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Overheads
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 fully to the product, service or department. Overheads is actually the total of the following: Indirect materials Indirect labour Indirect expenses In cost accounting there are two school of thoughts as to the correct method of dealing with overheads: Absorption costing Marginal costing
Overheads
There are four categories of overheads.
Production/ manufacturing overheads Marketing/ selling and distribution overheads Research and development overheads Administration overheads
3. The overheads are to be allocated to service department as well as to production departments. 4. Service department overheads are to be absorbed through jobs or products passing through production department. So service department costs are reapportioned to production departments.
Overhead allocation
Allocation is the process by which whole cost items are charged direct to a cost unit or cost centre For example, the following cost will be charged to the following cost centres via the process of allocation: Direct labour will be charged to the production cost centre The cost of warehouse security will be charged to the warehouse cost centre Costs such as canteen are charged direct to the various overhead cost centres.
Apportionment of overhead
Apportionment of overhead is distribution of overheads to more than one cost centre on some equitable basis. When the indirect costs are common to different cost centres, these are to be apportioned to the cost centres on an equitable basis. For example, the expenditure on general repair and maintenance pertaining to a department can be allocated to that department but has to be apportioned to various machines (Cost Centres) in the department. If the department is involved in the production of a single product, the whole repair & maintenance of the department may be allocated to the product.
Bases of apportionment
Overhead apportionment basis Overhead to which basis apply Basis of apportionment
Personnel, office, canteen, welfare, wages and costs of offices, first aid
Stores
Maintenance
Production planning
Eg. Total Overhead of dept = Rs. 10,000, Tota labour hrs = 250 Absorption rate = 10,000/250 = Rs. 40 per labour hr
Example
The Assembly cost center has estimated overheads for period 1 of Rs. 225,000/=. Labour hours are considered the most appropriate basis and it is expected that 9,000 hours will be worked in total during the period. What is the overhead absorption rate for Assembly? = 225,000 9,000 = Rs 25 per lobour hour
Example
Job 232 is one of many jobs that pass through the assembly cost center during a period. The only work done on job 232 is assembly work and its direct costs are, Direct materials 65 Direct labour ( 5 hours @ Rs 18) 90 Total direct cost 155 What is the total production cost of job 232 assuming that the Assembly OAR is Rs 25 per hour as previously calculated? = DM+DL+OH= total production cost =65+90+(25*5)=Rs 280
Example
ABC Co. Ltd has four production departments P1, P2, P3 and P4 and three service departments S1, S2 and S3. S1 stores S2 production control section S3 maintenance department Calculate for each production department an appropriate overhead absorption rate per machine hour. Calculate the total cost of each department.
The annual overheads are as follows:
Information
Cost
Indirect labour Supervision Power Rent
Total (Rs.000)
2,000 200 600 80
Insurance -Building
Insurance -Plant Depreciation -Building Depreciation -Plant
160
100 240 120
Information
Indirect Labour Costs Cost centres P1 P2 P3 P4 S1 S2 S3 Actual costs Rs.000 300 200 500 100 200 300 400
Information
S1 30 1,000 1,500 -
No. of employee Floor Area (Sq.M) Power (KWHrs) Pro.Cntrl Hours Stores Requisitions
6,000
120 300
8,000
80 200
5,000
200 100
6,000
100 80
120
50
150
25,000
500 1,000
Basis
Actual No. of employee KWHr Floor area Floor area Book value Floor area Book value
Total
2000 200 600 80 160 100 240 120 3500
P1
300 40 210
P2
200 40 150
P3
500 50 90 20 40 10 60 12 782
P4
100 60 60 20 40 8 60 9.6 357. 6
S1
200 3 45 2.5 5 12 7.5 14.4 289.4
S2
S3
7.5 22.5 15 30 45 20
343 498
Calculation
Item
Ind. Labour
Supervision Power Rent & rates Insurance -B Insurance-P Depreciation-B Depreciation-P
Basis
Actual
No. of Employee KWHr Floor area Floor area Book value Floor area Book value
Total P1
2000
200 (200/2,000)*400 600 (600/20,000)*7000 80 (80/32,000)*3000 160 (160/32,000)*3000 100 (100/1,000)*300 240 (240/32,000)*3000 120 (120/1,000)*300
300.0
= 40.0 = 210.0 = 7.5
Total
3500
661.0
Total P1
3500 661.0 86.8
P2
569.0 43.4
P3
782.0 36.2
P4
357.6
S1
289.4
S2
343.0 57.9
S3
498.0 43.4
21.7 -289.4
3500
748.8 89.1
837.9 135.3 973.2
612.4 111.35
723.75 180.4 904.15
818.2 111.35
929.55 112.7 1042.25
379.3 66.8
446.1 135.3 581.4
400.9 -400.9
541.4 22.3
3500 3500
- 563.7 - -563.7 -
S1stores
Store req
87.8
43.4
36.2
21.7
(289.4)
57.9
43.4
S1
P1 P2 P3 P4 S2 S3
(289.4/2000)*600 = 86.82 86.8 (289.4/2000)*300 = 43.41 43.4 (289.4/2000)*250 = 36.18 36.2 (289.4/2000)*150 = 21.71 21.7 (289.4/2000)*400 = 57.88 57.9 (289.4/2000)*300 = 43.41 43.4 Total 289.4
3500
748.8 89.1
612.4 111.35
818.2 111.35
379.3 66.8
400.9 - (400.9)
541.4 22.3
S2
P1 (400.9/18,000)* 4000= 89.08 89.1 P2 (400.9/18,000)* 5000=111.35 P3 (400.9/18,000)* 5000=111.35 P4 (400.9/18,000)* 3000=66.81 66.8 S3 (400.9/18,000)* 1000=22.27 22.3
S3Maint
Plant Hrs
3500
837.9 135.3
563.7 (563.7)
S3
Then, based on the production hours the overhead costs chargeable are as follows: Job 1 = 3*8.11+2.5*11.3+5*5.81 = 81.63 Job 2 = 12*8.11+5*5.21 = 123.37 Job 3 = 1.5*8.11+4*11.3+10*5.21+3*5.81 =
The costs of the two service departments S1 and S2 are to be re-apportioned to production departments using the following basis. S1 S2 P1 20% 30% P2 40% 30% P3 10% 20% S1 20% S2 30% Total 100% 100%
Continuous Allotment
Costs of service departments are re-allocated to other departments repeatedly until the amount remaining is too insignificant. s1 20% 40% 10% 30% 100% s2 30% 30% 20% 20% 100%
P1 P2 P3 S1 S2 Total
P2
P3
S1 1280
S2 3000
8000 6000
Total
2380
512 128 (1280) 384 1015 677 677 (3384) 271 68 (677) 203 62 40 40 (203) 16 4 (40) 12 3.6 2.4 2.4 (12) 4 3 9880 6920
As above
Total
P1
P2
P3
19000
2000 3600 1400* 2880 23280
(1400/70)*20 =400
5000
400* 1080 6480
8000
800* 1080 9880
6000
200* 720 6920
(1400/70)*40 =800
(1400/70)*10 =200
P1 P2 P3 S1 S2 Total
30*(100/80)
30*(100/80)
20*(100/80)
P1 5000
P2 8000
P3 6000
S1 1280
S2 3000
Dept S1
Dept. S2 Total 2380
256
1269 6525
512
1269 9781
128 (1280)
846 6974
384
- (3384) -
(1280/100)*10 =128
(1280)
(1280/100)*30 =384
Definition
Absorption costing
It is costing system which treats all manufacturing costs including both the fixed and variable costs as product costs
Marginal costing
It is a costing system which treats only the variable manufacturing costs as product costs. The fixed manufacturing overheads are regarded as period cost
Absorption costing Sales Less: Cost of goods sold Gross profit Less: Expenses Selling expenses X Admin. expenses X Other expenses X $ X X X
Marginal costing $ Sales Less: Variable cost of Goods sold Product contribution margin Less: variable non- manufacturing expenses Variable selling expenses Variable admin. expenses Other variable expenses Total contribution expenses Less: Expenses Fixed selling expenses Fixed admin. expenses Other fixed expenses Net Profit X X X
X X X X X X X X
Net Profit
A company started its business in 2005. The following information Was available for January to March 2005 for the company that produced A single product:
RS
Selling price pre unit Direct materials per unit Direct Labour per unit Fixed factory overhead per month Variable factory overhead per unit Fixed selling overheads Variable selling overheads per unit Budgeted activity was expected to be 1000 units each month Production and sales for each month were as follows: Jan Feb Unit sold 1000 800 Unit produced 1000 1300
Required: Prepare absorption and marginal costing statements for the three months
Absorption costing
January February March
Marginal costing
Sales Less: Variable cost of good sold ($35) 35000 Product contribution margin 65000 Less: Variable selling overhead4000 Total contribution margin 61000 Less: Fixed Expenses Fixed factory overhead 30000 Fixed selling overheads 1000 Net profit 30000
January $ 100000 February March $ $ 80000 110000 28000 52000 3200 48800 30000 1000 32800 38500 71500 4400 67100 30000 1000 30100
Wk1: Standard fixed overhead rate = Budgeted total fixed factory overheads Budgeted number of units produced = $30000 1000 units = $30 units
Wk 2: Production cost per unit under absorption costing: Direct materials Direct labour Fixed factory overhead absorbed Variable factory overheads
20 10 30 5 65
Wk 3: (Under-)/Over-absorption of fixed factory overheads: January February March $ $ $ Fixed overhead 30000 39000 27000 Fixed overheads incurred 30000 30000 30000 0 9000 (3000)
1000*$30 1300*$30 900*$30
Wk 4: Variable production cost per unit under marginal costing: $ Direct materials Direct labour Variable factory overhead No fixed factory overhead 20 10 5
35
Treatment for fixed Fixed manufacturing overheads are manufacturing overheads treated as product costing. It is believed that products cannot be produced without the resources provided by fixed manufacturing overheads
Fixed manufacturing overhead are treated as period costs. It is believed that only the variable costs are relevant to decisionmaking. Fixed manufacturing overheads will be incurred regardless there is production or not.
High value of closing stock will be Lower value of closing stock that obtained as some factory overheads included the variable cost only are included as product costs and carried forward as closing stock