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Overheads
Overhead is the cost incurred in the course of making a product, providing a service or running a department, but which cannot be traced directly and fully to the product, service or department. Overheads is actually the total of the following: Indirect materials Indirect labour Indirect expenses In cost accounting there are two school of thoughts as to the correct method of dealing with overheads: Absorption costing Marginal costing
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If a company sells more than one product, it will be difficult to judge how profitable each individual product is, unless overhead costs are shared on a fair basis and charged to the cost of sales of each product
Overhead allocation
Allocation is the process by which whole cost items are charged direct to a cost unit or cost centre For example, the following cost will be charged to the following cost centres via the process of allocation: Direct labour will be charged to the production cost centre The cost of warehouse security will be charged to the warehouse cost centre Costs such as canteen are charged direct to the various overhead cost centres.
Example1-Overhead allocation
Cost of company: Wages of foreman of department A Rs 200 Wages of foreman of department B Rs 150 Indirect materials consumed in department A Rs 50 Rent of premises shared by department A and B Rs 300 The accounting system might include three cost centres: Cost centre 1 Department A Cost centre 2 Department B Cost centre 3 Rent Calculate the overhead costs of cost centres 1, 2 and 3
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Apportionment of overhead
Apportionment of overhead is distribution of overheads to more than one cost centre on some equitable basis. When the indirect costs are common to different cost centres, these are to be apportioned to the cost centres on an equitable basis. For example, the expenditure on general repair and maintenance pertaining to a department can be allocated to that department but has to be apportioned to various machines (Cost Centres) in the department. If the department is involved in the production of a single product, the whole repair & maintenance of the department may be allocated to the 10 product.
Bases of apportionment
Overhead apportionment basis:Overhead to which basis apply Rent, rates, heating and light, repairs and depreciation of building Deprecation and insurance of equipment Personnel, office, canteen, welfare, wages and costs of offices, first aid Basis of apportionment Floor area occupied by each cost centre Cost or book value of equipment Number of employees, or labour hours worked in each cost centre
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Maintenance
Production planning
Absorption of overheads
Absorption of overheads is charging of overheads from cost centres to products or services by means of absorption rates for each cost center which is calculated as follows : Overhead absorption Rate =
TOTAL OVERHEADS OF COST CENTRE TOTAL QUANTUM OF BASE
The base ( denominator) is selected on the basis of type of the cost centre and its contribution to the products or services, for example, machine hours, labour hours, quantity produced etc.
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Overhead absorption
Overhead absorption is the process whereby overhead costs allocated and apportioned to production cost centres are added to unit, job or batch costs. Overhead absorption is sometimes known as overhead recovery Therefore having allocated and/or apportioned all overheads, the next stage is to add them to, or absorb them into, cost units Overheads are usually added to costs units using a predetermined overhead absorption rate, which is 22 calculated using figures from the budget.
Activity
The budgeted production overheads and other budgeted data of Nick are as below. Calculate the absorption rate using the various bases of apportionment
Production
Budget department A
Production
department B
Overhead cost Direct materials cost Direct labour cost Machine hours Direct labour hours Unit of production
Rs 5,000
1,000
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Activity
Ref co has a budgeted production overhead of Rs 50,000 and a budgeted activity of 25,000 direct labour hours. Calculate the under/over absorbed overheads and give reasons for the under/over absorption in the following circumstances:(a) Actual overheads cost Rs 47,000 and 25,000 direct labour hours are worked (b) Actual overheads cost Rs 50,000 and 21,5000 direct labour hours are worked (c) Actual overheads cost Rs 47,000 and 21,500 34 direct labour hours are worked