Lesson 8

U n i t - I I

OVERHEADS

OBJECTTVES

The objectives of the study are to:

. understand the meaning of overheads

classify the overheads

.know the need for codification of overheads

learn the procedure for distribution ofoverheads

STRUCTURE

8.1 Introduction

8.2 Classification of Overheads

8.2.1 According to Functions

8.2.1.1 Production Overheads
8.2.1.2 Administration Overheads
8.2.1.3 Selling Overheads
8.2.1.4 Distribution Overheads

8.2.2 According to Elements

8.2.2.1 Indirect Materials

8.2.2.2 Indirect Labor

8.2.2.3 Indirect Expenses

8.2.3 According to Behavior

8.2.3.1 Fixed Overheads

8.2.3.2 Variable Overheads

8.2.3.3 Semi Variable Overheads

8.3 Codification of Overheads

8.4 Distribution of Overheads

Collection of Overheads
8.4.1
Departmentalization of Overheads
8.4.2
Allocation of Overheads
8.4.2.1
8.4.2.2 Apportionment of Overheads

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 8.5 Summary
8.6 Glossary
8.7 Answers to Activities

8.8 Questions

8.1 INTRODUCTION

direct cos
osts and indirect
Every form of production olves two types of costs
direct wages and direlirect expenses
costs. The total of all directcosts such as direct material,
1S termed as 'Prime cost' and the total of all indirect costs such as indirect material, indirert

wages and indirect expenses is known as Overheads'. These indirect expenses cannot
De charged directly to a specific job, product or service. The indirect portton of the total

COst constitutes the overhead cost. Overheads are also known as Loading, Burden, Oncost
I.C.M.A. London defined overheads
Supplementary Costs, and Non Production Costs etc.
as an aggregate of indirect material, indirect wages and indirect expenses

Blocker and Welmer "overhead costs are the operating costs of a

According to
business enterprise which cannot be traced directly to a particular unit of output. Such

cOsts are invisible or unaccountable".

In the words of Harold J. Wheldon, overhead may be defined as the cost of indirect
material, indirect labouf and such other expenses including services as cannot conveniently
be charged to specific unit. Alternatively, overheads are all expenses other than direct

Costs"

8.2 CLASSIFICATIONOF OVERHEADS

Overheads may be broadly classified according to functions, elements and behaviour
The following chart gives their classification at aglance

Overheads

FunctionsS Elements Behavior

Production Indirect Materials Fixed

Administration Indirect Labour Variable
Selling Indirect Expenses Semi Variable
Distribution

8.2.1 According to Functions:

This method of classification is based on the major business functions i.e. production,
administration, selling and distribution.

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 8.2.1.1 Production Overheads:
These costs are also known as
overheads. Ihey are the aggregate ofmanufacturing
the indirect
overheads, factory overheads or WOks
division of a concerT and include all the expenses of operating the praduction
indirect
paterial into finished product. expenses incurred to convert the raw

Examples: lubricants: factory power; cotton

waste; consumable stores;
factory building; repairs and depreciationstore
insurance ot plant and machinery and and

keeping expenses; 1ndirect wages etc. maintenance,

8.2.1.2 Administration Overheads:
The other terms used are
general or office overheads. These include all such
connected with the direction; control and expenses
administration functions of the business excluding
those connected with selling and
distribution functions.
Examples: office rent and rates; office lighting and
heating; office salaries; audit fees,
postage and telephone; printing and stationery;
building and machinery etc. legal charges; depreciation of office

8.2.1.3 Selling Overheads:

This type nf expenditure is incurred in promoting sales and
retaining the customerS.
It is that portion of the marketing cost, which is incurred in serving orders.
Examples: advertisement; salesmen salaries; brokerage and commission: bad debts;
showroom expenses and traveling expenses etc.

8.2.1.4 Distribution Overheads:

The expenditure incurred firom the time product is completed in the factory until it
reaches the market or a customer is classified as distribution overheads.

Examples: packing and shipping expenses; carriage outwards; warehousing cost; delivery
van costs etc.

Selling and distribution overheads are incurred after the completion of the production
work and hence together are called as "After Production Costs"

8.2.2 According to Elements:

Under this category, the expenditure is classified into indirect material, indirect
labour and indirect expenses.

8.2.2.1 Indirect Material:

It is a cost, which cannot be directly allocated to a particular job or production but
Is absorbed by cost centres or cost units indirectly.

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 Examples: nuts and bolts, lubricatingoil, gum, sand paper, tools for general use etc
8.2.2.2 Indirect Labor:
It is such identified ith
unit.
wages, which cannot be conveniently a
particular cost
Examples: gratuity, holiday pay, leave pay, contribution
salary, overtime wages etc.
op supervisory
8.2.2.3 Indirect Expenses:

All the costs other than indirect material and indirect wages, wnich cannot be
Cd
e
dhrectly to any job, process or work are termed as indirect expenses.
Examples: rent and rates, depreciation, insurance etc.
8.2.3 According to Behavior:
Ihis
classificatioris based on the variability of overheads according to the volume
O
production. On this basis, overheads are classified into fixed overheads,
variable
Overheads and semi fixed or semi
variable overheads.
8.2.3.1 Fixed Overheads:
Tnese are
period costs, which remain fixed in total amount irTespective of the
Tluctuations in volume of output. But, if the
change in output is substantial, they also
increase in the
long run. Though the total cost is constant during a given period, the cost
per unit production varies inversely with the volume of
of
output. These costs are known
as period costs
because, these are dependent on time rather than on output.
Examples: rent and taxes, salaries of staff, postage, siationery, building depreciation
legal expenses etc.
8.2.3.2 Variable Overheads:

These costs, in aggregate, change in direct proportion to changes in the volume of

Output. But, the variable cost per unit of output remains the same.

Examples: indirect material, indirect labor, power, salesmen commission, fuel expenses
etc.

8.2.3.3 Semi Variable Overheads:

b
These costs are partly fixed and partly variable. They are constant upto a particular
levelof output and thereafter vary with the change in the level of output.

Examples: depreciation, repairs and maintenance, supervisory salary etc.

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 The classification of
costs into
fixed and variable assumes great 11
anning,
plant decision-making and controlling. The various uses of this mporan
classification ae
given below:

) In a tlexible budget, we prepare the budget for different levels of activity. In tne
preparation ot tlexible budgets, the distinction between fixed and variable cOst 1s
necessary as tixed costs remain constant at all
the levels of activity, whereas, variaol
costs vary according to the actual
level of output.
i) As the main problem of decision making so related to changes in the volumc

output, the seggregation of costs into fixed and variable

components assume
importance in decIsions relating to introduction of new product lines, fixation O
selling prices, using alternative methods of production etc.
ii) The marginal costing technique is totally dependent on the separation of COsts into
fixed and variable. In thistechnique, only variable costs are charged to the product
and fixed costs are treated as period costs which can be recovered in the long run
from the contribution 1.e. sales price in excess of variable cost.
iv) Classification of costs into fixed and variable facilitates effective cost control by
pointing out where the management should concentrate to control the cost. Fixed
cOsts are generally non-controllable in the short run, whereas, variable costs are

mostly controllable. For example, material cost which is a variable cost can be
controlled by purchasing in economic lots or purchasing during slack season whereas
salaries of the staff, a fixed cost, may not be controllable in the short run.

8.3 CODIFICATION OF OVERHEADS

After the classification of overheads as above, each group of overhead is to be

given a number or code so that the items of expenses of a similar nature may be grouped
together under one head. Such numbers or symbols are called as Standing Order Numbers
and are shown on all documents used in Cost Accounting System.

The allocation of code numbers or symbols can be done by following a serial

number (1,2,3,4 and so on) or a decimal system (1.1, 1.2, 1.3, 1.4 and so on) or an
alphabet (A, B, C, D and so on) or a combination ofalphabets and numbers (A1, A2, A3,
A4 and so on).

Example: If F' denotes Factory Overhead, Fl may indicate Factory Indirect Material,
F2 Factory Indirect Labour, F3 Factory Power and so on.

The number of standing order numbers depends on the size of the factory, type of
CXpenses and the extent of control necessary. The codification of overheads should be
Clear, unambiguous and flexible so that as and when need arises; suitable changes can be
lade without seriously dislocating the existing system

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 8.4 DISTRIBUTION OF OVERHEADS
After the classification and codification of overheads, the next step iis distributi
of overheads. As overhead costs annot be directly allocated to cost units, the followin
procedure is followed in the distribution of overhead cost.

() Collection of overheads according to standing order numocis

(2) Allocation and apportionment of overheads to Producdon and Service I
Departments
on some suitable basis.
hcaPportionment of Service Departments costs to Production Departments onl

Reapportionment of Service Departments costs to Production Departments and

Service Departments and
Cost Units.
O ADSOrption of overheads of each Production Departments by

8.4.1 Collection of Overheads:

ne various items of overheads are coHected under separate standing order numbers

The main sources from where overheads collected are invoices, stores requisition slips,
wages analysis sheets, cashbook, iournal entries and other reports and registers.

8.4.2 Departmentalization of Overheads:

Ihe allocation and apportionment of overheads to Production and Service

Departments is known as Departmentalisation or Primary Distribution of Overheads. It
involves two stages viz., Allocation and Apportionment of Overheads.

8.4.2.1 Allocation of Overheads:

It is the process of charging or allotting the full amount of overhead costs to a
particular cost centre or cost unit. It is possible only when the expenses can be easily
identified with a particular cost centre. It is that part of cost attribution, which charges a

specific cost to a cost centrel cost unit.

indirect
Example: salary paid to the foreman ofa particular Department, indirect material,
sub meters are installed in the Department) can
wages, overtime, idle time, power (when
be easily identified with a Department and therefore directly charged to that Department.

8.4.2.2 Apportionment of Overheads:

When an item of Overhead cost cannot be directly identified with a paricular

the cost centers on an equitable basis. it refers to the
Department, such cost is charged to
distribution of overheads among Departments or Cost Centres on an equitable
basis. It 1s
to Cost Centres/Cost Units. If an overhead
the allotment of proportions of items of cost
The costs which are common to the cost centres
cannot be allocated, it is apportioned.

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i k ep o w
whole factory, fire
e r

partmente penses, medical and insurance, lighting and

ween the various
other
duction and Servicewelfare expenses etc.powe
wer, stores and canteen
are to be equitably shared
betwe
equitaby
The main difference between Departments.
allocation deals with ihe allotment ofallocation and apportionment of overheads at
whole items while
allotment
of proportions
of items of
overheads. apportionment
deals w
ith the

Apportionme; ent of overheads to Production

and Service Depar
artments can be by
a n y
ofthe oliowing methods.
Service or Use: Here, the
overhead cosi borne by each
proportion to the service rendered by it. Greater thecost centre cost un
or w

he in
unit, service rendered by a cost
centre / cOst larger the amount of overhead cost borne is
apportioned to une Departments on the basis of floor area Example:byrent
by it.occupied eacn

Department.

Survey Method: When it is difficult to selecta suitable base or apportionment, a

survey 1S made ot the various factors involved and the overhead cost to be shared

by each cost centre / cost unit is determined. Example: Lighting expenses may DE
apportioned on the basis of a survey of the number of lights and the estimated
hours of use.

Gii) Ability to Pay Method: Here, the Unit/Department having the largest income is
charged with the largest of overhead cost similar to the theory of taxation which
of
holds that those who have the largest income should bear the highest proportion
the
tax burden. Thus, the most efficient or profitable Department burdened with
is
the method is generally considered as an
largest share of overhead cost. Therefore,
irrational and inequitable method.

Bases of Apportionnment:
of overhead are given below.
The most commonly used bases of aPportionment
Overheads
Basis of Apportionment
and
Rent of the building lighting
1. Floor Area other building
rates and taxes;
heating;
insurance, depreciation and repairs.
expenses like

repairs and
insurance,
Depreciation,
2. Capital Value plant and machinery;
maintenance
of
insurance of stock.

General Overheads.
3. Direct Labour hours
or Machine hours

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 4. Technical Estimates Lighting: power and steam consumption
managerial salaries; internal transport
ion

5. Number of Workers Canteen expenses; welfare expenses; tim

keeping expenses: supervision.

Material handling expenses; store keeping Materiat

6 Weight/Value of rials
expenses.
It should be noted that there is no hard and fast rule regarding the basis of
apportionment. The choice of an appropriate method of apportionment i1s a matter a
1dgement. Apportionment should be based on the technical opinion of the Departme
nt
concerned and the expertise of the Cost Accountant.

Activity 1

Overheads include total of all indirect costs such as

and

Activity 2

Overheads are also known as

Activity 3

Overheads may be broadly classified according to

Activity 4

According to Functions, Overheads are classified into

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Activity 5

Overheads are classified into

According to Elements,

Activity 6

According to Behavior, Overheads are classified into

Illustration 1

Shirisha Company is divided into four Departments A, B, C as Production

Departments and D as Service Department. The actual costs for a period are as follows.
Rs.

Rent 1,000
Repairs to Plant 600
Depreciation of Plant 450

Employer's liability for insurance 150

Superv.sion 1,500
Fire Insurance in respect of Stock 500

Power 900

Light u120

The following information is available in respect of the four Departments:

Dept. A Dept. B Dept.C Dept. D

Area (sq. Mts.) 1500 100 900 500

No. of employees 20 15 10

6000 4000 3000 2000

Total wages (Rs.)
Value of Plant (Rs.) 24000 18000 12000 6000
Value of Stock (Rs.) 15000 9000 6000
H.P. of Plant 24 18 12 6

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 on the most cquitable basis.
APportion the cost to the Departments

Solution
Overheads Distribution Statement

Dept. C
Item Basis Dept. A Dept. B Dept. D
Rs. Rs. Rs.
Rs.

Rent 375 275 225 125

Floor Area
240 180 120 60
Repairs Plant Value
135 90 45
Depreciation Plant Value 180
33 27 15
Light Floor Area 45
Power H.P. 360 270 180 90
450 300 150
Supervision No. of emp. 600
Fire Insurance Stock Value 250 150 100

Insurance No. of emp. 60 45 30 15

Total 2,110 1,538 1,072 500

Illustration 2

Shirisha Company is divided into four Departments A, B, C as Production

Departments and D as Service Department. The actual costs for a period are as follows.

Rs.

Rent 1,000
Repairs to Plant 600
Depreciation of Plant 450

Employer's liability for insurance 150

Supervision 1,500
Fire Insurance in respect of Stock
500
Power 900
Light 120

174
The to
fallowing information is available in respect of the four Departments

Dept. A Dept. B Dept. C Dept D

Area (s9 MIs.) 1500 1100 900 500

No. of employees 20 15 10
Total wages (Rs.) 6000 4000 3000 2000
24000 12000 6000
Value of Plant (Rs.) 18000
Stock (Rs.) 15000 9000 6000
Value of
HL.P. of Plant 24 18 12 6

ApDortion the cost to the Departments on the most equitable basis.

Solution

Overheads Distribution Statement

Dept. C Dept. D
Basis Dept. A Dept. B
ltem

Rs. Rs. Rs. Rs.

225 125
Floor Area 375 275
Rent
240 180 120 60
Plant Value
Repairs 45
Depreciation Plant Value 180 135 90

33 27 15
Floor Area 45
Light 180 90
H.Power 360 270
Power
450 300 150
No. of emp. 600
Supervision
250 150 100
Fire Insurance Stock Value
45 30 15
Insurance No. of emp. 60

1,538 1,072 500

Total 2,110

Illustration3
30.6.04 is given below.
A Company's production for the year ending
Service Department
Production Department

Pl P2 P3 Office Stores Workshop

Direct Wages (Rs.) 20,000 25,000 30,000

Direct Material (Rs.) 30,000 35,000 45,000

3,000 1,000 2,000 2,000
Indirect Material (Rs.) 2,000 3,000
Indirect Wages (Rs.) 3,000 3,000 4,000 10,000 10,000 5,000
Area (sq.mts) 250 300 150 100 250
200

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Machinery (Rs.) 30,000 35,000 25,000
15,000
H.P of Machinery 15 20 25
Machine hours
worked 10,000 20,000 15,000

General expenses: Rent Rs. 12,500; insurance Rs. 1,050; depreciation 15 o

value of machinery; power Rs. 3,800; light Rs. 1,250.

TOu are required to prepare an Overhead Distribution analySIS shect for sL

the
Department showing clearly the basis of apportionment where necessary.

Solution
Statement showing apportionment of Overheads
Production Department Service Department

Basis P1 P2 P3 Office StoresWorkshop

Rs. Rs. Rs Rs. Rs. Rs.
Indirect Material 2,000 2,000 3,000 1,000 2,000 2.000
IndirectWages 3,000 3,000 4,000 10,000 10,000 5,000
Rent Area 2,000 2,500 3,000 1,500 1,000 2,500
Insurance Machinery 300 350 250 150
Depreciation 4,500 5,250 3,750 2,250
Power H.P. 877 1,169 1.462 292
Light Area 200 250 300 150 100 250
Total 12,877 15,519 15,762 12,650 13,100 12,442
Secondary Distribution
Office expenses D.Wages 3,373 4,217 5,060 12,650
Stores expenses D. Material 3,573 4,168 5,359 -13,100 t
Workshop expenses Machine Hrs. 2,765 5,530 4,147 -12,442
Total 22,588 29,434 30,328
8.5 SUMMARY

The total of all direct costs such as direct

material, direct wages and direct expensc
istermed as Prime cost and the total of all indirect costs such
as indirect material,
wages and indirect expenses 1s known as "Overheads,
indirec
These indirect expenses can
be charged directly to a specilic job, product or
service. The indirect of the tal
portion
cost constitutes the overhead cost. to

176
 Overheads may be broadly classified according to functions, elements and behavior.
According to functions. they are classified as Production, Administration, Selling
and Distribution Overheads. According to Elements, they are grouped as Indirect Materials,
Indirect Labor and Indirect Expenses. According to Bchavior, they are classified as Fixed
Variable and Semi Variable Expenses.

After the classification of overheads as above, each group of overhead is to be

given a number or code so that the items of expenses of a similar nature may be grouped

together under one head. Such numbers or symbols are called as Standing Order Numbers
and are shown on all documents used in Cost Accounting System.

After the classification and codification of overheads, the next step is distribution
distribution of overhead costs involves
of overheads. The
(1) Collection of overheads according to standing order numbers.
Production and Service Departments
(2) Allocation and apportionment of overheads to
on some suitable basis.

(3) Reapportionment of Service Departments costs to Production Departments only

costs to Production Departments and
(4) Reapportionment of Service Departments
Service Departments and

of each Production Departments by Cost Units.

(5) Absorption of overheads

8.6 GLOSSARY

as indirect material, indirect wages

and
Overheads: include all indirect costs such
indirect expenses
Production Overheads: are the aggregate of the indirect expenses of operating
and include all the indirect expenses incurred
the production division of a concern
to convert the raw material
into finished product.

connected with the direction,

Administration Overheads: include all suchexpenses
connected
the business excluding those
control and administration functions of
with selling and distribution functions
incurred in promoting sales and retaining
Selling Overheads: include expenditure
the customers
incurred from the time protuct is
Distribution Overheads: The expenditure
a customer is classified as
reaches the market or
completed in the factory until it
distribution overheads
allocated to a particular job
which Cannot be directly
ndirect Material: is a cost,
cost centers or cost
units indirectly.
or production but is absorbed by
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 which cannot be conveniently tly identified witha
Indirect Labor: is such wages,
particular cost unit.
indirect material al and indirect
and indirect
Indirect Expenses: are the costs other than
or work are termed as i
wages
to any job, process
which cannot be allocatcd directly

expensees
which remain tixed in
total amo
amount
F i x e d Overheads: are the period costs,
in volume of output
irespective of the fluctuations
change in direct proportion
Variable Overheads: the costs, in aggregate,
are
unit of output remais
the volume of output. But,
the variable cost per nains
changes in
the samne
and partly They a
variable costs.
Semi Variable Overheads: are partly fixed
with the change in he
and thereafter vary
constant up to a particular level of output
level of ouiput.

Departmentalization or Primary
Distribution of Overheads: The allocation
Production and
Service Departments
and apportionment of overheads to
or allotting the full amount of
Allocation of Overheads: is the process of charging
or cost unit
Overhead costs to a particular cost centre
or Cost Centers
of overheads among Departments
Apportionment: the distribution
of items of cost to Cost
on an equitable basis.
It is the allotment of proportions
Centers /Cost Units

ACTIVITIES
8.7 ANSWERS TO

Material, Indirect Labor and Indirect Expenses

Activity 1: Indirect
Non-Production Costs
Burden, On-cost, Supplementary Costs,
Activity 2: Loading,
Behavior
Functions, Elements and
Activity 3:
Administration, Selling and Distribution Overheads
Activity 4: Production,
Material, Indirect Labor and Indirect Expenses
Activity 5: Indirect
Variable and Semi-Variable Overheads
Activity 6: Fixed,

8.8 QUESTIONS

1. Define overheads
and explain briefly the classification of overheads.
between fixed, variable and semi variable overheads
2, Expiain the differences

178
 3 .E
lain the terms allocation, apportionment, reapportion
onment and absorption
ol
overheads
with suitableillustrations.

How do you reapportion the selling and distribution cost?

4.
What are the different methods of apportionment of overheads?

Differentiate Primary Distribution of Overheads from condary Distribution of

Overheads.

Problems

Swetha Ltd. has tour Departments. A, B and C are the Production Departments
.
and D is a Service Department. The actual costs for a period are as follows

IndirectMaterials:
Department A Rs. 950
Department B Rs. 1,200
Department C Rs. 200
Department D Rs. 1,500

Indirect Wages :

Department A Rs. 900

Department B Rs. 1,100
Department C Rs 300

Department D Rs. 1,000

Rent Rs. 2,000; repairs Rs. 1,200; depreciation Rs. 900; light Rs. 200; supervision
Rs. 3,000; insurance (stock) Rs. 1,000; employees insurance (employer's liability)
Rs. 300; power Rs. 1,800

The following datà are also available in respect of four Departments.

Dept. B Dept. C Dept. D

Dept. A
Area (sq. Mts.) 150 110 90 50

No. of employees 24 16 12 8

Total wages (Rs.) 8000 6000 4000 2000

Value of Plant (Rs.) 24000 18000 12000 6000

Value of Stock (Rs.) 15000 9000 6000

on most equitable method.

Apportion the above costs to various departments
Dept. A Rs. 6,055; Dept. B Rs. 5,265; Dept. C Rs. 2,635 and Dept. D Rs. 3,595)

179
 2. A factory has two Produclion Departments and two Service Departments, he
following figures have been extracted from the books of the respective Department

Production Departments Service Departments

Dept. A Dept. B Dept. C Dept. D
Arca (sq. Mts.) 1500 1100 900 500
No. of employees 40 30 20 10
Total wages (Rs.) 8000 6000 3000 3000
Value of Plant (Rs.) 16000 12000 8000 4000
Value of Stock (Rs.) 25000 15000
Lighting units 5000 3000 1500 500

The following figures of actual costs were taken from the financial books:

Supervision Zero; Plant and Machinery repairs Rs. 1,200; light Rs. 1,000;
employer's contribution to ESI Rs. 200; rent Rs. 800; depreciation to Plant Rs. 2,000;
insurance (stock) Rs. 800; power Rs. 1,000; canteen expenses Rs. 100.

Apportion the above costs to various Departments on most equitable bas1S.

(Ans.: Dept. A Rs. 4,300: Dept. B Rs. 3,070: Dept. CRs. 4,830 and Dept. D Rs. 3,900)
3. The Overhead expenses of a manufacturing - cum-selling company re recorded

in cost accounts according to various functions i.e. Production, Administration and

Selling and Distribution. From the information given below, show in a statement
form the amount of overhead expenses function wise:

Rs.
Rent of Offices 1,500
Advertising 2,000
840
Stationery
Rates in factory 2,700
Salesmen's commission and expenses 1,400
Insurance of offices 80
Depreciation of Machinery 6, ,400

Warehouse rentals 800

Repairs to Plant 1,850
Secretarial wages 3,000
Insurance of factory 1,100
Accounting staff wages 8,200
Delivery charges 450
Factory indirect wages 15,000

(Ans.: Production Department Rs, 27,050; Administration Department Rs. 13,620

and Selling and Distribution Department Rs. 4,650).

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