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 Number of workers
exp, Time keeping, Supervision
3. ESI and PF contribution, Fringe Direct wages
benefits
4. Depreciation, repairs, insurance Capital values
of machinery
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 5,000 General lighting 600

Indirect wages 1,500 Power 1,500
Depreciation of 10,000 Sundry expenses 10,000
Machinery

The following details are further available:

 Total A B C D E

Floor space (sq 20,000 4,000 5,000 6,000 4,000 1,000

ft)

Light points 120 20 30 40 20 10

Direct wages 10,000 3,000 2,000 3,000 1,500 500

(RS)

H.P of 150 60 30 50 10 -
machines

Value of 2,50,000 60,000 80,000 1,00,000 5,000 5,000

machinery

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 Apportionment of production &

production deptt only other service deptt

Non reciprocal Reciprocal

Simultaneous Repeated distribution Trial & error method

equations methods 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) Computation of overhead rate :

Total overheads of cost centre/total units in base
vii) 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) Direct material cost percentage method:

Production overhead/Direct materials *100
3) Direct labour cost percentage method:
Production overhead/Direct labour cost *100
3) Prime cost percentage method:
Production overhead/Prime Cost*100
7) Direct labour hour method:
Production overhead/Direct labour hour
9) 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 Rs.4,000 4,000

2,000
Direct labour Rs.2,000 3,000
3,000
Direct expenses 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
STANDING CHARGES
1. Rent & Rates
2. Heating & Lighting
3. Supervision
4. Insurance
5. Lubricating oil and other
consumable stores
6. Miscellaneous expenses
BASIS
Floor area occupied by each
machine
No. of light points for each
machine, or floor area occupied by
each machine
Estimated time devoted by the
supervisor on each machine
Insured value of each machine
Capital values/machine hours
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 = Rs. 5 per machine hour
• Actual machine hours = 1,500
• Actual overheads = Rs. 9,000
• Overhead absorbed = 1,500 hrs. x Rs. 5 = Rs. 7,500
Under-absorption = Rs. 9,000-Rs. 7500 = Rs. 1,500

If the actual machine hours worked were 1,900, then:

• Overhead absorbed = 1,900 hrs. x Rs. 5= Rs. 9,500

Overhead over-absorbed = 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.