Overheads

Meaning of overheads
SUM OF INDIRECT MATERIALS, INDIRECT WAGES AND INDIRECT EXPENSES Cost of Indirect materials, indirect labour and indirect expenses which cannot be conveniently charged to specific unit

Classification of overheads
Can be classified, according to: 1. 2. 3. 4. 5. Nature Normality Controllability Variability Function

1. According to Nature:
1. Indirect Materials: Materials like lubricating oil, grease, coal, sand paper used in polishing, Cotton waste used for cleaning the products etc. does not become a part of finished goods. Such materials which does not become a part of finished goods are called indirect materials. 2. Indirect Labour: Labour expenses incurred for the payment of watchman, cleaner, clerk, supervisor, peon are not directly part of the labour expenses of production. Even though they help or assist production, they are not directly engaged in the process of production.

3. Indirect Expenses: Expenses like insurance, advertising, rent, depreciation, power and lighting are come under overhead of indirect expenses. All expenses which will not come under the indirect labour and indirect materials come under the head of Indirect Expenses.

2. According to Normality
1. Normal Overheads: refer to such overheads which are expected to be incurred in attaining a given output. These overheads are unavoidable. They are, therefore, included in production costs. 2. Abnormal Overheads: refer to such overheads which are not expected to be incurred in attaining a given output. E.g. cost of abnormal idle time. Such costs are charged to costing profit and loss A/c.

3. According to Controllability
1. Controllable Overheads: those which can be controlled by executive action. 2. Uncontrollable Overheads: those which can be controlled by executive action.

4. According to Variability
Fixed Overheads: There is no changes in such overheads irrespective of the output or level of production. E.g. Salaries, Rent and rates, legal expenses, bank charges etc. Decrease in production or increase in production does not affect such overheads. Variable Overheads: These vary according to the production, e.g. fuel, Salesmen commission, indirect materials, stationary, etc.

5. According to Function
1. Production/Factory overheads: These include indirect wages, indirect material cost, indirect factory expenses. 2. Administration overheads: Legal expenses, auditors fees, telephone charges, vehicles for managers, office rent, Salaries of office staff, office lighting and repairs of office buildings and equipments are some of the examples of administration overheads. 3. Selling & Distribution overheads: Costs incurred for creating demand for the product and securing and servicing orders comes under the selling overheads. E.g. Advertisement, bad debts, commission to selling agents, Salaries of sales persons, showroom expenses, traveling expenses, depreciation and repairs of delivery vans, packing cost, carriage outwards,

Stages of Overheads Distribution

1. Collection and classification of overheads 2. Departmentalization of overheads 3. Absorption of Overheads

1. Collection and classification of overheads

Grouping of items under suitable account headings. A code is attached to each heading, known as codification. Codes ensures ease of classification, accounting and control. Types:
Numerical codes -------11,12,13 Alphabetical codes / Mnemonic codes---------AA, AB, AC Alpha-numerical -------A1, A2, A3

2. Departmentalization of overheads
Departmentalization of overheads refers to allocation and apportionment of overhead to production and service departments. It is the process of allocation and apportionment of overheads to different departments or cost centres. Types:
Production dept. Service dept.

 Allocation:
process of charging the full amount of overhead costs to a particular cost centre. Nature of expense is such that it can be easily identified with a particular cost centre.

Apportionment:
Process of splitting up an item of overhead cost and charging it to the cost centers on an equitable basis. Done in case of those overheads which cannot be wholly allocated to a particular dept.

3. Absorption of Overheads
Charging of overheads of a cost centre to different cost units in such a way that each cost unit bears an appropriate portion of its share of overheads. This is done by means of overhead rates (refers to the rate at which the overheads are to be charged to different cost units).

Classification of overheads rates

Single overhead rate Multiple overhead rate

Single overhead rate

Also known as Blanket Overhead Rate. Overhead are absorbed on the basis of one single rate computed for the entire factory. Applied in case of those factories where the work performance in different departments is fairly uniform and standard. Single overhead rate = overhead cost for entire factory total quantity of the base selected

Multiple overhead rate

Overhead rates are calculated for each department or cost centre separately through which a product or job is to pass. Used in those cases where a job or a product has to pass through a number of departments or cost centre. In such case, the overhead rate for each department / cost centre will be calculated separately. Multiple overhead rate = overhead cost for cost centre dept. corresponding base

OVERHEAD 1. FACTORY RENT DEPRECIATION OF FACTORY BUILDING INSURANCE OF BUILDING 2. HEATING AND LIGHTING

BASIS OF APPORTIONMENT Floor area occupied or capital value of the asset

No. of Light points or floor area occupied, hours used, or watts if separate meters are avaliable. Value of machinery

3. DEPRECIATION AND INSURANCE OF MACHINERY 4. SUPERVISION 5. STORES OVERHEAD 6. MATERIAL HANDLING CHARGES

No. of workmen or amount of wages paid or floor area Value of direct material Weight of materials of each department subject to any special factor affecting handling cost.

SERVICE DEPARTMENT COST 1. MAINTENANCE DEPARTMENT

BASIS OF APPORTIONMENT Actual services utilized or hours worked for each department

2. PAYROLL OR TIME KEEPING DEPT. 3. PERSONNEL DEPT. 4. STORE KEEPING DEPT. 5. PURCHASE DEPT. 6. WELFARE DEPT. 7. INTERNAL TRANSPORT SERVICE

Direct labour hours, machine hours, no. of employees Rate of labour turnover, no of employees No. of requisition, quantity or value of material purchased No. of purchase orders, value of material purchased No. of employees Weight or value of the products, or weights and distance covered.

Inter-Departmental Service
Charging service dept. cost to each other on a reciprocal basis. Such costs are also called reciprocal costs. Methods:
Simultaneous equation method Repeated distribution method Trial and Error method

1. Simultaneous equation method

The amount of overhead of each production department is obtained by solving simultaneous equations.

2. Repeated distribution method

Service departments costs are apportioned over departments, production as well as service, according to agreed percentage until the total costs of the service departments become zero or the figures become too small to matter.

3. Trial and Error method

This method is used where two or three interlocked service cost centres are involved. The cost of one service cost centre is apportioned to another service cost centre. The cost of another service centre plus the shares received from the first cost centre is again apportioned to the first cost centre. The process is repeated till the amount to be apportioned becomes negligible.