TOPIC
FIVE
ACCOUNTING
FOR OVERHEADS
5.1
Introduction
Overheads are the expenditure which cannot be
conveniently traced to or identified with any particular cost unit. Such
expenses are incurred for output generally and not for a particular work order.
Overheads are also very important cost element along with direct materials and
direct labour. Often in a manufacturing concern, overheads exceed direct wages
or direct materials and at times even both put together. On this account, it
would be a grave mistake to ignore overheads either for the purpose of arriving
at the cost of a job or a product or for controlling total expenditure.
Overheads also represent expenses that have been
incurred in providing certain ancillary facilities or services which facilitate
or make possible the carrying out of the production process; by themselves
these services are not of any use. For instance, a boiler house produces steam
so that machines may run and, without the generation of steam, production would
be seriously hampered. But if machines do not run or do not require steam, the
boiler house would be useless and the expenses incurred would be a waste.
Overheads are incurred not only in the factory of
production but also on administration, selling and distribution.
5.2
Meaning and Definition
According to Wheldon, Overhead may be defined as
"the cost of indirect material, indirect labour and such other expenses
including services as cannot conveniently be charged to a specific unit."
Blocker and WeItmer define overhead as follows :
"Overhead costs are operating cost of a business
enterprise which cannot be traced directly to a particular unit of output.
Further such costs are invisible or unaccountable."
5.3
Importance of Overhead Cost
Nowadays business is a dynamic organism. Advancement
of technological development and innovation, economic situations and social
considerations are the important factors for modernization of industries at
mass production to meet its more demand. The overhead charges are heavily
increased and they represent major portion of total cost. Therefore, it assumes
greater importance for cost control and cost reduction.
5.4
Classification of Overheads
Classification of overheads is the process of grouping
of costs based on the features and objectives of the business organization. The
following are the important methods on which the overheads are classified:
a)
On the basis of
Nature
b)
On the basis of
Function
c)
On the basis of
Variability
d) On the basis of Normality
e) On the basis of Control.
5.4.1
On the Basis of Nature
One
of the important classifications is on the basis of nature or elements. Based
on nature the aggregate of all indirect material cost, indirect labour cost and
indirect other expenses are known as overheads. Accordingly, overheads are
grouped into (a) Indirect Material Cost (b) Indirect Labour Cost and (c)
Indirect Expenses.
(a) Indirect Material Cost: Indirect materials do not
form part of the finished products. Indirect materials are indirectly or
generally used for production which cannot be identified directly. For example,
oil, lubricants, cotton waste, tools for repairs and maintenance etc. are
indirect materials.
(b) Indirect Labour Cost: Indirect labour is for work
in general. The importance of the distribution lies in the fact that whereas
direct labour can be identified with and charged to the job, indirect labour
cannot be so charged and has, therefore, to be treated as part of the factory
overheads to be included in the cost of production. Examples are salaries and
wages of supervisors, storekeepers, maintenance labour etc.
(c) Indirect Expenses: Any expenses that are not
specifically incurred for or can be readily charged to or identified with a
specific job. These are the expenses incurred in general for more than one cost
centre. Examples of indirect expenses are rent, insurance, lighting, telephone,
stationery expenses ·etc.
5.4.2
On the Basis of Function
The classification overheads on the basis of the various function of the
business concern is known as function wise overheads. Here there are four important
functional overheads such as
a) Production Overhead
b) Administration Overhead
c) Selling Overhead
d) Distribution Overhead
(a) Production
Overhead: Production overhead is also termed as manufacturing overhead or
works overhead or factory overhead. It is the aggregate of all indirect
expenses which are incurred for work in operation or factory. These costs are
normally incurred during the period when the production process is carried on.
For example, factory rent, factory light, power, factory employees' salary,
oil, lubrication of plant & machinery, etc.
(b) Administrative
Overhead: Administrative expenses are incurred in general for management to
discharge its functions of planning organizing, controlling, co-ordination and
directing. These expenses are not specifically incurred and cannot be
identified with the specific job. It is also termed as office cost. For
example, office rent, rates, printing, stationery, postage, telegram, legal
expenses etc. are the office and administrative costs.
(c) Selling
Overheads: Selling expenses are
overheads which are incurred for promoting sales, securing orders, creating
demand and retaining customers. For example, salesmen's salaries,
advertisement, rent and rates of show room, samples, commission etc.
(d)
Distribution Overhead: Distribution
overhead are incurred for distribution of products or output from producers to
the ultimate consumers. For example, warehouse staff salaries, expenses of
delivery van, storage expenses, packing etc.
5.4.3
On the Basis of Variability
One of the important classifications is on the basis
of variability. According to this, the expenses can be grouped into (a) Fixed
Overhead (b) Variable Overhead and (c) Semi-Variable Overhead.
(a) Fixed
Overhead: Fixed cost or overhead
incurred remain constant due to change in the volume output or change in the
volume of sales. For example, rent and rates of buildings, depreciation of
plant, salaries of supervisors etc.
(b)
Variable Overhead: Variable
overhead may be defined as "they tend to increase or decrease in total
amount with changes in the volume of output or volume of sales."
Accordingly the change is in direct proportion to output. Indirect materials,
Indirect labour, repair and maintenance, power, fuel, lubricants etc. are
examples of variable overhead costs.
(c)
Semi-Variable Overheads:
Semi-variable overheads are incurred with a change in the volume of output or
turnover. They neither remain fixed nor do they tend to vary directly with the
output. These costs remain fixed up to a certain volume of output but they will
vary at other part of activity. Semi-variable overheads are mixed cost, i.e.,
partly fixed and partly variable. For example, power, repairs and maintenance,
depreciation of plant and machinery telephone etc.
5.4.4
On the Basis of Normality
Overheads are classified into normal overheads and
abnormal overheads on the basis of normality features. According to this normal
overheads are incurred in achieving the target output or fixed plan. On the
other hand, abnormal overhead costs are not expected to be incurred at a given
level of output in the conditions in which the level of output is normally
produced. For example, abnormal idle time, abnormal wastage etc. Such expenses
are transferred to Profit and Loss Account.
5.4.5
On the Basis of Control
It is one of important classifications of overhead on
the basis of control. Based on control it is grouped into controllable overhead
and uncontrollable overhead. Controllable overhead which can be controlled by
the action of a specified number of undertaking. For example, idle time,
wastages etc. can be controlled. Uncontrollable overheads cannot be controlled
by the action of the executive heading the responsibility centre. For example,
rent and rates of building cannot be controlled
5.5
Usefulness of Overhead classification
i)
It ensures
effective cost control.
ii)
It helps the
management for effective decision making.
iii)
The application
of marginal costing is essentially for profit planning, cost control, decision
making etc. are based on the classification of overheads.
iv)
On the basis of
classification of fixed and variable cost, flexible budgets are prepared at
different levels of activity.
v)
It facilitates
fixing of selling price.
vi)
Cost
classification is useful for break-even analysis. Break-even analysis mainly
depends on overall cost and profit which can be useful for making or buying
decision.
vii)
It helps to find
out the unit cost of production
5.6
Accounting and Control of Manufacturing
Overheads
Generally manufacturing overheads form a substantial
portion of the total overheads. It is important, that such overheads should be
properly absorbed over the cost of production. We have to find out a way by
which the overheads can be distributed over the various units of production.
One method of working out the distribution of overheads over the various
products could be to ascertain the amount of actual overheads and distribute
them over the products.
This however, creates a problem since the actual
amount of overheads can be known only after the financial accounts are closed.
If we wait that long, the cost sheets lose their main advantages and utility to
the management. All the decisions for which cost sheets are prepared are
immediate decisions and cannot be postponed till the actual overheads are
known. Therefore, some method has to be found by which overheads can be
included in the cost of the products, as soon as prime cost, the cost of raw
materials, labour and other direct expenses, is ascertained.
5.7
Allocation and Apportionment of Overhead
to Cost Centres
The first
step of overhead analysis is distribution of overhead to production department
and service department. Before analysing overhead, we should know the concept
of Allocation, Absorption and Apportionment, Re-apportionment:
5.7.1
Cost allocation
The term ‘allocation’ refers to assignment or
allotment of an entire item of cost to a particular cost center or cost unit.
It implies relating overheads directly to the various departments. The
estimated amount of various items of manufacturing overheads should be
allocated to various cost centres or departments. For example- if a separate
power meter has been installed for a department, the entire power cost
ascertained from the meter is allocated to that department. The salary of the
works manager cannot be directly allocated to any one department since he looks
after the whole factory. It is, therefore, obvious that many overhead items
will remain unallocated after this step.
5.7.2
Cost apportionment
There are some items of estimated overheads (like the
salary of
the works manager) which cannot be directly allocated to the various departments and cost
centres. Such un-allocable expenses are to be spread over the various departments or cost
centres on an appropriate basis. This is called apportionment. Thus apportionment implies
“the allotment of proportions of items of cost to cost centres or departments”. After this stage,
all the overhead costs would have been either allocated to or apportioned over the various
departments. Apportionment is done by using some of the suitable basis. Example of the commonly used basis are shown in the table below
the works manager) which cannot be directly allocated to the various departments and cost
centres. Such un-allocable expenses are to be spread over the various departments or cost
centres on an appropriate basis. This is called apportionment. Thus apportionment implies
“the allotment of proportions of items of cost to cost centres or departments”. After this stage,
all the overhead costs would have been either allocated to or apportioned over the various
departments. Apportionment is done by using some of the suitable basis. Example of the commonly used basis are shown in the table below
|
Item
|
Basis of Apportionment
|
|
Factory rent
|
Floor
space
|
|
Factory lighting
|
Floor
space
|
|
Power
|
KWH,
power consumption KHW
|
|
Depreciation of plant and machinery
|
Value
of plant and machinery
|
|
Insurance of the building
|
Value
of building/ floor space
|
|
Indirect material
|
Direct
material cost
|
|
Indirect
wages
|
Direct
labour hours or cost
|
|
Supervision
|
No
of personnel
|
|
Repairs
to plant
|
Value
of plant
|
|
Canteen
expenses
|
No
of personnel
|
5.7.3
Re-apportionment
Up to the last
stage all overheads are allocated and apportioned to
all the departments- both production and service departments. Service departments are those
departments which do not directly take part in the production of goods. Such departments
provide ancillary services. Examples of such departments are boiler house, canteen, stores,
time office, dispensary etc. The overheads of these departments are to be shared by the
production departments since service departments operate primarily for the purpose of
providing services to production departments. The process of assigning service department overheads to production departments is called reassignment or re-apportionment. At this stage, all the factory overheads are collected under production departments.
all the departments- both production and service departments. Service departments are those
departments which do not directly take part in the production of goods. Such departments
provide ancillary services. Examples of such departments are boiler house, canteen, stores,
time office, dispensary etc. The overheads of these departments are to be shared by the
production departments since service departments operate primarily for the purpose of
providing services to production departments. The process of assigning service department overheads to production departments is called reassignment or re-apportionment. At this stage, all the factory overheads are collected under production departments.
5.7.4
Absorption
After completing the distribution as stated above the
overheads charged to
department are to be recovered from the output produced in respective departments. This
process of recovering overheads of a department or any other cost center from its output is
called recovery or absorption. The overhead expenses can be absorbed by estimating the
overhead expenses and then working out an absorption rate. When overheads are estimated,
their absorption is carried out by adopting a pre-determined overhead absorption rate.
department are to be recovered from the output produced in respective departments. This
process of recovering overheads of a department or any other cost center from its output is
called recovery or absorption. The overhead expenses can be absorbed by estimating the
overhead expenses and then working out an absorption rate. When overheads are estimated,
their absorption is carried out by adopting a pre-determined overhead absorption rate.
As the actual accounting period begins, each unit of
production automatically absorbs a
certain amount of factory overheads through pre-determined rates. During the year a certain
amount will be absorbed over the various products. This is known as the total amount of
absorbed overheads.
certain amount of factory overheads through pre-determined rates. During the year a certain
amount will be absorbed over the various products. This is known as the total amount of
absorbed overheads.
v Difference between Allocation and
Apportionment
The
difference between the allocation and apportionment is
important to understand because the purpose of these two methods is the
identification of the items of cost to cost units or centers. However, the main
difference between the above methods is given below.
1. Allocation
deals with the whole items of cost, which are identifiable with any one department.
For example, indirect wages of three departments are separately obtained and
hence each department will be charged by the respective amount of wages individually.
On the other hand apportionment deals with the
proportions of an item of cost for example; the cost of the
benefit of a service department will be divided between those departments
which has availed those benefits.
2. Allocation
is a direct process of charging expenses to different cost centres whereas apportionment
is an indirect process because there is a need for the identification of the appropriate
portion of an expense to be born by the different departments benefited.
3. The
allocation or apportionment of an expense is not dependent on its nature, but
the relationship between the expense and the cost centre decides that whether
it is to be allocated or apportioned.
4. Allocation
is a much wider term than apportionment
5.8
Methods of Absorbing Overheads to
Various Products or Jobs
The method selected for
charging overheads to products or jobs should be such as will ensure:
i)
That
the total amount charged (or recovered) in a period does not differ materially
from the
actual expenses incurred in the period. And
ii) That the amount charged to
individual jobs or products is equitable. In case of factory overhead, this means :
a) That the time spent on
completion of each job should be taken into consideration;
b)
That
a distinction should be made between jobs done by skilled workers and those done by unskilled workers.
and
c)
That jobs
done by manual
labour and those
done by machines
should be distinguished.
In
addition, the methods should be capable of being used conveniently; and yield
uniform result
from period to period as far as possible; any change that is apparent should
reflect a change
in the underlying situation such as substitution of human labour by machines.
Several
methods are commonly employed either individually or jointly for computing the appropriate overhead rate.
The more common of these are:
(1) Percentage of direct materials,
(2) Percentage of prime cost,
(3) Percentage of direct labour cost,
(4) Labour hour rate,
(5) Machine hour rate and
(6) Rate per unit of Output
To
summarise, the predetermined overhead
rate will be computed as follows:
|
Predetermined overhead rate =
|
Estimated
manufacturing overhead
|
|
|
Estimated
activity(material cost, labour cost, labour hours or machine hours)
|
Overhead
application: The process of assigning overhead cost to jobs is called overhead application.
Example 5.1
You are
required to find out (1) Direct Material Cost Rate (2) Direct Labour Cost Rate
(3) Direct Labour Hours and (4) Prime Cost Rate from the following particulars
:
Total
overhead for the period Tshs.
25,000
Total
direct labour cost (Direct wages) Tshs.
8,000
Total
materials used or Direct material cost Tshs.
10,000
Total direct labour hours Tshs. 2,000
5.8.1
Under- and over-applied overhead
Since
the predetermined overhead rate is established before a period begins and is
based on estimated data, there will be a difference between the amount of
overhead cost applied and the amount of overhead cost actually incurred during
a period. The difference between the
applied overhead cost and actual overhead cost is termed either underapplied or overapplied overhead.
What
is the cause of underapplied or overapplied overhead? Generally, the cause can be either one of two
factors. Firstly, the cost of inputs may
change from what was estimated at the beginning of the period because of
external market forces. Secondly, the
actual level of activity which is the activity realised during a specific
period and known as actual direct
labour hours / machine hours / completed units, may be different from what was
estimated at the beginning of the period.
To summarise, the under- or overapplied overhead can be computed by the
following formula:
Under-
or overapplied = Actual overhead less overhead applied
overhead
An
allocation base should be used that acts as cost driver in the incurrence of
overhead cost. A cost driver is a factor,
such as machine hours, computer hours, flight hours, beds occupied etc. that
causes overhead costs.
If
a base is used to compute overhead rates that does not “drive” overhead cost,
then the result will be inaccurate overhead rates and inaccurate product costs
If there exists no causal relationship between the product and the cost driver
and another “wrong” cost driver is used to allocate overhead, products will be
over- or undercosted.
In
the changing manufacturing environment (from manual labour to machine labour)
direct labour is becoming less of a factor and overhead is becoming more of a
factor in the cost of products. In
organisations where direct labour and overhead cost have been moving in opposite
directions, it would be difficult to argue that direct labour “drives” overhead
cost.
5.8.2
Accounting entries
In
the general ledger the transactions will be recorded as follows:
·
Actual manufacturing
overhead incurred:
Debit Manufacturing Overhead Control
Credit Accounts payable or Bank depending
if the amount has already been paid.
·
Applied manufacturing
overhead:
Debit Work in Process Control
Credit Manufacturing Overhead Control
The
balance on the Manufacturing
Overhead Control Account is the under-
or overapplied manufacturing overhead.
Please note that:
Actual > Applied = Underapplied
overhead
Actual < Applied = Overapplied
overhead
Under-applied
overhead is a loss and will decrease profits which means an under-applied
overhead will be debited.
Vice
versa: Over-applied overhead is
favourable and will increase profit which means over-applied overhead will be credited.
Non-manufacturing
overhead: This cost should not go into the
Manufacturing Overhead Control Account and should be recorded separately in a
Non-manufacturing Overhead Control account.
The transaction for expenses incurred for sales and administrative
activities will be entered in the general ledger as follows:
Debit
Sales and Administrative expenses
Credit
Accounts payable or Bank depending if the accounts have been paid.
Example 5.2
The following is the budget of superb engineering works for the year 2013
:
Tshs.
Factory overheads
62,000
Direct labour cost
98,000
Direct labour hours 155,000,
Machine hours 50,000
(a) From the above figures prepare the overhead application rate using
the following methods
(i) Direct Labour Hour (ii) Direct Labour Cost (iii)
Machine hour
(b) Prepare a comparative statement of cost, showing the result of
application of each of the above rates to Job No. 555 from the undermentioned
data.
Direct material cost Tshs. 45
Direct labour: wages Tshs. 40
Direct labour: hours 40
Machine hours 30
Until now the discussion was on a single overhead
rate for an entire factory which is called a plant wide overhead rate or blanket overhead rate. In larger organisations multiple
predetermined overhead rates or departmental overhead rates are often
used. In a multiple predetermined overhead rate system there is a different
overhead rate for each production department.
This system is more complex but more accurate. Then for departments
which are relatively labour intensive, overhead can be based on direct labour
hours. In departments which are
relatively machine intensive, machine hours can be used as allocation base.
This multiple predetermined overhead rate method of
assigning overhead cost is called a level-two
approach as the plant wide overhead rate method is called a level-one approach.
The
level-two approach works on a basis of two stages, namely, the first stage of
assigning manufacturing overhead to departments or cost centres and the second
stage where the cost of the departments will be assigned to products
The manufacturing overhead costs attributable to each
production department must therefore be determined (budgeted). This is referred
to as the departmentalization of manufacturing overheads.
Treatment of manufacturing overheads where separate
departments exist should be dealt with as follows:
1.
Primary
allocation/apportionment, where ALL overhead expenses (eg rent, salaries,
insurance etc) are divided among ALL the departments in the organisation,
including the service departments (ie maintenance, scheduling) and
non-production departments (ie administration and sales, where necessary). Accumulation
of a department’s overhead cost either occurs directly (eg depreciation on
plant in department A will only reside in department A’s costs) or by
apportionment (eg total rent paid, common to all departments, will be
apportioned amongst the various departments).
2.
Secondary
allocation (reapportioning), where the accumulated overhead costs (from step 1
above) of service departments are allocated to the production and
non-production departments for which they (the service/support department)
render services. This is carried out by means of an allocation rate or service
charge. An example: the maintenance department reallocates its total
accumulated manufacturing overheads to the respective production departments
(maintenance of production plant and equipment) and the dispatch department
(maintenance of delivery vehicles). In this way, all production-related
overheads are finally accumulated solely in the various production departments.
3.
A recovery rate (as explained before) is
determined for each respective production department depending on its own
overhead and allocated service costs, and using a basis suitable to its
activities. Each production department will therefore have its own recovery
rate.
4.
Each departmental overhead rate is then
applied to actual activity data for each product type it processes in order to
calculate the total applied manufacturing overheads.
Steps 1 and 2 are referred to as the first-stage
allocations. These allocations involve the allocation of manufacturing related
overheads to production departments (also called cost centres). Steps 3 and 4
are referred to as second stage allocations. These allocations involve
allocating manufacturing overhead costs to products and other cost objects.
5.9.1
Primary allocation of overheads
In the primary allocation stage, every overhead item
(eg depreciation, salaries, rent, electricity etc) are assigned
directly/apportioned to the organisation’s production, service (support) and
non-manufacturing departments on appropriate bases. Each of these departments
is referred to as a cost centre, because each department is mainly controlled
and managed on the basis of the costs it incurs.
Production departments are identified based on the
type of goods they produce or the activities they perform.
Examples are production departments for cutting,
assembling, drilling and finishing.
In a production environment, a number of service departments provide
support functions to the production departments and, at times, to other service
departments as well. A service department might also render services to
non-production departments.
Examples of service departments are production scheduling, maintenance,
quality control, information technology and HR. Service departments play a
vital role in the overall manufacturing process and provide auxiliary support
to production departments and the rest of the organisation. In highly technical
production environments, these departments may contribute a substantial amount
to the total manufacturing overhead costs.
For the primary allocation of overheads (as well as
secondary allocation), it is necessary to find a suitable basis for the
apportionment of individual cost items among the various departments. The basis
will be determined by the causal relationship between the cost and the ultimate
allocation activity. The allocation basis used to allocate a particular
department’s costs should drive these costs. For example, the area utilised (m2)
by each department would be the most appropriate basis for the apportionment of
the rental cost for a factory building to the various departments.
Example 5.3
Kuntakite
Ltd. has a production, service and administration department; the following
budgeted information is available:
Production Service
Administration
Number of
employees 53 5 2
Number of
copies made (Xerox) 3 000 1 250 5 100
Value of
machines and equipment Tshs.70
000 Tshs.20 000 Tshs.10 000
Floor
area (m2) 1
150 100 50
The
following budgeted overhead costs are applicable: Tshs
Buildings
insurance 23
600
Machinery
insurance 12
400
Cafeteria 11
400
Maintenance of copy machines 16 000
Protective
overalls 3 600
Indirect
material:
Production 14
000
Service 2 400
Administration 1 500
5.9.2
Re-apportioning service department overheads over
production department
The
re-apportionment of the service department cost to the production department is
known as secondary distribution.The re-apportionment of service department
expenses over the production departments may be carried out by using any
one of the following methods:
(i) Direct
re-distribution method.
(ii) Step method of secondary distribution or non-reciprocal method.
(iii) Reciprocal Service method.
(i)Direct re-distribution method
Service
department costs under
this method are apportioned over the production departments
only, ignoring the services rendered by one service department to the
other. To understand the applications of this method go through the
illustration which follows.
Illustration
1: (Re-apportionment
of costs under Direct re-distribution method)
XL
Ltd., has three production departments and four service departments. The
expenses for these
departments as per Primary Distribution Summary are as follows :
Production
Departments : Tshs Tshs
B 26,000
C 24,000 80,000
Service
Departments : Tshs Tshs
Stores 4,000
Time-keeping
and Accounts 3,000
Power 1,600
Canteen 1,000 9,600
The following information is also available in respect of
the production departments:
Dept.
A Dept. B Dept. C
Horse
power of Machine 300 300 200
Number
of workers 20 15 15
Value
of stores requisition in (` ) 2,500 1,500 1,000
Apportion the costs of service departments
over the production departments.
Solution
Secondary Overhead Distribution Statement
Item of cost Basis
of Total Production Depts
(as per primary apportionment
summary) Tshs Tshs Tshs Tshs
Cost as
per primary 80,000 30,000 26,000 24,000
distribution summary
Stores Value
of
(5:3:2) Store requisition 4,000 2,000 1,200 800
Time-keeping No.
of
and Accounts workers
(4:3:3) 3,000 1,200 900 900
Power H.P.
of
(3:3:2) Machine 1,600 600 600 400
Canteen No.
of
(4:3:3) workers 1,000 400 300 300
89,600 34,200 29,000 26,400
(ii) Step Method or
Non-reciprocal method:
This
method gives cognizance to the services rendered by service department to
another service department. Therefore, as compared to
previous method, this method is more complicated because a
sequence of apportionments has to be selected here. The sequence here
begins with the department that renders service to the maximum number of other
service departments. In other words the cost of the
service department which serves the largest number
of other service and production departments is distributed first. After this,
the cost of
service department serving the next largest number of departments is apportioned.
service department serving the next largest number of departments is apportioned.
This
process continues till the cost of last service department is apportioned. The cost
of last service department is apportioned among
production departments only.
Some
authors are of the view that the cost of service department with largest amount
of cost should be distributed first. Refer to the
illustration which follows to understand this method.
Illustration
2: (Re-apportionment of costs under non-reciprocal method)
Suppose the expenses of two production
departments A and B and two service departments X and Y are as under :
Amount Tshs Apportionment
Basis
Y A B
X 2,000 25% 40% 35%
Y 1,500 — 40% 60%
A 3,000
B 3,200
Solution
Summary of Overhead Distribution
Departments X Y A B
Tshs Tshs Tshs Tshs
Amount as
given above 2,000 1,500 3,000 3,200
Expenses of X Dept.
apportioned over Y,A and
B Dept. in
the ratio (5:8:7) —2,000 500 800 700
Expenses of Y Dept.
apportioned over A and
B Dept. in
the ratio (2:3) - —2,000 800 1,200
Total Nil Nil 4,600 5,100
(iii) Reciprocal
Service Method: This method recognises the fact that where
there are two or
more service departments they may render services to each other and, therefore,
these inter-departmental
services are to be given due weight while re-distributing the expenses of the
service departments.
The
methods available for dealing with reciprocal services are:
(a)
Simultaneous equation method;
(b)
Repeated distribution method;
(c) Trial and error method.
(a) Simultaneous equation method: According
to this method firstly, the costs of service departments are
ascertained. These costs are then re-distributed to production departments on
the basis of given percentages. (Refer to the following illustration to
understand the method)
Illustration
3: (Re-apportionment of costs under Simultaneous equation method)
Service departments’ expenses
Tshs
Boiler House 3,000
Pump Room 600
3,600
The allocation is :
Production
Departments Boiler
House Pump Room
A B
Boiler
House 60% 35% - 5%
Pump
Room 10% 40% 50% -
Solution
The total expenses of the two service departments will be
determined as follows:
Let B stand for Boiler House expenses and P for Pump Room expenses.
Then
Let B stand for Boiler House expenses and P for Pump Room expenses.
Then
B= 3,000 + 1/2 P
P = 600 + 1/20 B
P = 600 + 1/20 B
Substituting the value of B,
P= 600 + 1/20 (3,000 + 1/2 P) = 600 + 150 + 1/40 P
= 750 + 1/40 P
40 P= 30,000 + P
39 P= 30,000
P= Tshs.
769 (approx.)
The total of expenses of the Pump Room are ` 769 and
that of the Boiler House is Tshs
3,385 i.e., Tshs
3,000 + 1/2 × Tshs 769.
The expenses will be allocated to the production departments as under:
Production departments: A B
Tshs Tshs
Boiler House (60% and 35% of Tshs 3,385) 2,031 1,185
Pump Room (10% and 40% of Tshs 769) 77 307
Total 2,108 1,492
The
total of expenses apportioned to A and B is Tshs
3,600.
(b)
Repeated distribution
method: Under this
method, service departments’
costs are distributed
to other service and production departments on agreed percentages and this process
continues to be repeated, till the figures of service departments are either
exhausted or reduced to too small a figure. (Refer to
the following illustration to understand this method)
Illustration 4:
(Re-apportionment of costs under Repeated distribution method)
PH
Ltd., is a manufacturing company having three production departments, ‘A’, ‘B’
and ‘C’ and two service departments ‘X’ and ‘Y’. The following is the budget
for December 2011:
Total A B C X Y
Tshs Tshs Tshs Tshs Tshs Tshs
Direct
material 1,000 2,000 4,000 2,000 1,000
Direct
wages 5,000 2,000 8,000 1,000 2,000
Factory rent 4,000
Power 2,500
Depreciation 1,000
Other overheads 9,000
Additional information:
Area
(Sq. ft.) Capital value 500 250 500 250 500
(x100,000) of assets 20 40 20 10 10
Machine
hours 1,000 2,000 4,000 1,000 1,000
Horse
power of machines 50 40 20 15 25
A technical assessment of the apportionment of expenses of
service departments is as under:
A B C X Y
Service
Dept. ‘X’ (%) 45 15 30 - 10
Service
Dept. ‘Y’ (%) 60 35 - 5 -
Required:
(i) A
statement showing distribution of overheads to various departments.
(ii) A statement showing re-distribution of service
departments expenses to production departments.
(iii) Machine
hour rates of the production departments ‘A’, ‘B’ and ‘C’.
Solution
(i) Overhead
Distribution Summary
Basis Total A B C X Y
Tshs Tshs Tshs Tshs Tshs Tshs
Direct
materials Direct - - - - 2,000 1,000
Direct
wages Direct - - - - 1,000 2,000
Factory
rent Area 4,000 1,000 500 1,000 500 1,000
Power H.P.
× M/c Hrs. 2,500 500 800 800 150 250
Depreciation Cap.
value 1,000 200 400 200 100 100
Other
overheads M/c hrs. 9,000 1,000 2,000 4,000 1,000 1,000
16,500 2,700 3,700 6,000 4,750 5,350
(ii) Redistribution
of Service Department’s expenses:
A B C X Y
Tshs Tshs Tshs Tshs Tshs
Total
overheads 2,700 3,700 6,000 4,750 5,350
Dept. X overhead apportioned
in the
ratio (45:15:30:—:10) 2,138 712 1,425 -4,750 475
Dept. Y overhead apportioned
in the
ratio (60: 35:—:5 :—) 3,495 2,039 − 291 -5,825
Dept. X overhead apportioned
in the
ratio (45:15:30:—:10) 131 44 87 -291 29
Dept. Y overhead apportioned
in the
ratio (60:35:—:5:—) 17 10 − 2 -29
Dept. X overhead apportioned
in the
ratio (45:15:30:—:10) 1 − 1 -2 −
8,482 6,505 7,513 − −
(iii) Machine hour rate:
Machine
hours 1,000 2,000 4,000
Machine
hour rate (`) 8.48 3.25 1.88
(` 8,482/
1,000 hrs) (` 6,505/
2,000 hrs.) (` 7,513/
4,000 hrs.)
(c) Trial and error method: According to this method the cost of one service Cost Centre is
apportioned to another service Cost Centre. The cost of another service centre plus the share received from the first Cost Centre
is again apportioned to the first cost centre. This process is repeated till the amount to be apportioned becomes negligible. (Refer to the following illustration
to understand this method.)
Illustration
5: (Re-apportionment of costs under Trial and error method)
The ABC Company has the following account
balances and distribution of direct charges on 31st
March, 2011.
Total Production Depts. Service Depts.
Machine Packing Gen. Store
&
Shop Plant Maintenance
Allocated
Overheads: Tshs Tshs Tshs Tshs Tshs
Indirect
labour 14,650 4,000 3,000 2,000 5,650
Maintenance
material 5,020 1,800 700 1,020 1,500
Misc.
supplies 1,750 400 1,000 150 200
Superintendent’s
salary 4,000 - - 4,000 -
Cost
& payroll salary 10,000 - - 10,000 -
Overheads to be apportioned :
Power 8,000
Rent 12,000
Fuel and heat 6,000
Insurance 1,000
Taxes 2,000
Depreciation 1,00,000
1,64,420 6,200 4,700 17,170 7,350
The following data were compiled by means of the factory
survey made in the previous year:
Floor Radiator No. of Investment H.P
Space Sections Employees ` hours
Machine
Shop 2,000 Sq. ft. 45 20 640,000 3,500
Packing 800 ” ” 90 10 200,000 500
General
Plant 400 ” ” 30 3 10,000 -
Store
& Maint. 1,600 ” ” 60 5 150,000 1,000
4,800 ” ” 225 38 1,000,000 5,000
Expenses charged to the stores and maintenance
departments are to be distributed to the other
departments by the following percentages: Machine
shop 50%; Packing 20%; General Plant 30%; General Plant overheads is
distributed on the basis of number of employees:
(a)
Prepare an overhead
distribution statement with
supporting schedules to
show
computations and basis of distribution including distribution of the service department
expenses to producing department.
computations and basis of distribution including distribution of the service department
expenses to producing department.
(b) Determine the
service department distribution by the method of continued distribution.
Carry through 3 cycles. Show all calculations to the nearest Shilling
Carry through 3 cycles. Show all calculations to the nearest Shilling
Solution
(a) Overhead Distribution Statement
Production
Departments Service
Departments
Machine Packing General Stores
&
Allocated
Expenses: Shop Plant Maintenance
Indirect
labour 4,000 3,000 2,000 5,650
Maintenance
material 1,800 700 1,020 1,500
Superintendent’s
salary − − 4,000 −
Misc.
supplies 400 1,000 150 200
Cost &
payroll salaries − − 10,000 −
Total 6,200 4,700 17,170 7,350
Apportioned expenses
(See
schedule below) 77,720 25,800 2,830 22,650
Total 83,920 30,500 20,000 30,000
Schedule of Apportioned Expenses
Item Basis Machine Packing General Stores
&
Shop Plant Maintenance
(`) (`) (`) (`)
Power Horse Power Hrs. 5,600 800 - 1,600
Rent Floor Space 5,000 2,000 1,000 4,000
Fuel &
Heat Radiator Secs. 1,200 2,400 800 1,600
Insurance Investment 640 200 10 150
Taxes Investment 1,280 400 20 300
Depreciation Investment 64,000 20,000 1,000 15,000
Total 77,720 25,800 2,830 22,650
(b) Distribution
of Service Department Expenses
Production
Departments Service
Departments
Machine Packing General Stores
&
Plant Maintenance
(`) (`) (`) (`)
Total
Expense [as per (a)] 83,920 30,500 20,000 30,000
Transfer from Stores &
Maintenance 15,000 6,000 9,000 -30,000
Transfer
from General Plant 16,571 8,286 -29,000 4,143
Transfer from Stores &
Maintenance 2,072 829 1,242 -4,143
Transfer
from General Plant 710 355 -1,242 177
Transfer from Stores &
Maintenance 88 36 53 -177
Transfer
from General Plant 35 18 -53 —
Total 1,18,396 46,024 — —
0 comments:
Post a Comment