What is Accounting for overhead?What is overhead accounting?
Concept of overhead
The total costs can be divided into two types. They are direct and indirect cost. The costs that changes with the change in output proportionately and can be identified with the products
Total cost = prime cost + overheads
The prime cost is an aggregate of direct materials cost, direct wages and direct expenses. All indirect costs from part of overhead, which is an aggregate of indirect material cost, indirect wages and indirect expenses.
Overhead cannot be easily identified to a unit cost or a production cost or department cost. In this way, the indirect portions of the cost constitute the overhead cost. The term 'indirect' denotes that which cannot be allocated but which can be apportioned to cost centers or absorbed by cost units. The overheads are incurred not for any particular job, process or unit but for the business as a whole. Overhead costs are also denoted by work on cost, burden cost. Of all the terms 'overhead' is the most common, no one can develop any goods and services in shoe services in the absence of overhead whether any job or produce or department does not directly absorb it.
For example, threat, glue and nails used in binding books are indirect material, salary and wages of foreman and supervisor are indirect labour, and rent and insurance of factory building are indirect expenses. The following are some of the definitions of overhead.
The national association of accountants, USA. "Cost that have to be incurred although they have no directly measurable, observable relationship to specific activities, production or cost objectives."
Block and whelmer "overhead costs are the operating cost of a business enterprise which cannot be traced directly to a per unit of output."
The above definitions clearly indicate that the indirect expenses that cannot be directly identified to a product are called the overhead.
Classification of overhead / What is overhead accounting?
Classification of overhead is the process of grouping the overhead according to some common characteristics. Under the classification of overhead, the overhead costs are collected at first. In the second stage, the overhead costs having the common characteristics are kept in a group. In third stage, the overhead costs are distributed to different cost center through the most equitable basis. In the last stage, the total overhead costs are turned as per unit cost. For simplicity, overhead can be grouping or classifying on the basis of (a) element (b) function (c) control as given below:
On the basis of element
Based on its elements, overhead may be classified into three different categories namely indirect material, indirect labour and indirect expenses as mentioned below:
a. Indirect material
Those materials, which plays supplementary role in production and cannot be allocated to a particular unit of product nor from a part of finished product are called indirect material. These materials may not be variable in finished product. Indirect material cost is common to several units of production. Thus, material cost which cannot be allocated but which are to be apportioned to cost centers or absorbed by cost units, are known as indirect materials cost. Lubrication oil, consumable stores, cotton waste, tools used for repair and maintenance are some of the example of indirect material cost.
Notes: some material may be direct material for some product where as indirect for another product. Similarly, sometimes indirect material cost includes direct materials cost, which is so small or complex that direct tracing to specific units is inexpedient, for example, glue, thread and chalks etc.
b. Indirect labour or wages
The wages paid to the laborers which cannot be allocated to a particular unit of product is known as indirect labour. Indirect labour cost is common to several units. In other words, it refers to the labour cost or wages cannot be allocated but which are to be apportioned to cost centers or absorbed by cost units. Examples of indirect labour are salary of foreman, salary of supervisor, salary of works manager, salary of store-keeper, wages for maintenance workers, idle time wages, fringe benefits, leave pay etc.
c. Indirect expenses
Except indirect material and indirect labour, there are some other expenses, which do not come under these heading are indirect are indirect expenses. Only indirect materials and indirect labour are not sufficient to produce and sell the product. Indirect expenses refer to expenses, other than indirect material and indirect labour, which cannot be allocated but which can be apportioned to or absorbed by cost centers or cost units. Examples of indirect expenses are rent, rate and taxes, lighting and heating, training expenses, insurance, depreciation, repairs and maintenance etc.
On the basis of function
On the basis of functions, the overheads are classified into four types as mentioned below:
a. Factory or production or manufacturing overheads
The total indirect costs incurred for manufacturing department i.e. within factory are manufacturing overhead. The term manufacturing stands for activities, which begin receipt of raw materials and end with completion of finished product. Manufacturing overhead represents all manufacturing costs other than the costs of direct materials, direct labours and direct other expenses. These costs cannot be identified specifically with or treced to cost objective. In other words, manufacturing overheads are indirect manufacturing costs. It is also known as production overhead, factory overhead, works overhead, factory on cost, work on cost etc. the manufacturing overhead includes:
On the basis of function
On the basis of functions, the overheads are classified into four types as mentioned below:
a. Factory or production or manufacturing overheads
The total indirect costs incurred for manufacturing department i.e. within factory are manufacturing overhead. The term manufacturing stands for activities, which begin receipt of raw materials and end with completion of finished product. Manufacturing overhead represents all manufacturing costs other than the costs of direct materials, direct labours and direct other expenses. These costs cannot be identified specifically with or treced to cost objective. In other words, manufacturing overheads are indirect manufacturing costs. It is also known as production overhead, factory overhead, works overhead, factory on cost, work on cost etc. the manufacturing overhead includes:
b. Office and administration overhead
On the basis of functions, the overheads are classified into four types as mentioned below:
a. Factory or production or manufacturing overheads
The total indirect costs incurred for manufacturing department i.e. within factory are manufacturing overhead. The term manufacturing stands for activities, which begin receipt of raw materials and end with completion of finished product. Manufacturing overhead represents all manufacturing costs other than the costs of direct materials, direct labours and direct other expenses. These costs cannot be identified specifically with or treced to cost objective. In other words, manufacturing overheads are indirect manufacturing costs. It is also known as production overhead, factory overhead, works overhead, factory on cost, work on cost etc. the manufacturing overhead includes:
b. Office and administration overhead
Administrations overhead include the indirect costs incurred for the direction of an enterprise as a whole. It encompasses cost of management, secretarial, accounting and administrative services, which cannot be related to a separate production. It includes all such expenses which are incurred in office for proper management and administration i.e. planning controlling, directing etc. given are a few example of different items included in different groups of administration overhead.
c. Selling and distribution overhead
c. Selling and distribution overhead
Selling and distribution overheads include only indirect costs relating to selling and distribution, which are different to manufacturing and administrative overheads. Selling overheads refers to all costs of seeking to create and stimulate demand or of securing orders. Distribution overhead refers to all expenses incurred from the time the product is finished in the factory till its delivery to ultimate customers or consumers. Some of the examples of selling and distribution overheads are:
D. research and development overhead
The structure and quality of production should also be changed according to the changes in the need wants and interests of consumers. It becomes necessary to introduce new products or innovate the same, new technologies and sophisticated distributions systems to compete in the market. The express incurred for achieving the above come under research and development overhead.
On the basis of Behaviors or variability
Based on behavioral patterns, overhead can be divided into variable, semi variable and fixed overheads. They are mentioned below:
a. Variable overhead
Variable overhead represents that part of indirect cost, which varies with charge in volume or activity varies in total but its incidence on unit cost remains constant. In other words, that portion of overhead which increase or decrease proportionately with increase or decrease in production unit is known as variable overhead, overhead cost per unit remains unchanged thought the production unit changes. The example of variable overheads are indirect material, indirect labour, commission to salesman, fuel & power, carriage outward, internal transport, lubricants, tools & spares etc.
B. fixed overhead
The structure and quality of production should also be changed according to the changes in the need wants and interests of consumers. It becomes necessary to introduce new products or innovate the same, new technologies and sophisticated distributions systems to compete in the market. The express incurred for achieving the above come under research and development overhead.
On the basis of Behaviors or variability
Based on behavioral patterns, overhead can be divided into variable, semi variable and fixed overheads. They are mentioned below:
a. Variable overhead
Variable overhead represents that part of indirect cost, which varies with charge in volume or activity varies in total but its incidence on unit cost remains constant. In other words, that portion of overhead which increase or decrease proportionately with increase or decrease in production unit is known as variable overhead, overhead cost per unit remains unchanged thought the production unit changes. The example of variable overheads are indirect material, indirect labour, commission to salesman, fuel & power, carriage outward, internal transport, lubricants, tools & spares etc.
B. fixed overhead
Fixed overhead represents indirect cost, which remains constant in total within budgeted period regardless of charges in volume of activity. The incidence of fixed overhead on unit cost decreases as production increase and vice-versa.
In other words, the overhead, which remains constant up to a certain level of production, is called fixed overhead. In total, it does not change, thought production units increase or decrease. But fixed overhead per unit decrease when production unit increase and fixed overhead per unit increase, when production unit decrease.
Fixed overhead is also called 'period cost' or 'stand-by cost' or 'fixed cost' because these costs are incurred even when no production activity takes place. Examples of fixed overheads are: end of building, depreciation of plant & machinery and building, cost hospital and dispensary, pay and allowance of managers and administrative staff etc.
d. Semi-variable overhead or mixed overhead
The indirect expenses, which do not remain constant nor change proportionately as per change in production unit are called semi variable overhead. These overhead show mixed relationship, when plotted again volume. Semi-variable overheads may remain fixed within a certain activity level, but once that level is exceeded, they very without having direct relationship with volume changes. Semi-variable overhead does not fluctuate in proportion to volume. Examples are: depreciation of plant and machinery, repairs and maintenance, cost of supervision, service department wages, postage and telephone, electricity and water supply etc.
The main problem to a cost accountant is to segregate the semi-variable overhead into fixed and variable elements. Segregation of semi-variable overheads into fixed and variable elements can be done by adopting different methods. The methods of segregation have been discussed in the chapted2.
On the basis of control
On the basis of controllability overhead can be divided into two types. These have been mentioned below in detail.
a. Controllable overhead: the overheads that can be controlled by the activities and decisions of the management are called controllable overheads. The indirect material and indirect labour can be controlled to some extent by purchasing the materials in the economic order quantity, getting discount on purchase, reducing the misuse of indirect materials, reducing the indirect labour etc.
b. Uncontrollable overhead: the overheads that cannot be controlled by the activities and decisions of the management are called uncontrollable overheads. Rent, remuneration of top level managers, insurance premium are some of the examples of uncontrollable overheads.
Allocation and absorption of overhead
Allocation of overhead
When items of overhead can be identified with specific departments, these are allocated to these departments and, thus, this process of identification whole items of overhead to specific departments is termed as allocation. Overhead costs arising solely from the existence of a particular production or service department can be charged or allocated to that department. Only those costs are allocable, which are directly identified or related to any specific cost center. For example, the salary of departmental head, foreman's salary and the cost of indirect materials issued to a particular department are solely allocated to that department. Repair and maintenance of equipment is allocated department are solely allocated to that department. Repair and maintenance of equipment is allocated to factory department.
Apportionment of overhead
Apportionment of overhead is the process of distributing those items of overhead which cannot be allocated to a cost center or department. They are distributed between the cost centers or departments on a reasonable or equitable basis. All items of overhead that cannot be allocated are apportioned among the production or services departments on some logical and reasonable basis, which is decided after a to of analysis and careful consideration of factors involved. Overhead cost such as factory rent, factory insurance, factory lighting, factory power, salary of factory manager, etc. incurred for the entire factory required apportionment to different production and service department on some reasonable or equitable basis.
Following bases are most commonly used for apportioning items of overhead among production and service department for primary distributions:
In other words, the overhead, which remains constant up to a certain level of production, is called fixed overhead. In total, it does not change, thought production units increase or decrease. But fixed overhead per unit decrease when production unit increase and fixed overhead per unit increase, when production unit decrease.
Fixed overhead is also called 'period cost' or 'stand-by cost' or 'fixed cost' because these costs are incurred even when no production activity takes place. Examples of fixed overheads are: end of building, depreciation of plant & machinery and building, cost hospital and dispensary, pay and allowance of managers and administrative staff etc.
d. Semi-variable overhead or mixed overhead
The indirect expenses, which do not remain constant nor change proportionately as per change in production unit are called semi variable overhead. These overhead show mixed relationship, when plotted again volume. Semi-variable overheads may remain fixed within a certain activity level, but once that level is exceeded, they very without having direct relationship with volume changes. Semi-variable overhead does not fluctuate in proportion to volume. Examples are: depreciation of plant and machinery, repairs and maintenance, cost of supervision, service department wages, postage and telephone, electricity and water supply etc.
On the basis of control
On the basis of controllability overhead can be divided into two types. These have been mentioned below in detail.
a. Controllable overhead: the overheads that can be controlled by the activities and decisions of the management are called controllable overheads. The indirect material and indirect labour can be controlled to some extent by purchasing the materials in the economic order quantity, getting discount on purchase, reducing the misuse of indirect materials, reducing the indirect labour etc.
b. Uncontrollable overhead: the overheads that cannot be controlled by the activities and decisions of the management are called uncontrollable overheads. Rent, remuneration of top level managers, insurance premium are some of the examples of uncontrollable overheads.
Allocation and absorption of overhead
Allocation of overhead
When items of overhead can be identified with specific departments, these are allocated to these departments and, thus, this process of identification whole items of overhead to specific departments is termed as allocation. Overhead costs arising solely from the existence of a particular production or service department can be charged or allocated to that department. Only those costs are allocable, which are directly identified or related to any specific cost center. For example, the salary of departmental head, foreman's salary and the cost of indirect materials issued to a particular department are solely allocated to that department. Repair and maintenance of equipment is allocated department are solely allocated to that department. Repair and maintenance of equipment is allocated to factory department.
Apportionment of overhead
Apportionment of overhead is the process of distributing those items of overhead which cannot be allocated to a cost center or department. They are distributed between the cost centers or departments on a reasonable or equitable basis. All items of overhead that cannot be allocated are apportioned among the production or services departments on some logical and reasonable basis, which is decided after a to of analysis and careful consideration of factors involved. Overhead cost such as factory rent, factory insurance, factory lighting, factory power, salary of factory manager, etc. incurred for the entire factory required apportionment to different production and service department on some reasonable or equitable basis.
Following bases are most commonly used for apportioning items of overhead among production and service department for primary distributions:
Principle of apportionment of overhead costs
To apportion the overhead, suitable bases or cost drivers are needed without any base; it is not possible to distribute overheads. Following are useful guides to identify suitable basis or cost drivers:
a. Service or use or benefit derived: under this principle, overhead are distributed over various production department on the basis of services actually rendered. This criterion has the grated applicability in case where overhead costs can be easily and directly traced to departments receiving the benefits.
b. Ability to pay: this principle presumes that higher the revenue of a production department, higher is the proportionate charge for services. This principle is inequitable because it penalizes the efficient department for their efficient.
c. Efficiency: under the principle production targets are fixed for each department and overhead costs are apportioned with reference to those targets. If department fails to achieve the target, it unit cost goes up, indicating its inefficiency. On the other hand, if departments achieve or exceeds the target, it shows its efficiency in the form of reduction in unit cost.
d. Analysis or survey: this principle is particularly used when it is difficult to select a suitable basis for apportionment. Under this method specific criteria are laid down after careful survey and analysis for apportionment of charge for different services functions.
Difference between allocation and apportionment
The following are the different between allocation and apportionment of overhead.
Reapportionment of overhead
In the first stage, the overhead are allocated and apportioned to various production and service departments. The main objective of such allocation and apportionment of overhead is to find out the per unit cost of production. Now, it is necessary to distribution the total cost of service department to the production departments. The product does not pass through services departments, but services an equipment share of the cost of services departments. Based on this logic, the total overhead costs of services department should be reapportioned among the production department which is called the reapportionment of overhead. Hence the process of redistributing the cost of service departments among production department is known as re-apportionment of overhead.
Following is the representative list of common bases, which are frequently used for apartments of cost of service department among production departments.
Method of re-apportionment of overhead
The major methods of re-apportment of overhead are given below:
a. Direct distribution method
Under this method, the totals overhead are directly apportioned to the production department. The total amount overhead of services department is not apportioned to the production department on the basis of the contribution made by it; rather the re-apportionment is done according to a certain ratio.
b. Step down method
Under the method, the total overhead of the service department is re-apportioned to production departments as per its respective contribution to the production departments. The following example makes it clearer.
c. Reciprocal services method
If there are two or more than two services department and they provides services to each other besides the production departments, the reciprocal method is used to re-apportion the overhead of service departments. The following techniques are used to re-apportion the overhead costs under this method.
j. Simultaneous equation method:
under this technique, an equation is developed on the basis of the percentage of services provides by the service department to other department and the actual overhead cost of services department is ascertained.
k. Repeated distributions method:
if the number of services department is high, it becomes different to re-apportion the overhead of service departments. In such a situation, repeated distributions method is applied to re-apportion the overhead of service departments.
l. Trial and error method:
under this method, the overhead of the service department are distributed among them only. After finding out the overhead of service department they are re-apportioned to production departments. The following example clarifies the use of reciprocal service method.
The overhead cost is finally required to be charged to the output of goods or services. The process of charging the overhead cost to the final precuts is known as absorption of overheads. In other words charging or shorting the overhead to specific product or individual unit is known as absorption of overhead.
After secondary distributions or re-apportionment, overhead is collected under the production department only. Now, a basis for absorption of overhead for each department is found out so that each job a product gets' proper share of overhead, when it passed through that department. Thus, overhead absorption involves apportionment of overhead relating to a department among the units produced in that department during the relevant period. Selection of correct method of overhead absorption is very important for pricing policies tenders and other managerial decisions. Overhead absorption accomplished by overhead rates.
Method of overhead absorption
Choice of a particular method of absorption depends on the circumstances of each individual case. As such the method of absorption may differ from industry to industry, and form company to compare also. As far as possible, the method applier should be rquitable so that the absorbed overhead are not in much different with the actual overheads.
The method for absorption of overhead may be put into different categories:
1. Unit of output
2. Percentage method
3. Hourly rate method
Absorption of overhead
Meaning of absorption of overheadThe overhead cost is finally required to be charged to the output of goods or services. The process of charging the overhead cost to the final precuts is known as absorption of overheads. In other words charging or shorting the overhead to specific product or individual unit is known as absorption of overhead.
After secondary distributions or re-apportionment, overhead is collected under the production department only. Now, a basis for absorption of overhead for each department is found out so that each job a product gets' proper share of overhead, when it passed through that department. Thus, overhead absorption involves apportionment of overhead relating to a department among the units produced in that department during the relevant period. Selection of correct method of overhead absorption is very important for pricing policies tenders and other managerial decisions. Overhead absorption accomplished by overhead rates.
Method of overhead absorption
Choice of a particular method of absorption depends on the circumstances of each individual case. As such the method of absorption may differ from industry to industry, and form company to compare also. As far as possible, the method applier should be rquitable so that the absorbed overhead are not in much different with the actual overheads.
The method for absorption of overhead may be put into different categories:
1. Unit of output
2. Percentage method
3. Hourly rate method
1. Unit of output method
Under the method, absorption of overhead is made on the basis of the number of units manufactured. The overhead rate is obtained by dividing the amount of overhead by the number of units of output. The formula for calculating the overhead rate based on this method can be per as follows:
Overhead rate per unit = total overhead cost/ total production unit
This method can be applied in single output industries, where only one product or a few grades of the same product are manufactured.
2. Percentage method
Under the method, the overhead absorption rate is calculated by determining the percentage of overhead to different bases. Under this, following four methods are applicable:
a. Direct material cost method: under this method, the overhead rate is expressed as a percentage of the direct material cost and is calculated by dividing the overhead cost for a particular period by the cost of direct materials used during the period and multiplying it by 100. Thus formula for calculating the overhead rate based on this method can be put as follows:
Percentages of overheads on direct material cost = total overhead cost of the period/ total direct material cost x 100
b. Direct labour cost method: under this method, the overhead rat expressed a a percentage of direct wages and is obtained by dividing the overhead cost for a particular period by the direct labour cost or wages paid during that period and multiplying it by 100. The overhead rat is obtained by applying the following formula:
Percentage of overheads on direct labour cost= (overhead cost)/(direct labour cost) x 100
c. Prime cost method:
this method considers both direct materials and direct labour for allocation of overhead and absorption of overhead is made on the basis of prime cost. Under this method, overhead rate is obtained by dividing the overhead cost for a particular period by the prime cost and multiplying it by 100. The formula for calculating the overhead rate can be put as follows:
Percentage of overhead on prime cost = overhead / prime cost x 100
d. Sale price method:
under this method, the overhead rate is expressed as a percentage of sales revenue and is obtained by dividing the overhead cost for a particular period by the sales revenue during that period and multiplying it by 100. The overhead rate is obtained by applying the following formula:
Under hourly rate method, there are two methods:
a. Direct labour hour rate method: under this method, overheads are charged to production on the basis of number of direct labour hours of work put on every job. The overhead rate is calculated by dividing the total overhead cost for the department for a given period by the total direct labour hours for the same period. The formula for calculating the overhead rate is as follows:
Overhead rate pr labour hour = overhead cost for the period/ direct labour hour for the period
b. Machine hour rate method:
this method of absorption of overhead is used in those cases where the processes of manufacture are carried out by machine and there is very little or practically no manual labour. It is dopa mine by dividing the overhead cost to be apportionment or absorbed by the number of machine hours expended or to be expended. The formula for calculating the overhead rate may be put as follows:
For computing the machine hour rate, each machine or a group of similar machine in production department is considered as a smaller department and the departmental expenses are re-apportned to the machine or group of machine in the department. All the department expenses to be considered for computing the machine hour rate are divided into two parts:
a. Standing charges (or fixed expenses)
b. Machine or running charged (or variable expenses)
a. Standing charges
Standing charges include all those expenses, which remain fixed or constant and relate to the department as a whole. These expenses are not affected by the operating of the machines. Example of those charges are factory rent, rates, taxes and insurance, factory lighting, factory supervising, insurance of machinery, expenses for oil, grease, cotton waste, sundry stores etc. for computing the machine hour rate, all the standing charges relating to the production department will be apportioned to the individual machine on the following basis:
The standing charges will be taken for the bases period. An hourly rate of fixed charges will be calculated by totaling them and dividing by the number of normal worked by the machine.
b. Machine or running charges
Machine or running charges include the expenses which are incurred in connection with the operation of the machine e.g., depreciation, repair and maintenance, power, stream, water etc. separate hourly rate for each of the machine expenses will be calculated. The hourly rate of various items of machine or running charges will be computed separated in the following manner:
i. Depreciation: the hourly rate of department of the machine will be calculated by the following formula:
Hourly rate of depreciation = original cost – estimated scrap value/ effective working life of machine in terms of running hours
Notes: generally, depreciation is considered as standing charges. But in some cases, it might be running charges if it is calculated on the basis of unit of production method.
ii. Repairs and maintenance: running expenses of repairs and maintenance of the machine over its effective working life is estimated on the basis of past experience. The hourly rate of repairs and maintenance cost will be ascertained by applying the following formula:
Hourly rate of repairs and maintenance
= estimated cost of repairs and maintenance over the life of machine/ effective working life of machine in terms of running hours
iii. Power, steam and water: the hourly cost of power, steam and water consumed will be ascertained on the basis of actual hourly consumption, or estimated hourly consumption ascertained on the basis of past experience.
iv. Maintenance and setting-up time: the time taken a job on the machine is termed as setting up time while time taken to remove a job from the machine is termed as setting off time, it is to be noted that from the total working hours the hours, which are required for maintenance or for setting up or setting off (unless taken as productive time) must be deducted for this purpose.
v. Comprehensive or composite machine hour rate: wages paid to the machine operate form the part of direct wages and hence will be excluded from the overhead to be considered for computing the machine hour rate. But sometime a manufacturing concern may be interested in calculating a comprehensive or composite machine hour rate. The comprehensive machine hour rate also rate factory overhead and direct wages are absorbed in a single rate.
1. What do you mean by overhead costs?
The cost that cannot be easily identified to a unit cost or a product cost or department cost are called the overhead costs. In the words, the indirect portions of the total cost constitute the overhead cost. The term indirect denotes that which cannot be allocated but which can be apportioned to cost centers or absorbed by cost units. The overhead are incurred not for any particular job, process or unit but for the business as a whole. Overhead costs are also denoted by work on cost, burden cost, indirect expenses, non-productive cost, supplementary cost, logistic support cost and loading cost.
2. What do you mean by allocation and apportionment of overhead?
Allocation of overhead: when items of overhead can be identified directly with specific departments, these are allocated to this department and, thus, this process of identification whole items of overhead to specific department is termed as allocation. Overhead costs arising solely from the existence of a particular production or service department can be charged or allocated to that department. For example, the salary of departmental head, foreman's salary and the cost of indirect materials issued to a particular department are solely allocated to that department.
Apportionment of overhead: apportionment of overhead is the process of distributing those items of overhead which cannot be allocated to cost centre or department. They are distributed between the cost centers or departments on a reasonable or equitable basis. Overhead costs such as factory rent, factory insurance, factory lighting, factory power, salary of factory manager, etc. incurred for the entire factory require apportionment to different production and service department on some reasonable or equitable basis.
3. Write the differences between allocation and apportionment of overhead.
The following are the differences between allocation and apportionment of overhead.
a. Distribution: under allocation, the expenses are directly allocation to the department under apartment.
b. Activity: the expenses incurred in a particular department are allocated to that department but the costs are incurred in two or more departments are apportioned on some equitable bases.
c. Burden: under allocation, the entire expenditure is distributed to a particular department. Under apportionment, the total expenditure is distributed among the department.
d. Application: allocation is made if the expenditure is made if particular department where apportionment is made if expenditure is related to a number of department.
e. Use of suitable bases: for allocation, no base is required to include the cost to a particular department. Under apportionment, the expenses are distributed among department on some equitable bases.
c. Prime cost method:
this method considers both direct materials and direct labour for allocation of overhead and absorption of overhead is made on the basis of prime cost. Under this method, overhead rate is obtained by dividing the overhead cost for a particular period by the prime cost and multiplying it by 100. The formula for calculating the overhead rate can be put as follows:
Percentage of overhead on prime cost = overhead / prime cost x 100
d. Sale price method:
under this method, the overhead rate is expressed as a percentage of sales revenue and is obtained by dividing the overhead cost for a particular period by the sales revenue during that period and multiplying it by 100. The overhead rate is obtained by applying the following formula:
Percentage of overheads on sales = overhead cost/ sales value x 100
3. Hourly rate methodUnder hourly rate method, there are two methods:
a. Direct labour hour rate method: under this method, overheads are charged to production on the basis of number of direct labour hours of work put on every job. The overhead rate is calculated by dividing the total overhead cost for the department for a given period by the total direct labour hours for the same period. The formula for calculating the overhead rate is as follows:
Overhead rate pr labour hour = overhead cost for the period/ direct labour hour for the period
b. Machine hour rate method:
this method of absorption of overhead is used in those cases where the processes of manufacture are carried out by machine and there is very little or practically no manual labour. It is dopa mine by dividing the overhead cost to be apportionment or absorbed by the number of machine hours expended or to be expended. The formula for calculating the overhead rate may be put as follows:
Overhead rate per machine hour = overhead cost for the period/ machine hour for the period
Computation of machine hour rateFor computing the machine hour rate, each machine or a group of similar machine in production department is considered as a smaller department and the departmental expenses are re-apportned to the machine or group of machine in the department. All the department expenses to be considered for computing the machine hour rate are divided into two parts:
a. Standing charges (or fixed expenses)
b. Machine or running charged (or variable expenses)
a. Standing charges
Standing charges include all those expenses, which remain fixed or constant and relate to the department as a whole. These expenses are not affected by the operating of the machines. Example of those charges are factory rent, rates, taxes and insurance, factory lighting, factory supervising, insurance of machinery, expenses for oil, grease, cotton waste, sundry stores etc. for computing the machine hour rate, all the standing charges relating to the production department will be apportioned to the individual machine on the following basis:
b. Machine or running charges
Machine or running charges include the expenses which are incurred in connection with the operation of the machine e.g., depreciation, repair and maintenance, power, stream, water etc. separate hourly rate for each of the machine expenses will be calculated. The hourly rate of various items of machine or running charges will be computed separated in the following manner:
i. Depreciation: the hourly rate of department of the machine will be calculated by the following formula:
Hourly rate of depreciation = original cost – estimated scrap value/ effective working life of machine in terms of running hours
Notes: generally, depreciation is considered as standing charges. But in some cases, it might be running charges if it is calculated on the basis of unit of production method.
ii. Repairs and maintenance: running expenses of repairs and maintenance of the machine over its effective working life is estimated on the basis of past experience. The hourly rate of repairs and maintenance cost will be ascertained by applying the following formula:
Hourly rate of repairs and maintenance
= estimated cost of repairs and maintenance over the life of machine/ effective working life of machine in terms of running hours
iii. Power, steam and water: the hourly cost of power, steam and water consumed will be ascertained on the basis of actual hourly consumption, or estimated hourly consumption ascertained on the basis of past experience.
iv. Maintenance and setting-up time: the time taken a job on the machine is termed as setting up time while time taken to remove a job from the machine is termed as setting off time, it is to be noted that from the total working hours the hours, which are required for maintenance or for setting up or setting off (unless taken as productive time) must be deducted for this purpose.
v. Comprehensive or composite machine hour rate: wages paid to the machine operate form the part of direct wages and hence will be excluded from the overhead to be considered for computing the machine hour rate. But sometime a manufacturing concern may be interested in calculating a comprehensive or composite machine hour rate. The comprehensive machine hour rate also rate factory overhead and direct wages are absorbed in a single rate.
1. What do you mean by overhead costs?
The cost that cannot be easily identified to a unit cost or a product cost or department cost are called the overhead costs. In the words, the indirect portions of the total cost constitute the overhead cost. The term indirect denotes that which cannot be allocated but which can be apportioned to cost centers or absorbed by cost units. The overhead are incurred not for any particular job, process or unit but for the business as a whole. Overhead costs are also denoted by work on cost, burden cost, indirect expenses, non-productive cost, supplementary cost, logistic support cost and loading cost.
2. What do you mean by allocation and apportionment of overhead?
Allocation of overhead: when items of overhead can be identified directly with specific departments, these are allocated to this department and, thus, this process of identification whole items of overhead to specific department is termed as allocation. Overhead costs arising solely from the existence of a particular production or service department can be charged or allocated to that department. For example, the salary of departmental head, foreman's salary and the cost of indirect materials issued to a particular department are solely allocated to that department.
Apportionment of overhead: apportionment of overhead is the process of distributing those items of overhead which cannot be allocated to cost centre or department. They are distributed between the cost centers or departments on a reasonable or equitable basis. Overhead costs such as factory rent, factory insurance, factory lighting, factory power, salary of factory manager, etc. incurred for the entire factory require apportionment to different production and service department on some reasonable or equitable basis.
3. Write the differences between allocation and apportionment of overhead.
The following are the differences between allocation and apportionment of overhead.
a. Distribution: under allocation, the expenses are directly allocation to the department under apartment.
b. Activity: the expenses incurred in a particular department are allocated to that department but the costs are incurred in two or more departments are apportioned on some equitable bases.
c. Burden: under allocation, the entire expenditure is distributed to a particular department. Under apportionment, the total expenditure is distributed among the department.
d. Application: allocation is made if the expenditure is made if particular department where apportionment is made if expenditure is related to a number of department.
e. Use of suitable bases: for allocation, no base is required to include the cost to a particular department. Under apportionment, the expenses are distributed among department on some equitable bases.
0 comments:
Post a Comment