Grade 12 Account Note

Accounting for Overheads

Introduction

A manufacturing concern incurs different items of costs while converting raw materials into finished outputs. Such costs can be classified on different bases. One such basis is the directness of the costs to the product unit or identification of costs with a particular product unit. The direct portion of the total costs is called known as prime cost and the indirect portion is called overheads.

 

MEANING AND DEFINITION

The cost that can be easily defined with and directly allocated to a particular cost centre or cost is known as direct cost. The cost is divided into direct and indirect cost. Direct materials, direct labours, and direct expenses are some examples of direct costs and the total of these costs is known as prime cost.

 

CLASSIFICATION OF OVERHEADS BASED ON FUNCTIONS

A manufacturing concern carries out mainly two types of functions. These are manufacturing and non-manufacturing functions. Manufacturing functions are concerned with converting raw materials into finished goods while non-manufacturing functions are concerned with general administration, selling and distribution of goods. The organisation incurs several indirect expenses while performing such manufacturing and non-manufacturing activities.

The major types of overheads are;

1.Manufacturing overheads: They are also known as production overheads or works or factory overheads. These are indirect expenses that are incurred in carrying out manufacturing activities of the concern. Manufacturing overheads include all the indirect expenses incurred in converting raw materials into finished goods. Power, factory rent, factory insurance, indirect materials, indirect wages depreciation and repair and maintenance are the example of manufacturing overhead.

2.Non-manufacturing overheads: The non-manufacturing overheads include the following two overheads:

3. Administrative overheads:

These are indirect expenses that are incurred in connection with the general administration of the whole concern. These overheads incur while carrying out office and administrative activities. Example: office salaries, rent, printing and stationary, telephone and electricity, depreciation and repair and maintenance of office building, furniture and other office expenses.

4. Selling and distribution overheads:

All the indirect expenses incurred for selling and distribution of finished goods are known as selling and distribution overheads. Selling overheads are incurred for creating demand, attracting present and potential customers and retaining old customers. Examples: free gift, advertisement, showroom expenses,  and so on.

Distribution overheads are incurred in maintaining stocks and carrying the goods to customer destinations. Examples: packing charges, carriage and freight out, warehouse expenses, depreciation and others.

 

Classification of overheads based on behaviour

This classification is based on the behaviour or variability of overheads. Such a classification of overheads is based on change in the amount of overheads with the change in output. There are four types of overheads;

1.Fixed overheads: These overheads are also called period costs or capacity costs. They are incurred for creating an output capacity of the concern for a fixed period of time, say, month or a year. They are the costs, which remain fixed or constant in total despite changes in the volumes of production or sale. Examples: rent, salaries, depreciation, interest and legal expenses.

2.Variable overheads: These are the overheads which vary positively with the production and sales volume. Hence, they vary directly in proportion to the volume. They increase in total with the increase in volume and vice versa. Examples; indirect materials, indirect wages, indirect expenses.

3.Semi-variable overheads: These variables are neither completely fixed nor variable. Therefore, they are also called semi-fixed costs. These overheads comprise the quality of both the fixed and variable costs. They vary disproportionately with the change in the volume of output. Examples; salesman remuneration, heating, lighting, supervision etc.

4.Step fixed: These overhead remain fixed within a certain range of output level and jump up once the range of output level exceeds. They remain constant for a given volume, but increase by another fixed amount the moment there is addition of volume, and keep on focusing by a fixed amount with the addition of volume.

 

Classification of overhead based on elements

Based on the components or elements, overheads can be classified as indirect materials, indirect labour and other indirect expenses. This classification is also known as classification of overheads according to their nature of sources.

 

Each element of such overheads is described below;

1.Indirect materials: All materials other than direct ones are indirect materials. They do not form the part of the finished product. They cannot be identified with or traceable to a particular cost unit or cost centre. They cannot be allocated but can be apportioned to a number of cost units or centres. Examples: cost of lubricants, cotton waste, grease and others.

2.Indirectlabour: The labour that is not directly involved in production process is called indirect labour and wages paid to such labour are called indirect wages. Indirect labour, however, assists in the production process. Examples; watchmen, sweepers, worker in department services, supervisors and so on.

3.Other indirect expenses: The indirect expenses other than indirect materials and indirect labour are called other indirect expenses. These expenses also cannot be directly traced to any product unit or cost centre. Examples: rent, insurance, telephone, charges, lighting, office salaries and depreciation.

 

Classification of overheads based on control

Control of costs is one of the prime concerns of management. There are some expenses that can easily be controlled by the management while some other cannot be. From the point of view of cost control, therefore, overheads can be divided into two types;

1.Controllable overhead: These are the indirect expenses that the management of a manufacturing concern can keep under its control, as they are influenced by its decisions. Therefore, those overheads that vary due to the management decisions are called controllable overheads. Examples: indirect materials, power expenses and lighting expenses.

2.Uncontrollable overhead: On the other hand, those indirect expenses that are beyond the control of the management are known as uncontrollable overheads. Examples; factory rent, office salaries, depreciation and legal expenses.

 

Allocation of overheads

Meaning

Allocation of overheads is the process of charging overhead costs to a particular department or cost centre. It is the allotment or assignment of an overhead cost to a particular cost unit. If the overhead cost is associated with a single department or cost centre, the whole amount is charged or distributed among the units of output of that particular department. For example, the whole amount of repair and maintenance expenses for a machine is charged pr allocated to that department where the machine has been installed.

 

Apportionment of overhead

Distribution of an overhead cost to several department or cost centre is known as apportionment of overheads. It is the process of charging or apportioning costs to a number of cost centres or cost units. If a given cost is common to two or more departments or cost centres, such cost should be apportioned or divided among theses departments on an equitable basis. For examples, the amount of factory rent should be apportioned to all the departments. Similarly, the amount of remuneration to the general manager should be distributed to the production, administration and marketing departments, as the general manager is associated with all these departments.

 

Differences between allocation and apportionment of overheads

Allocation

Apportionment

It involves a particular department or cost centre.

It involves two or more department of=r cost centres.

The process of charging the costs to a particular department or cost centre is allocation of overheads.

The process of charging the costs to a number of departments or cost centres is apportionment of overheads.

It is based on direct distribution.

It is distributed on some equitable bases like direct labour hours, number of workers, machine hours and space and area occupied.

It is applicable when the overhead cost is associated with a single department or cost centre.

It is applicable when the overhead cost is associated with two or more departments or cost centres.

Allocation of overhead is done when the most centre uses while of the benefits of the expenses.

Apportionment of overhead is done when the cost centres use only a portion of the benefits of the whole expenses.

 

 

Absorption of overhead

The absorption of overheads is also called the recovery of the overhead costs. It is the process of sharing the overhead costs by all products of a particular department. It is the application of overheads to each unit of output. In other words, the process of ascertaining the total overhead costs if each unit of output or job by using overhead rate is known as the absorption of overhead. Thus, the distribution of the overhead expenses allotted to a department over the units produced in that department is absorption of overheads.

 


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