SSR COLLEGE OF ARTS, COMMERCE AND SCIENCE. : SSR COLLEGE OF ARTS, COMMERCE AND SCIENCE. COSTING : COSTING OVERHEADS : OVERHEADS MEANING:- Overhead is the aggregate of indirect material cost, indirect wages and indirect expenses. Hence all the expenses over and above the prime cost are known as ‘Overhead’ charges.
DEFINITION:- “Overheads are those costs which do not result from the existence of individual cost units.” CLASSIFICATION OF OVERHEADS : CLASSIFICATION OF OVERHEADS factory Administration Selling Distribution Material Labour Expenses Elements Fixed Variable Semi-Variable Behaviour Controllability Controllable Uncontrollable Function Slide 5: CLASSIFICATION OF OVERHEADS:-
Classification of overheads is the process of grouping of indirect costs on the basis of common characteristics and clear objectives.
Functional Classification :
The main groups of overheads on the basis of this classification are as follows :-
Factory Overheads :
Factory overheads are termed as production overheads, works overheads or manufacturing overheads . It means indirect expenditure incurred in connection with production operations. e.g. Lubricants, factory power and light, depreciation of plant and machine etc. Slide 6: Administration Overheads:-
This consists of all expenses incurred in the direction, control and administration of an undertaking which is not related directly to production, selling and distribution functions. Administration overheads are also known as office overheads, management overheads etc. e.g. audit fee, legal charges, postage and telephone manager’s salary etc.
It is the cost incurred for promoting sales and retaining customers. e.g. advertising, showroom expenses, bad debts, catalogues and price lists etc. Slide 7: Distribution Overheads:-
It comprises of all expenditure incurred from the time, product is completed in the factory, until it reaches its destination (customer). e.g. packing cost, carriage outward, delivery van costs, warehousing costs etc.
Both selling and distribution costs are incurred after the production work is over and thus taken together these are known as “After Production Costs.” Slide 8: Element wise Classification:-
The main classes under this heading are as follows:
In the course of manufacture of a product, indirect materials do not form part of a finished product. Indirect materials cost is the material cost which cannot be allocated, but which can be apportioned to or absorbed by cost centres or cost units. e.g. electrodes, coolant, cotton wastes etc. Slide 9: Indirect labour:-
Indirect wages are the wages and overtime paid for all labour in the factory, viz. helpers in factory, foremen, supervisors etc. who do not help directly to in converting the raw material into a finished product. It also includes salary paid to office and selling and distribution staff.
Indirect expenses are all expenses of the factory such as rent, rates, taxes and insurance of factory, repairs of factory machines, power etc. it also incldes indirect expenses incurred for office and selling and distribution. Slide 10: Behaviour wise Classification:-
Different overheads behave in different ways when volume of production increases or decreases. On the basis of behaviour, overheads may be classified as follows:-
These overheads remain unaffected or fixed in total amount by fluctuation in volume of output. e.g. rent and rates, managerial salaries, building depreciation, legal expenses etc. Slide 11: Variable Overheads:-
This is the cost which in aggregate, tends to vary in indirect proportion to changes in the volume of output. Variable overhead per unit remains fixed. e.g. indirect labour, indirect material, salesman’s commission, power etc.
This overhead is partly fixed and partly variable. In other words , such cost vary in part with the volume of production and in part they are consistent, whatever be the volume of production. e.g. electricity charges, telephone charges, repairs and maintenance etc. Slide 12: Contolwise classification:-
There are two aspects in control of overheads :one is accounting aspects of control which consists of classification, collection, apportionment and absorption of overheads and also analysis according to function and variability. This is helpful for ascertainment of overheads with accuracy and control.
Controllable overheads are the indirect costs which may be directly controlled at a given level of management authority. Variable overheads are generally controlled by departmental heads. Slide 13: Un-controllable Overheads:-
Un controllable overheads are the indirect costs which cannot be influenced by the action of a specific member of an organization. e.g. rent and taxes, office salaries etc. ACCOUNTING AND CONTROL OF OVERHEADS : ACCOUNTING AND CONTROL OF OVERHEADS Steps in Overhead Accounting:-
Unlike direct materials and direct wages, overheads cannot be allocated to cost units directly. The various steps taken for distribution of overheads costs are as follows:
Collection and classification of overheads.
Allocation and apportionment of overheads.
Re-apportionment of overheads.
Absorption of overheads. Slide 15: Collection of Overheads:-
the main sources from which overhead costs are collected are as follows:
Invoice: for collection of indirect expenses like rent, insurance etc.
Stores Requisition: For collection of indirect materials.
Wages analysis sheet: For collection of indirect wages.
Journal Entries: For collection of those overhead item which do not result in current cash outlay and need adjustments e.g. depreciation etc. Slide 16: Allocation and Apportionment of Overheads:
Allocation of overheads:
Certain items of overhead costs can be directly identified with a particular department or cost centre as having been incurred for that cost centre. Allotment of such costs to departments or cost centres is known as allocation.
Apportionment of overheads:
Certain overhead costs cannot be directly charged to a department or cost centre. Such costs are common to a number of cost centres or departments. Distribution of such overhead costs to various departments is known as apportionment of overheads. Slide 17: Re-apportionment of Overheads:
Once the overheads have been allocated and apportioned to production and service departments and totaled, the next step is to re-apportion the service department cost to production departments. This is necessary because our ultimate object is to charge overheads to cost units, and no cost units pass through service departments.
Absorption of Overheads:
After apportionment of overheads to production departments, these can be charged to cost units. In essence the procedure is to take each production department and distribute its overheads among all cost units passing through that particular department. This is known as absorption of overheads. Slide 18: Overhead Rates:-
Overhead absorption rates are determined for the purpose of absorption of overheads is costs of job, process or products. The rate is given by following formula:
RATE = AMOUNT OF OVERHEADS
QUANTITY OR VALUE OF BASE
Amount of overhead absorbed in a product = Unit of base * overhead rate Slide 19: Types of Overheads:-
This rate is determined by dividing actual overheads incurred during the accounting period by actual quantity or value of base selected. The rate is calculated as follows:
Actual Rate = Actual Overhead Expenses
Actual Quantity or Value of Base
This rate is determined on the basis of budgeted overheads and the budgeted base for the period. Formula:
Pre-determined Rate = Budgeted overheads for the period
Budgeted base for the period Slide 20: Blanket Rate:-
This is the single or general overhead rate applicable to the whole factory. This is calculated as follow:
Blanket Rate = Overhead cost for the factory
Total quantum of the base selected
These are the rates for different department in the factory. A separate rate is determined for each department. Formula:
Overhead Rate = Department cost centre or product
Corresponding Base Slide 21: Method of Overhead Absorption:-
Direct Labour Hour Rate:-
The expenses incurred other than wages paid to workers on each category of workers are listed and totaled for a certain period. The amount is divided by the number of hours put in by all the direct workers during the period to get the rate. Formula:
Direct Labour Hour Rate = Factory Overheads
Direct Labour Hour During a Period
Machine Hour Rate:-
The machine hour rate is determined by dividing the overhead costs by the number of effective machine hours likely to be worked. Slide 22: Computation of Machine Hour Rate:-
Each machine or a group of machine is treated as a cost centre in order to identify the overhead expenses.
Machine overhead expenses are of two types viz. standing charges (fixed) machine expenses (variable).
These expenses remains constant. They do not vary with the use of machines. e.g. rent, rates etc. these exp. are divided by the total working hour of the period will give an hourly rate for standing charges. Slide 23: Machine Expenses:-
These are variable expenses which vary with the use of machine e.g. power, repairs etc. the amount of machine expenses are divided by normal working hours to give hourly rate for each item.
Combined Machine Hour Rate and Labour Hour Rate:-
In this method the expenses which are inseparable from the running of the machine are allocated on the basis of Machine Hour Rate and other expenses which are not directly related to the machine are allocated on the basis of Labour Hour Rate. Slide 24: Percentage on Direct Material Cost:-
Under this method, the cost of material consumed in production is considered as a basis of absorption of overheads. The rate is determined by dividing the total overheads by cost of direct material. Formula:
Rate = Factory Overheads*100
Direct Material Cost
Percentage of Direct Labour Cost:-
Under this method, overheads are recovered on the basis of pre-determined or actual rate. Formula:-
Rate = Factory Overheads*100
Direct Labour Cost Slide 25: Percentage of Prime Cost:-
This method can be used where a standard product requiring a constant quantity of materials and a number of labour hours is produced. Formula:-
Rate = Factory Overheads*100
When the amount of overheads absorbed is less than the amount of overheads incurred. It is called Under Absorption or Under Recovery. Slide 26: Over Absorption:-
When the amount of overhead absorbed is more than the amount of overhead incurred, it is known as Over Absorption or Over Recovery.
Reasons For Under and Over Absorption:-
Faulty estimation of overhead costs.
Faulty estimation of the quantity of output.
Non utilization of normal capacity.
Unforeseen changes in the production capacity.
Seasonal fluctuation in the amount of overhead in certain industries. SPECIAL ITEMS OF OVERHEAD COSTS : SPECIAL ITEMS OF OVERHEAD COSTS Capacity cost, idle capacity cost
Research and development cost
Cost of obsolescence
Cost of tools
Cost of training Slide 28: Capacity cost:-
capacity of a factory refers to its ability to produce with the resources and facilities available at its disposal. Example a company is able to produce 1500 units of a product per day, the capacity of the factory is said to be 1500 units of product per day. the plant capacity may be expressed in terms of any of the following:-
Units of products
Production Hours or Machine Hours.
Value in Rupee. Slide 29: Types of capacity levels:
The maximum capacity of a plant can be achieved only under perfect conditions. i.e. when there is no loss of operating time it is also known as theoretical capacity.
also known as practical operating capacity, this is the maximum capacity less output or time lost due to unavoidable factors like plant repairs and maintenances, setting up time, Sundays and holidays etc and other normal delays. It does not consider external factors such as lack of orders, unbalanced capacity in any department etc. Slide 30: Capacity based on sales expectancy:-
this is a capacity based on expected sales and is determined after a careful study of the market conditions. This capacity level is usually less than practical capacity because of lack of orders from the customers.
Normal capacity/Average capacity:-
The concept of normal capacity is based on the average utilization of plant capacity over a long period.
This is the capacity actually achieved during a particular period. This is known only after the period is over and may be below or above the capacity based on sales expectancy. Slide 31: Idle capacity cost:-
This is the difference between practical capacity and capacity based on sales expectancy or actual capacity. In other words idle capacity is production capacity lost due to reasons like lack of orders from customers, absenteeism, shortage of materials etc.
Research and development cost:-
Research cost is “the cost of searching for new or improved products, new applications of materials, or new or improved methods.”
Development cost is “the cost of the process which begins with the implementation of the decision to produce a new or improved product with the use of
new and improved technology. Slide 32: Depreciation cost:-