Amity School of Business

Amity School of Business

Module 3
Cost and Management Accounting

1
 What are overhead costs?
Amity School of Business

 Costs that cannot be allocated directly to cost units.

 Overheads are another term for indirect costs.
 Overhead costs are charged to cost centre’s.

“aggregate of indirect material cost, indirect labour cost and indirect

expenses”
-By ICMA

2
 STEPS IN OVERHEADS ACCOUNTING
Amity School of Business

STEP 1: Classification of Overheads

STEP 2: Codification of Overheads
STEP 3: Collection of Overheads
STEP 4: Allocation & Apportionment of overheads to departments
STEP 5: Reapportionment of Overheads
STEP 6: Absorption of Overheads
 Step I: Classification of Overheads Costs
Amity School of Business

Functional classification.
Classification with regard to behaviour of the expenditure.
Element - wise classification.
Basis of normality.

4
 Step II: Codification of Overheads
Amity School of Business

 Refers to assignment of a number or symbol for each item of

overheads with a view to accumulate them.
 Codification is next step after classification of overheads.
 Useful in accumulating and controlling of overheads.

Objects of codification of overheads:

 To accumulate overheads systematically.
 To facilitate control over them.
 To account for all types of overheads.
 To distinguish between different types of overheads.
 To facilitate convenience of identifying the overheads.

5
 STEP III: COLLECTION OF OVERHEADS
Amity School of Business

 Classified and coded overheads are collected and recorded under standing
order number and cost accounting number.
 To facilitate recording, separate ledger called Overhead Ledger is
maintained.
 Separate accounts are opened for standing order number and cost
accounting number in this ledger.
STEP IV: Allocation & Apportionment of overheads
Amity School of Business

Creation of departments
 Difference between Allocation & Apportionment
 Apportionment
 Primary Distribution
 Secondary Distribution

7
 Allocation and Apportionment of Overheads
Amity School of Business

Overheads that can be charged directly to specific

departments are ALLOCATED.
 Overheads that relate to more than one department are
shared or APPORTIONED on a fair basis.

Examples of Basis of Apportionment of Overheads

 Floor area for rent.
 Number of employees for canteen costs.

8
 Allocation & Apportion of Overheads
Amity School of Business

 Allocation:
 Identifying an item of overhead and the allotment of the whole
amount to one department or cost centre.
 Example: Salary of a foreman, wages of machine operator.

 Apportion:
 Overheads which cannot be allocated to a specific department or cost
centre.
 Has to be done on equitable basis.
 Example: Salary of general manager is to be apportioned to various
departments on the basis of time devoted by him on several
departments.

9
 Step V: Reapportionment: Service
Department Amity School of Business

 The process of apportioning service department’s overheads to

production department.
 Service department costs should be reapportioned between production
departments.

Guidelines for reapportionment:

 Nature of service rendered by each service department.
 Extent of service rendered to production.
 Determining the production departments which derived services from
service departments.
 Selecting the basis of apportionment.

10
Inter Service Departmental Overheads
Amity School of Business

 Reciprocal services method

 Recognizes the fact that if given department receives service from
another department, the department receiving such service should be
charged.
Three methods:
• Simultaneous Equation method.
• Repeated distribution Method
• step ladder method.
• Trial & Error Method.

11
 Step VI: Absorption Costing
Amity School of Business

 Method of costing in which the costs of an item (product or service)

IS the sum of direct costs and a fair share of overhead costs, to
obtain a full cost or a fully-absorbed cost.
 Involves:
 Allocation and appropriation of overheads.
 Reapportionment of service cost centre overheads.
 Absorption of overheads.

12
 Absorption of Overheads
Amity School of Business

 The process of charging the overheads from cost centre to cost units.
 .
 It involves charging of production department overheads to the
number of units produced in those departments.
Basis of Absorption
An absorption rate per unit.
 An absorption rate per direct labour hour worked.
 An absorption rate per machine hour worked..
Most common bases are direct labour hours and machine hours

13
 Activity-Based Costing Method
Amity School of Business

The company must first identify activities in the factory that

create costs.
Then a basis or cost driver must be decided upon to allocate
COST to each of the activity cost pools.
This approach is best when the company has significant non
volume-related costs in its plant which are not caused by
traditional cost drivers such as labor hours and machine hours.
End Term Examination Amity School of Business

All the Best to You !

Practice numericals

15