OVERHEAD S

Overheads
Indirect cost or overhead is the total of the indirect costs incurred in the course of making a product , providing a service or running a department , but which cannot be traced directly and in full to the product or service.
INDIRECT MATERIALS

OVERHEA D

INDIRECT LABOUR INDIRECT EXPENCES

PRODUCTION OVERHEAD

CATOGERI ES OF OVERHEAD

SELLING OVERHEAD

ADMINISTRATION OVERHEAD

DISTRIBUTION OVERHEAD

ABSORBTI ON COSTING

ABSORBTION COSTING
Absorption costing is a method of sharing overheads between number of different products or services on a fair basis. It involves allocation , apportionment and absorption.

OBJECTIVE :
To include in the total cost of a product or service an appropriate share of the organisations total overhead. Practical REASONS for using absorption costing Inventory valuations . Production overheads are added to the cost of production to give the factory cost or full cost of production Establishing the profitability of different products of services.

ABSORBTION COSTING PROCEDURE

ALLOCATION APPORTIONMENT REAPPORTIONMENT ABSORBTION

 ALLOCATION
Allocation is the process of assigning whole items of cost to cost centres
Some cost are shared by all departments within organisation , so that they cannot be allocated in full to production , administration or sales and distribution overheads Some cost can be directly allocated to cost centres for production, administration and sales and distribution overheads Some cost can be allocated directly to specific production cost or service cost centres

 APPORTIONMENT
A procedure whereby indirect cost (Overhead) are spread/share between cost center based on a fair basis. Examples of Apportionment Basis:
Shared Overhead Cost Item
Rent, rates, heating and light, repairs and depreciation

Basis of Apportionment
Floor area accupied by each cost centre

Insurance of equipment, where Cost or book value of equipment the same policy covers equipment in different cost centre

Taken from BPP text book page:

 RE-APPORTIONMENT
Re-apportion service cost centre to the production cost centre. Alike apportionment , the basis used must be fair.

For Example:
Service Cost Centre
Stores

Posible Basis Of Apportionment

Number of cost value of material requisitions.
Hours of maintenance work done for each cost centre. Direct labour hours worked in each production cost centre.

Maintenance
Production Planning

Direct Method Of Re Apportionment

METHODS
ReApportionment
2

Step-Down Method Of Re Apportionment

DIRECT
Apportioning the cost of each Service Centre to the Production Cost Centre ONLY!

STEP DOWN
In this method, the Service Cost Centre will not apportion only to the Production Cost Centre but also to some Service Centre.

Taken from BPP text book page:

IMPORTANT!

Taken from BPP text book page: 145 & 146

 ABSORBTION
Overhead is absorbed into cost units

Determined an OAR based on appropriate basis

Examples

Rate per machine hour

Percentage of direct labour cost

Percentage of prime cost

Rate per labour hour

Rate per unit

*It depends on the concern of an organisation or department

INSENTIVE
Labour Production Department (Machinery)

BASIS USED
Labour hour rate Direct Machine Hour

Arbitrary nature of Absorption Costing: - less likely to be accurate - methods or absorption used must be reviewed regularly

 PREDETERMINED OAR
= An Total budgeted OH expected Total budgeted Activity cost Predetermined VS Actual
PREDETERMINED ACTUAL
Predetermined OAR is used It is not practical for but over or under absorption of management planning and OH will occur due to factors control purposes to wait until that vary throughout the the end of accounting period to period. calculate the actual OH

 OVER & UNDER ABSORB

Under Absorb = Actual > Absorbed Over Absorb = Absorbed > Actual Important Formula! Actual OH Absorb OH = Value ( + / )

-ve (n) = Over absorption (o) +ve (p) = Under absorption (u)
NOPU !!
Why under/ over absorption is very important in absorption costing using predetermined absorption rates? The rate is predetermined from estimates of OH cost n the expected volume of activity

 NON-PRODUCTION OVERHEAD
The indirect cost of an org. that are not classified as manufacturing OH e.g: Administration OH, Selling OH, Distribution OH n Research n Development (R&D) costs. a) Internal Reporting
-Estimation of total cost/actual cost requires a total cost per unit of output. -For product pricing purposes n for internal management reports => Appropriate to allocate nonproduction OH to units of output.

Bases Of Apportioning
The methods of allocating : Choose a basis for the OAR. Use the prod cost as the basis for allocating non-prod costs to products.

OAR = Estimated non-prod OH Estimated prod costs

Types Of OH
Selling n Marketing Research

Possible Absorption Base

Sales Value Consumer cost = prod cost cost of direct material Added value = Sales value of product cost of bought in materials n services Sales value Full prod cost *Absorption rates are usually stated as %

Distribution Administration

Administration OH
Consists:
Executive salaries n wages/salaries of all staff in administration dept. Office rent n rates Lighting Heating n cleaning the office
*Absorption rates for administration OH => % of full prod cost.

Selling n distribution OH
Selling costs => incurred to obtain sales Distribution costs => Begin as soon as the finished goods are put into warehouse despatched to the customer. *Selling OH is absorbed on the basis on the basis of sales value. * Distribution OH more closely linked to prod > sales - Extra cost of prod - Absorbed on a % of prod cost but special situation (size n weight of products affecting the delivery charges) may cause a