Overheads

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

A

B

C

D

E

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 employer’s 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.