

SUM OF INDIRECT MATERIALS,INDIRECT WAGES AND INDIRECT EXPENSES

Cost of Indirect materials, indirect labour and such other Expenses including services which cannot be conveniently charged to specific unit

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Features of Overhead Expenses

•OHEs are indirect Costs •They are common Costs •They include both escapable and inescapable costs •They comprise of cash expenses (rent) and book expenses (Depreciation) •They include Both Production & non- production expenses (AOH &SDOH) •They both fixed and variable 07/09/09

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CONTOL OF OVERHEAD 1 CLASSIFICATION 2 CODIFICATION 3 COLLECTION 4 ALLOCATION & APPORTIONMENT TO COST CENTRES

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Behavio ur

Function al

Overhead Classificati on Element s

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Controllabil ity

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Collection of Overheads • • • • • •

Stores Requisition Wage Sheets Cash Book Purchase Orders and Invoices Journal Entries Other Registers and Records

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Departmentali zation 1 Process of dividing the factory into number of Segments Is called

P1

P2

P3

Prod Departments

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Chandrakant@SOM,KIIT University

S1

S1

Service Dept. 8

Departmentali zation

2 Process of allocating and apportioning POHEs to different departments or cost centers (Prod & ServiceFactory ) Overheads

P1

P2

P3

Prod Departments

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Chandrakant@SOM,KIIT University

S1

S1

Service Dept. 9

Departmentalizati on Factory Overheads Allocation & Apportionment

P1

P2

P3

Prod Departments

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Chandrakant@SOM,KIIT University

S1

S1

Service Dept. 10

Service Departments

Repair Department

Maintenance Department

Power House

Cante en

Purchas e

Fire Protection

Tool Room

Boiler House 07/09/09

Personnel Departme nt

Stores

TimeKeeping

Transport

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Distribution of Overhead ALLOCATION

APPORTIONMENT

Common Costs

Specific Costs

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Distribution of Overhead ALLOCATION

Specific Costs

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Allocating whole amount Of an item of POHs to the department for which The expenditure was incurred

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Distribution of Overhead APPORTIONMENT

Common costs are apportioned Amongst different departments or cost centers on some basis Common Costs

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Principal Basis of Apportionment Of Overheads

üFloor Area üCapital Value Of Assets üNumber Of Employees üMachine Hours üDirect Labour Hours üLight Points üKilowatt Hours üTechnical Analysis

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BASIS FOR APPORTIONMENT

Rent, Rates & Taxes, Lighting & Heating Insurance & depreciation of Building, Cost of repairs & maintenance of Building, Air Conditioning

Floor Area Occupied

Insurance & Depreciation on Plant & Machinery, maintenance of PM, Insurance on building, etc

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Capital Value

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BASIS FOR APPORTIONMENT

Welfare Expenses, time-Keeping ,pay-roll Office, Canteen, Recreation, Supervision

Repairs & Maintenance of Plant & Machinery

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No. Of Employee s

Machine Hours

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BASIS FOR APPORTIONMENT

Direct Labour Hrs

Light Points Or Kilowatt Hours

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Work’s Manager’s Remuneration, Salary of Supervisors etc

Electricity Charges

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BASIS FOR APPORTIONMENT

Technical Estimate

Horse Power

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Where not possible to apportion on some Bases Technical estimate is made

Motive Power Expenses

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BASIS FOR APPORTIONMENT

Value or Weight of Materials

Truck Mileage Tonnage Truck Hours No. Of

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Store Keeping Expenses

Transport Service Expenses

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PRINCIPLES OF APPORTIONMENT Service or Benefits received By the department

Utility or Service Principle What the Traffic can bear Basis of Sales or Profit

Ability To Pay 07/09/09

When Difficult to select Basis Production Manager’s Salary (Time spent in Each Dept)

Survey Method Out put as the basis

Higher Production Low Overhead Rate Low Production High OH Rate

Efficiency Principle Chandrakant@SOM,KIIT University

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üQuick Check

Identify the Basis for following Overheads

Rent Plant Repairs Power Depreciation of Building Building Repairs Insurance Of Building Fire Insurance of Stock Lighting Expenses Supervision Power ESI Employer’s Cont. to PF Amenities To Staff

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üFloor Area üValue of Plant üMachine Hours/HP/VM üValue Of Building üValue Of Building üFloor Area üValue Of Stock üNo. Of Light Points üNo. Of Employees üKilowatt/Value of Plant üDirect Wages üDirect Wages üNo. Of Employees/Wages

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Secondary Distribution Of • Service dept. costs are to be apportioned to the production depts. or the cost centers where production is going on. • This process of apportionment of overhead is called as ‘Secondary Distribution’.

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The Need for Cost Apportionment Service Departm ent (Cafeteri Service Departm ent (Account Service Departm ent 07/09/09 (Personn

First Stage Apportionment Service department costs are apportioned to operating departments.

Operatin g Departm ent Operatin g Departm ent Chandrakant@SOM,KIIT University

The Produ cts

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The Need for Cost Apportionment Service Departm ent (Cafeteri Service Departm ent (Account Service Departm ent 07/09/09 (Personn

Second Stage Apportionment Operating department overhead costs and apportioned service department costs are applied to products.

Operating Departme nt (Machinin Operating Departme nt Chandrakant@SOM,KIIT University

The Produ cts

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Methods of Reapportionment Problem Re- Apportioning costs of service departments to different production departments Solutions Direct Method Step method Reciprocal method 07/09/09

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Direct Method Interaction s between service departmen ts are ignored and all costs are allocated directly to

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Service Departm ent (Cafeteri

Operatin g Departm ent

Service Departm ent (Custodi

Operatin g Departm ent

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Step Method Custodial will have a new total to Apportion to operating departments ; its own costs plus those costs

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Service Departme nt (Cafeteria

Operatin g Departm ent

Service Departme nt (Custodial

Operatin g Departm ent

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Reciprocal Services Method Interdepartm ental services are given full recognition rather than

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Service Departm ent (Cafeteri

Operatin g Departm ent

Service Departm ent (Custodi

Operatin g Departm ent

Because of its mathematical complexity, the reciprocal method is rarely

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Reciprocal Services Methods

Trial & Error Method Repeated Distribution Method Algebraic Simultaneous Equation Method 07/09/09

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Trial & Error Method

Reciprocal Services Methods

üCost Of one Service Dept (Say A ) is apportioned To another Service Dept (Say B) based on service rendered üThe cost of another dept (B) plus its share In the cost of first service department (A) Is again apportioned to first service department üThe amount so apportioned to A will again be apportioned to the service department B

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üThe process continues till amount becomes negligible Chandrakant@SOM,KIIT University

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Reciprocal Services Methods

Repeated Distribution Method

1 Distribute the cost of a service Dept . to the Production and service department Using the percentage 2 Apportion the cost of 2nd service department (Aggregate) to production and other service department as per % given 3 Use the same procedure with other service 07/09/09 Chandrakant@SOM,KIIT University departments

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Reciprocal Services Methods Algebraic Simultaneou s Equation Method

•Total Costs of Service Departments are Expressed in algebraic equation •Equations are developed on the basis of Primary distribution & % of service rendered to each other •Total Costs of Service

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Overhead Absorption •It is a systematic process of distributing the OH, (allocated, apportioned and reapportioned) to production department) among the units produced by them (by production department)

OVERHEAD ABSORPTION RATE

Multiple/plant wise Absorption Rate

Each Unit/Division Has Separate Rate

Methods Of Overhead Absorption

Production Unit Method Method

% Methods % Direct Materials % Direct Wages

Hourly Rate Methods

DL Hour Rate Machine Hour

Methods Of Overhead Absorption

Production Unit Method Method

OHAR=POHEs for the

period No. Of Units Of

üSuitable when only one product is produced or üSimilar type of products are produced

Methods Of Overhead Absorption

% Methods % Direct Materials

For the OHAR=POHEs Period Cost of Direct Materials

Where materials Cost is a major Component

Methods Of Overhead Absorption

% Methods % Direct Wages

For the OHAR=POHEs Period Direct Wages

üPopular in Labour intensive industry üNot suitable where labour paid according to piece rate

Methods Of Overhead Absorption

% Methods % Prime Cost

For the OHAR=POHEs Period Prime Cost

üEnsures Advantages of previous two methods üSuffers from their limitations too

Methods Of Overhead Absorption

Hourly Rates Machine Hour Rate

OHAR=

POHEs for the period No. Of Machine Hours

üMost Popular Method üCan be fixed for a Machine or Group Of Machines

Computing Machine Hour Rate Machine Running Expenses Or Variable Expenses

Standing Expenses Or Fixed Expenses

Cost Of Cost of Power Steam Oil Repairs Maintenance Depreciation

Rent & Rates Lighting & Heating Supervision Insurance Cotton Waste Indirect Labour Consumable Stores Lubricants

Over / Under Absorption • The amount of overhead absorption in costs is the total amount of the overhead costs allotted to individual cost units by application of overhead rate. • If the amount absorbed is less than the amount incurred, the difference is known as under-absorption and vice versa. 07/09/09

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