This document discusses overhead costs, including:
1) Overhead costs are indirect expenses that cannot be directly attributed to a product or service, such as factory rent, salaries of managers, and machine depreciation.
2) Overhead costs are classified by function (manufacturing, administration, distribution), behavior (fixed or variable), and elements (indirect materials, labor, expenses).
3) Overhead costs must be allocated to cost centers and then distributed to products using appropriate bases, such as floor area, number of employees, or machine hours. This ensures overhead costs are properly considered when determining product costs and prices.
This document discusses overhead costs, including:
1) Overhead costs are indirect expenses that cannot be directly attributed to a product or service, such as factory rent, salaries of managers, and machine depreciation.
2) Overhead costs are classified by function (manufacturing, administration, distribution), behavior (fixed or variable), and elements (indirect materials, labor, expenses).
3) Overhead costs must be allocated to cost centers and then distributed to products using appropriate bases, such as floor area, number of employees, or machine hours. This ensures overhead costs are properly considered when determining product costs and prices.
This document discusses overhead costs, including:
1) Overhead costs are indirect expenses that cannot be directly attributed to a product or service, such as factory rent, salaries of managers, and machine depreciation.
2) Overhead costs are classified by function (manufacturing, administration, distribution), behavior (fixed or variable), and elements (indirect materials, labor, expenses).
3) Overhead costs must be allocated to cost centers and then distributed to products using appropriate bases, such as floor area, number of employees, or machine hours. This ensures overhead costs are properly considered when determining product costs and prices.
This document discusses overhead costs, including:
1) Overhead costs are indirect expenses that cannot be directly attributed to a product or service, such as factory rent, salaries of managers, and machine depreciation.
2) Overhead costs are classified by function (manufacturing, administration, distribution), behavior (fixed or variable), and elements (indirect materials, labor, expenses).
3) Overhead costs must be allocated to cost centers and then distributed to products using appropriate bases, such as floor area, number of employees, or machine hours. This ensures overhead costs are properly considered when determining product costs and prices.
Warunika N. Hettiarachchi Learning outcomes Identification of overhead cost Overhead cost collection, allocation, apportionment and absorption overheads Overhead cost is a vital element in manufacturing cost/cost of services ex: when determining the price of a loaf of bread produced in a bakery, it’s necessary to consider the insurance expense in bakery building. building rent should be considered when determining the tuition fee Overhead costing includes collection, allocation, apportionment and absorption of overheads Definition and Classification of Overheads overhead cost/ indirect cost: Expenses which cannot be directly attributed to a product/service Incurred commonly for goods/services Ex: factory rent, salary of factory manager, machine depreciation Cost Centre: Cost Unit: Classification of Overheads Functions - Manufacturing - Administration - Distribution Behavior - Fixed - Variable Elements - Indirect material - Indirect labour - Indirect expenses Cost Classification Functional Behavioral Element
Yeast
Salary of supervisor
Insurance expenses for the
bakery
Salary of bread distribution Classification
using elements is Salary of accounts clerk applicable only for Distribution commission manufacturing overheads Cost Classification Functional Behavioral Element
Yeast Manufacturing Variable Indirect material
Salary of supervisor Manufacturing Fixed Indirect labour
Insurance expenses for the Manufacturing Fixed Indirect expenses
bakery
Salary of bread distribution Distribution Fixed Classification
using elements is Salary of accounts clerk Administration Fixed applicable only for Distribution commission Distribution Variable manufacturing overheads Distribution of Overheads Distribution of overhead costs among products is two step process
1st step: Allocation of overheads among cost centre
2nd step: Accumulated costs at cost centers are
distributed among products Ex: Allocation of overhead cost in a motor vehicle manufacturing entity First Step: Distribution of overhead to Cost Centers Overheads are initially identified with cost centers Production centers: produce a product Service centers: provide related auxiliary services to production centers (do not produce product) Overheads are allocated among the production and service centers. Some overheads can directly identify with relevant production or service centre Ex: salary of storekeeper directly relate to store The process of including those costs to the cost of the cost center is “allocation” Overhead costs that incurred commonly that cannot be allocated to specific cost centers are distributed among cost centers using a reasonable basis Ex: Factory rent Machinery insurance This process referred to as “apportionment” Apportionment can be identified in two stages Primary apportionment Secondary apportionment
Primary apportionment Common overheads are distributed among production and service centers using a suitable basis Ex: Factory rent of Rs. 150 000 distributed among cost centers using floor area Overheads Basis of allocation Factory rent. Maintenance of factory building, Floor area depreciation of factory building
Canteen expenses, employee welfare expenses, Number of employees
employee supervision expenses, employee safety related expenses
Asset depreciation, assets insurance, assets Value of assets
maintenance Times of machine breakdowns
Electricity expenses Machine hours, Floor area
Heating, air conditioning expenses Technical estimations
Secondary apportionment
Apportioned overheads and the directly allocated
overhead costs to service centres are distributed among the production centres. Ex: The area of each department of a motor vehicle manufacturer is assumed as follows: Square meters Assembly department 3 000 Body fixing department 4 000 Engine department 2 000 Store department 6 000 15 000
Distribution of building rent of Rs. 150 000 among the
departments Rs Assembly department 30 000 (150 000 x 3 000) 15 000 Body fixing department 40 000 Engine department 20 000 Store department 60 000 150 000
Depending on the service provided to the production
centres, overheads of service department (Rs. 60 000) are distributed among three production centres. Ex: Assume the wages and other expenses of the stores department was Rs. 900 000 (including rent Rs. 60 000) Number of material requisition notes to issue raw materials to production centers by the stores are as; Assembly department 10 000 Body fixing department 20 000 Engine department 30 000 60 000
Total overhead of store Rs. 900 000 is distributed among
production centers as; Assembly department 150 000 (900 000 x 10 000) 60 000 Body fixing department 300 000 Engine department 450 000 Ex: There are 3 production departments and 2 service departments of Sarini PLC which produces automobiles. Annual overheads of the company is given below. This company produces motor bicycles, cars and hand tractors
Overhead item Total Production department Service department
Maintena- 200 000 10 000 15 200 000 nce Total 2 500 000 100 000 100 2 000 000 200 000 250 000 Contribution of stores and maintenance department to the respective production departments are given
department Value of issued Maintenance
raw materials time Rs. Production Engine 50 000 33 500 Finishing 40 000 20 000 Assembly 21 500 10 000 111 500 63 500 Allocate Indirect labour cost and indirect material cost can directly relate to production and service departments
Overhead item Total Production department Service department
amount Rs. Engine Finishing Assembl Stores Maintena y nce Indirect materials Indirect wages Total Overhead item Total Production department Service department amount Rs. Engine Finishing Assembl Stores Maintena y nce
Total 610 000 220 000 170 000 110 000 45 000 65 000 Apportionment of overheads to production and service department Overhead Basis Total Production department Service item amount department Rs. Engine Finishi Assembl Stores Mainten ng y ance Electricity 50 000 Rent 100 000 Machinery 250 000 depreciation Machinery 100 000 insurance Building 40 000 insurance Manager’s 100 000 salary (HR) 640 000 Overhead Basis Total Production department Service item amount department Rs. Engine Finishi Assembl Stores Mainten ng y ance Electricity Floor area 50 000 Rent Floor area 100 000 Machinery Value of 250 000 depreciation machines Machinery Value of 100 000 insurance machines Building Value of 40 000 insurance building Manager’s No of 100 000 salary (HR) employees 640 000 Overhead Basis Total Production department Service item amoun department t Rs. Engine Finishi Assemb Stores Mainten ng ly ance Electricity Floor area 50 000 20 000 12 500 5 000 7 500 5 000 Rent Floor area 100 000 40 000 25 000 10 000 15 000 10 000 Machinery Value of 250 000 100 000 80 000 30 000 20 000 20 000 depreciation machines Machinery Value of 100 000 40 000 32 000 12 000 8 000 8 000 insurance machines Building Value of 40 000 16 000 10 000 4 000 6 000 4 000 insurance building Manager’s No of 100 000 20 000 15 000 40 000 10 000 15 000 salary (HR) employees 640 000 236 000 174 500 101 000 66 500 62 000 Re-apportionment of overhead expenses of service departments to production departments
Overhead item Service department
Stores Maintenance
Allocated
Apportioned
Total Overhead item Service department
Stores Maintenance
Allocated 45 000 65 000
Apportioned 66 500 62 000
Total 111 500 127 000
Overhead item Basis Total Production department amount Rs. Engine Finishin Assembl g y
Stores Value of 111 500
issued raw materials Maintenances Maintaining 127 000 hours Overhead item Basis Total Production department amount Rs. Engine Finishin Assembl g y
Stores Value of 111 500 50 000 40 000 21 500
issued raw materials Maintenances Maintaining 127 000 67 000 40 000 20 000 hours 238 500 117 000 80 000 41 500 Total overhead cost of production departments
Overhead item Production department
Engine Finishing Assembly
Allocated 220 000 170 000 110 000
Apportioned 236 000 174 500 101 000
Re-apportioned 117 000 80 000 41 500
Total 573 000 424 500 252 500
Second Step: Distribution of overhead to Products
Accumulated overhead cost in production centres
should distributed among the products This process is referred to as “absorption” Absorption rate should be calculated for this Overhead Cost Absorption Rates Overheads are absorbed to products using pre- determined rates It’s “Overhead Absorption Rate”
Cost Centres Basis
Capital intensive production department Machine hours
Labour intensive production department Labour hours/labour cost
Budgeted labour hours In addition following methods can be used for overhead absorption
As a percentage of direct material cost
As a percentage of direct labour cost As a percentage of prime cost As a rate for unit of production Calculation of overhead absorption rate
Already, overhead costs have been distributed to
production centres
OAR should calculate for each department
Overheads should absorb to products using OAR
Ex: Consider the Sarani PLC automobile producer Engine department – capital intensive Finishing department – capital intensive Assembly department – labour intensive
Basis can use
Production Department Basis
Engine department Machine hours
Finishing department Machine hours
Assembly department Labour hours
Calculate the over head absorption rates
Production Department OAR
Engine department 573 000 = Rs. 3.82 per machine hour 150 000
Finishing department 424 500 = Rs. 4.25 per machine hour
100 000
Assembly department 252 500 = Rs. 2.53 per labour hour
100 000 Overhead Cost Absorption Charging the overheads to the finish products when calculating the cost per unit Use the predetermined OAR Charged the cost by using the actual quantity of the basis used for absorption
Absorbed Overhead = Actual x Overhead
Cost machine hours absorption rate (per unit) (per unit) Ex: Consider the Sarani PLC automobile producer. Actual hours to produce one product of each automobile are as follows
Engine Finishing Assembly
Motor bicycle 5 3 2 Cars 9 7 8 Hand tractors 7 5 4
Calculate the overhead absorption per unit
Engine Finishing Assembly Total
Motor 5 hrs x Rs. 3.82 per m.h. 3 hrs x Rs. 4.25 per m.h. 2 hrs x Rs. 2.53 per l.h. Rs. 36.91 bicycle = Rs. 19.10 = Rs. 12.75 = Rs. 5.06
Cars 9hrs x Rs. 3.82 per m.h. 7hrs x Rs. 4.25 per m.h. 8hrs x Rs. 2.53 per l.h. Rs. 84.37 = Rs. 34.38 = Rs. 29.75 = Rs. 20.24
Hand 7hrs x Rs. 3.82 per m.h. 5hrs x Rs. 4.25 per m.h. 4hrs x Rs. 2.53 per l.h. Rs. 58.11 tractors = Rs. 26.74 = Rs. 21.25 = Rs. 10.12 Over/Under Absorption of Overhead OAR calculated using budgeted data
Overheads are absorbed to products by using actual
capacity/actual time
Budgeted data can be differ from actual data
Therefore, it’s required to calculate over/under
absorption of overheads
Should adjust as income or expense for the period
Absorbed Actual Over > = amount amount absorption
Absorbed Actual Under
amount < amount = absorption Ex: Absorbed overheads for the production of 1 000 motor bicycles is Rs. 36 190 (1 000 x Rs. 36.91) and assume the actual overhead is Rs. 40 000
Under absorption : Rs. 3 810
Assume that actual overhead is 34 000
Over absorption : Rs. 2 190
Ex: Electro PLC produces electronic appliances. There are two production departments finishing and assembly and two service departments as stores and maintenance. Overheads and other details for next period is as follows Overheads Rs. Indirect materials- Finishing 98 000 Assembly 31 000 Maintenance 25 500
Other Details finishing assembly stores maintenance
Number of employees 75 125 5 5
Cost of machineries 220 000 50 000 20 000 10 000
Floor area (square
3 000 1 800 600 400 meters)
Consumed units of 1 500 900 160 240 electricity
Machine hours 25 000 10 000 1 000 3 000
Labour hours 10 000 20 000 2 000 5 000
Number of material 175 125 - - requisition notes
Maintenance hours 120 80 - -
Actual data relating to a electric fan produced Direct material Rs. 800 Direct labour Rs. 300 Machine hours - Finishing 8 - Assembly 2 Labour hours - Finishing 3 - Assembly 4
Overheads of finishing department are absorbed using
machine hours and assembly department absorbed using labour hours Required:
1. Overheads analysis sheet showing allocation,
primary and secondary apportionment 2. Calculate overhead absorption rates for finishing and assembly departments 3. Calculate the total cost of an electric fan 4. If the total overhead cost of producing 1 000 fans is Rs. 450 000, calculate the under/over absorption and write the accounting adjustment for it Thank You
