Overheads Overheads Allocation, Assignment and Absorption.
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Transcript of Overheads Overheads Allocation, Assignment and Absorption.
Overheads Overheads Allocation, Assignment and Absorption
Assignment of direct and indirect costs
Assignment of direct and indirect costs
• Direct costs can be specifically and exclusively identified with a given cost object – hence they can be accurately traced to cost objects.
• Indirect costs cannot be directly traced to a cost object – therefore assigned to cost objects using cost allocations.
• Cost allocations = process of assigning costs to cost objects that involve the use of surrogate rather than direct measures.
• Surrogates are known as allocation bases or cost drivers.• For accurate cost assignment, allocation bases should be
significant determinants of the costs (i.e. cause-and-effect allocations).
Objective 1
Explain under-costing and over-costing of products and services
1
Under-costing and Over-costing Example
Ram, Anil and Nitin orderseparate items for breakfast.
Ram’s order amounts to £ 14Anil consumed 30Nitin’s order is 16Total £60
What is the average cost per breakfast?
Undercosting andOvercosting Example
£60 ÷ 3 = £20
Ram and Nitinare over-costed.
Anil isUnder-costed.
© 2000 Colin Drury
• Some firms use a single overhead rate (i.e.blanket or plant-wide) for the organization as a whole.
ExampleTotal overheads = £900 000Direct labour (or machine hours) = 60 000Overhead rate = £15 per hour
Assigning indirect costs using blanket overhead rates
• Assume that the company has 3 separate departments and costs and hours are analysed as follows:
• Product Z requires 20 hours (all in department C)
Separate departmental rates should be used since product Z only consumes overheads in department C.
Cost Appropriation Process
• The cost appropriation process has three steps: (1) identify the cost objectives, (2) form cost pools, and (3) select an allocation base to relate the costs to the cost objectives.
• The problem of apportionment of overheads mainly related with various sub centers in manufacturing department,
• For example in a company there may be sub centers like crushing , refining, finishing, as production departments,
• And various other departments which are providing direct services to above centers like maintenance department, personnel department, purchase department, storekeeping, labor welfare etc.,
• But the expenses are incurred as a common expense to manufacturing and services department,
• Thus in order to know the actual expenditure, it is important to separate expense for each sub center; and therefore- apportionment is necessary
Bases of Apportionment of overheads • Direct Labor Hours : some expenditure like salary of factory
supervisor, factory manager, R&D etc. can be distributed among various centers on the basis of works hours in each center.
• Number of Workers: some of expenditure which increase or decrease on the basis of number of workers like welfare expenses, canteen expenses, entertainment expenses, medical expenses etc. are distributed on the basis of number of workers working in each department
• Relative Areas of Departments: expenses like lighting & heating, repairs of building, rent, rates, taxes on building, air conditioning exp. etc.
• Machine Hour Rate: expenses like power, repairs and maintenance of machines, depreciation on machinery etc.
• Asset Value basis: expenses like insurance on building, depreciation on buildings, etc.
• Light Points Basis: like lighting expenses of machineries.
• Direct Wages basis: expenses like PF contribution, Insurance premium, etc.
• Technical Estimates: This basis is used for the apportionment of those expenses which have no other basis of apportionment. An assessment of the equitable proportion is carried out by technical experts for distributing works manager’s salary, internal transport, steam, water, etc., when these are used for processes.
Class Exercise
• The modern company has three production departments viz. A, B and C and two service departments (D and E).
• From the given figures apportion the costs to various departments on the most equitable basis.
• Assume the cost driver to be direct wages for the service department.
Rs.
Indirect Materials Indirect Wages Depreciation on Machinery Depreciation on Buildings Rent, Rates and Taxes Electric Power for Machinery Electric Power for Lighting General Expenses Total
15,000 12,000 20,000 10,000 10,000 15,000
300 21,000
1,03,300
Items Total A B C D E
Direct Materials (Rs.) Direct Wages (Rs.) Value of Machinery (Rs.) Floor Area (sq. ft.) No. of Light Points Horse Power of Machines Labor Hours
60,000 40,000
2,50,000 50,000
50 150
15,000
20,000 15,000 60,000 15,000
15 50
5,000
10,000 15,000
1,00,000 10,000
10 60
5,000
19,000 4,000
40,000 10,000
10 30
2,000
6,000 2,000
25,000 5,000
5 5
1,000
5,000 4,000
25,000 10,000
10 5
2,000
Expenses Basis Total Production Dept. Service Dept.
A B C D E
Direct MaterialsDirect WagesIndirect Material Indirect Wages Dep. of Machinery Dep. of Building Rent, Rates, etc. Electric Power For Machinery For Lighting General Expenses
GivengivenDirect Material Direct Wages Machine Value Floor Area Floor Area H.P. Light Points Labor Hours.
60,00040,000
15,000 12,000 20,000 10,000 10,000
15,000
300 21,000
20,00015,0005,000 4,500 4,800 3,000 3,000
5,000
90 7,000
10,00015,0002,500 4,500 8,000 2,000 2,000
6,000
60 7,000
19,0004,000
4,750 1,200 3,200 2,000 2,000
3,000
60 2,800
6,0002,000
1,500 600
2,000 1,000 1,000
500
30 1,400
5,0004,000
1,250 1,200 2,000 2,000 2,000
500
60 2,800
Expenses of Dep. D between A,B,C
Expenses of Dep. E between A,B,C
In ratio to Direct Wages
In ratio to Direct Wages
2,03,300
-------
-------
2,03,300
67,390
7,072
9,180
83,635
57,060
7,072
9,180
73,305
42,010
1,886
2,450
46,360
16,030
(16030)
0000
20,810
(20810)
0000
Budgeted overhead rates
Therefore, costs should be allocated as follows:Budgeted unit rate X Actual hours of computer time used