Overheads

Dr. Mohamed Kutty Kakkakunnan
Associate Professor
P.G. Dept. of Commerce
NAM COLLEGE KALLIKKANDY
Kannur – Kerala - India

OVERHEADS /OVERHEAD COSTS
• Costs or expenses incurred over and above the
prime cost
• Sum total of indirect material, indirect labor and
other indirect expenses
• Any cost which is not directly attributable to a cost
centre or cost unit
• “The aggregate of indirect material cost, indirect
labor cost and indirect expenses” ICMA
• Since benefits of such expenses cannot be
attached to a particular cost centre /cost unit, such
expenses cannot directly allocated
• Are apportioned on equitable base
• Also known as burden, on cost

Steps in Overhead Accounting
 Overheads cannot be directly charged, but are
apportioned equitable on some base.
 Stages or steps involved in the allocation of
overheads to different cost centers -
1. Classification of overheads
2. Codification and collection of overheads
3. Allocation and apportionment of overheads
(departmentalization of overheads)
4. Re-apportionment of overheads
5. Absorption of overheads

Classification of Overheads
• Process of grouping
• Divided into groups and sub groups
Bases for Classification
I. Function or Functional classification
II. Elements or Element-wise classification
III. Nature or Behavior or Behavioral
classification
IV. Controllability

I. Function or functional classification
a. Factory or manufacturing overheads
b. Office or administration overheads
c. Selling overheads
d. Distribution overheads
e. Research and development overheads
II. Elements or element-wise classification
a. Indirect material
b. Indirect labor
c. Indirect expense

III. Nature or behavior or behavioral
classification
a. Variable
b. Fixed
c. Semi-variable or semi-fixed
IV. Controllability
a. Controllable
b. Non-controllable

2. Codification and Collection of Overheads
• For easy identification, dealing and accounting the
overheads, the classified overheads are given different
codes
• Is the process of allotting number or symbols to each
group or sub groups of overheads for easy
identification
FURTHER, Expenses are incurred at different periods for
different purposes, by different persons responsible
These scattered expenses are to be collected under
suitable headings – known as collection
Can be collected form various vouchers and documents
such as (a) invoice, (b) cash book (c) subsidiary records,
journals etc

3. Allocation and apportionment of expenses
(departmentalization)
• For ease of management and administration, an
organization will be divided into different units or
divisions, known as departments
• Three types of departments
i. Production department : Engaged in the conversion
of raw material into finished products
ii. Service department: Auxiliary departments, not
directly engaged in the production; but helps the
production departments by rendering services
required. Eg Office, Personnel department etc
iii. Partly producing departments

A. Allocation of Overheads
• The process of identification of overheads with cost
centers
• An expense which is directly identifiable is with a
specific cost centre is allocated to that cost centre
• “is the allotment of whole item of cost to a cost centre
or cost unit” or
• “charging of expenses which can be identified wholly
with a particular department”
Eg:- 1. Overtime wages paid to workers in the production
dept., can be fully allocated to the production
department.
2. Repair charges for a particular machinery used in a
particular department

B. Apportionment of Overheads
 Certain costs or expenses are commonly incurred to
different departments, thus, cannot be identified with
a particular cost centre or department
 Costs which cannot be identified with a particular cost
centre or department need be divided or apportioned
among the beneficiary departments equitably
 Apportionment - the allotment of expenses which
cannot be identified wholly with a particular
department
 “As the allotment to two or more cost centers of
proportions of the common items of cost on the
estimated basis of benefit received.
Eg: Rent, rates, taxes, works manager’s salary etc

Differences Between Allocation and Apportionment
Allocation Apportionment
Means the allotment of whole
item of cost to cost centers or cost
units
Means allotments of proportion
of items of cost to cost centre or
cost units
Deals with whole item of cost Deals with only proportions of
items of cost
Cost is directly allocated to
cost centre or cost unit
Not directly allocated, but are
divided or apportioned to different
departments on suitable basis
Allocated when the cost centre
uses whole of the benefits of the
expense
Apportioned when cost centers
use only a proportion of the
benefits of the whole expenses
No bases are required for
allocation
Need a suitable base

BASES OF APPORTIONMENT
 Allotment?
 Whole item of cost
 Apportionment?
 Allotment of proportions of items
 THUS, Apportionment need proper (equitable)
base for allotment of overhead expenses to
different departments and service department
costs to production departments
 Allotment and apportionment of overhead
expenses to different departments including
service department is known as PRIMARY
DISTRIBUTION

Bases for apportionment (contd.)
1. Direct Allocation
 Directly allocated to different departments on the
basis of expenses incurred, if identifiable
eg:- Overtime wages paid to the workers in a
particular dept.
 Repair charges incurred for a machine used in a
particular dept.
2. Direct Labor / Machine Hours
 Apportioned on the basis (ratio) of direct labor /
machine hours
 Majority of general overhead items are
apportioned on this basis

3. Value of Material Used
Eg: material handling expenses
4. Direct Wages
Overheads which are incurred on the basis of
labor costs
5. Number of Workers
Overheads varies on the basis of number of
workers (canteen expenses, , medical
expenses, time keeping, supervisions etc)
6. Floor Area
rent, rates, taxes, maintenance on building etc

Bases of apportionment contd.
7. Capital values
repairs, maintenance, insurance, taxes et
8. Light Points
9. Kilowatt hours
10. Technical estimates

Eg:- Modern Ltd., has four departments – three production
depts namely, X, Y and Z and one service dept. called A.
Actual costs of the firm for the year are as follows:-
Costs Rs. Costs Rs.
Rent 1000 Supervision 1500
Repairs to plant 600 Fire insurance (stock) 500
Depreciation (plant) 450 Power 900
Employer’s Liability for insurance 150
Lighting 120

Following information is available
X Y Z A
Area (sq.mts) 1500 1100 900 500
Number of employees 20 15 10 5
Total wages (Rs.) 6000 4000 3000 2000
Value of plant (Rs.) 24000 18000 12000 6000
Value of stock (Rs.) 15000 9000 6000 -
Horse power of plant 24 18 12 2
Apportion the costs to the various depts., on the most
equitable base

OVERHEAD DISTRIBUTION SUMMARY
item
Bases of
apportionment
TOTAL
Production Departments
Service
Dept.
X Y Z A
Rent Floor area 1000 375 275 225 125
Repairs to
plant
Plant value
600 240 180 120 60
Depreciation Plant value 450 180 135 90 45
Light Floor area 120 45 33 27 15
Power Horse power 900 360 270 180 90
Supervision No. of
employees 1500 600 450 300 150
Fire insurance Stock value 500 250 150 100 -
Employer’
liability to
No of
employees 150 60 45 30 15
Total 5220 2110 1538 1072 500

RE-APPORTIONMENT OF SERVICE DEPARTMENT
COSTS TO PRODUCTION DEPARTMENTS
Three types of departments
Actual production goes on in production
department, service department help the
production departments by rendering services
required.
Thus, service department costs are to be re-
apportioned to production depts.
The process of re-apportionment of service
department costs to production departments is
known as Secondary Distribution

SERVICE DEPARTMENTS BASIS OF APPORTIONMENT
Maintenance Hours worked
Payroll – time keeping Total labor or machine hours
or number of employees
Employment – personnel Labor turnover rate or
number of employees
Store keeping Number of requisitions or
value of materials
Purchase Number of orders or value of
materials
Welfare, ambulance, canteen,
recreation
Number of employees
Building service area

SERVICE DEPARTMENT BASIS OF APPORTIONMENT
Internal transport or
overhead crane services
Weight, value of product
handled, weight and
distance travelled
Transport Crane hours, truck hours,
weights, distance, number
of packages
Power house – electric
power
Wattage, horse power,
machine hours , number of
electric points
Power house Floor area, cubic content

Methods of re-apportionment (re-distribution)
Methods of
secondary
distribution
Direct
Step down
Reciprocal
services
Repeated
distribution
Trial and error
Simultaneous
equation
method

Repeated Distribution Method
Under this method, the totals of each department (both
production and service) is shown separately in the first
row of the table
Then, one service department cost is taken and is
distributed to other departments (including service
departments) in the given ratio
Then the next service department cost (total cost as per
primary distribution + cost received as per the second
step above) is taken and is distributed to other
departments (including service department)
This process is repeated till the entire cost of the service
department is exhausted

SECONDARY DISTRIBUTION SUMMARY
P1 P2 P3 S1 S2
As per Primary
distribution
800 700 500 234 300
Service Dept. S1 47 94 70 (234) 23
Service Dept. S2 129 65 65 64 (323)
Service Dept. S1 14 25 19 (64) 6
Service Dept. S2 2 2 2 - (6)
Total 992 886 656

Trial and Error Method
In this method, as a first stage, service dept
costs are taken and apportioned as is done in
the case of repeated distribution method
Then, all the positive figures in the column are
added to ascertain the total cost of each
service department
These totals are then distributed to production
departments in the given percentage or ratio

SECONDARY DISTRIBUTION (Trial and Error Method)
S1 S2
Cost as per Primary distribution 234 300
Service Dept. cost S1 (10%) (234) 23
Service Dept. cost S2 (20%) 65 (323)
Service Dept. cost S1 (10%) (64) 7
Service Dept. cost S2 (20%) 1 (6)
Total 300 330
Production Department P1 (800 + 20% of S1 total + 40% of S2
total) = 992
total) = 886
total) = 656

ABSORPTION OF OVERHEAD
Next step in overhead accounting
Means – distribution of overhead expenses allotted
to a particular department over the units
produced in that department
“ is the process of absorbing all overhead costs
allocated or apportioned over particular cost
centre or production department”
Apportionment of overhead expenses of cost
centers to cost units
Also known as recovery of overheads from the cost
of production

Steps in Absorption of Overheads
Two steps
1. Computation of overhead rates and
2. Applying overhead rates to cost units
Computation of overhead rates
What is rate? How to calculate rate?
 Overhead rate is the rate obtained by
dividing overhead costs by the base.
 The base can be the direct material cost,
direct wages, prime cost, labor hours,
machine hours etc

Applying overhead rates to cost units
To calculate cost of each unit produced the
overhead rate is multiplied with the units of the
base contained in each individual product, job or
process.
(Overhead Rate X Units of base in the product)
Eg:-
Total overhead cost of Production dept X for June is
Rs. 1,50,000 and total labor hours during the
month is 25,000. If product A produced in X
requires 100 hours – calculate the amount of
overhead to be charged to Product A

Two steps
1. Determination of rate
1. Application of rate (determination / charging
of overhead cost to the product)
Overhead rate X Units of base in the product
Rs. 6 x 100 hours = Rs. 600

Different Types of Overhead Rates
1. Actual rate
The rate obtained by dividing actual overheads with actual
quantity or value of the base
2. Predetermined (Budgeted)Overhead rate
The rate obtained by dividing predetermined or budgeted
overhead expenses by the budgeted base of the period

3. Blanket or Single rate
When a single overhead rate is calculated for
the factory as a whole, it is known as Blanket
or single rate- suitable
4. Multiple rates:
when different overhead rates are calculated
for each production department, service dept.
cost centers, product line, fixed overheads,
variable overheads etc. it is known as multiple
rates

5. Normal overhead rates
Refers to the overhead rates calculated with reference to
normal capacity
6. Supplementary Rates
When pre-determined rates are used for absorption of
overhead, there can be difference between actual overhead
cost and overhead absorbed. To adjust this difference
supplementary rates are used

Methods of Absorption of Overheads
1. Direct material cost method
2. Direct labor cost (wages) method
3. Prime cost method
4. Direct labor (production) hour method
5. Machine hour rate

Overheads

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Overheads