COST ACCOUNTING UNIT I

CH.4 - OVERHEADS

INTRODUCTION:
Total Cost includes two types of costs - Direct and Indirect. Direct cost is a specific cost and can be
conveniently identified with particular product, job or process. It consists of direct materials, direct
labour and direct expenses. Indirect cost is a general cost and cannot be identified to any product, job
or process. This cost does not relate to any one specific cost unit or cost centre. It consists of all
indirect material, indirect labour and indirect expenses. The total of direct cost is called as Prime
Cost and total of indirect cost is called Overheads. Overhead Costs are also known as non-
productive cost, burden cost, on cost, supplementary cost etc.

As per Cost Accounting Standard 3, Overheads comprise of indirect materials, indirect employee
costs and indirect expenses which are not directly identifiable or allocable to a cost object in an
economical feasible way.

CLASSIFICATION OF OVERHEADS:
The overheads can be classified under different heads. Following are the important criteria of
classification of overheads.

(A) On the basis of Element:

1. Indirect Material
2. Indirect Labour
3. Indirect expenses

(B) On the basis of Behaviour:

1. Fixed Overheads
2. Variable Overheads
3. Semi-variable Overheads

(C) On the basis of Functions:

1. Production Overheads
2. Administration Overheads
3. Selling and Distribution Overheads

DISTRIBUTION OF OVERHEADS
Direct costs are charged directly to the cost centres or cost units without any difficulty. But
distribution of overheads i.e. indirect costs to cost units is one of the most complex problem of cost
accounting. This is because overhead cost cannot be identified with individual cost units.

Steps in Overhead Distribution:

1. Allocation and Apportionment of overheads to production departments and service departments.
(i.e. Primary Distribution of Overheads)
2. Re-apportionment of service department costs to production departments.
(i.e. Secondary Distribution of Overheads)
3. Absorption of overheads of each production department in cost units.

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I. Allocation and Apportionment of Overheads to Production Departments and

Service Departments (i.e. Primary Distribution of Overheads):

Allocation :
Allocation of overhead means assigning the whole item of cost to a cost centre or department for
which the expenditure was incurred. When the exact amount of overhead incurred in a department is
known, the entire amount of expenditure is allotted to that department or cost centre. This process of
allotting the whole amount of an item of overhead directly to a department or cost centre is called
allocation. For example, the cost of repairs of a machine in a department can wholly be charged to
that department. Overheads, which can not be directly allocated, are apportioned.

Apportionment :
Indirect expenses which can not be directly allocated or charged to various departments are
apportioned. Apportionment refers to the distribution of overhead to more than one department or
cost centre on an equitable basis. When the indirect costs are common to different departments or
cost centres, they are apportioned to the different departments or cost centres on equitable basis. For
example, the general managers salary has to be distributed on an equitable basis among various
departments.

BASIS OF APPORTIONMENT / DISTRIBUTION OF OVERHEADS TO PRODUCTION AND SERVICE

DEPARTMENTS

Overhead Cost Basis of Apportionment

Canteen Expenses Number of Employees in each department
Time Keeping Expenses .
Supervision, Hospital, Recreation Expenses
Labour Welfare Expenses and other Fringe benefits

Contribution to P.F., Employee State Insurance Direct Wages

Depreciation, Repairs and Maintenance of Machine Value of Machine

Insurance of Machine

Insurance of Stock Value of Stock

Rent, Taxes, Repairs, Insurance and Depreciation of

Factory building , Fire Precaution Exp. of building Floor Area Occupied.

Lighting or Heating Expenses Number of Light Points

Or Floor Area Occupied.

Power/Steam Consumption Horse Power of Machine or Machine

hours

Stores Keeping and Material Handling Expense Weight or Value of Materials

Sundry Expenses/Other Miscellaneous Overheads Direct Wages or Direct Labour Hours

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EX.1. 20 Microns Ltd. has four departments: A, B, and C are Production Departments and D is a Service
Department. The actual overheads for a period are as follows:
Overheads Rs.
Indirect Materials : Department A 900
Department B 1,200
Department C 1,000
Department D 2,000

Indirect Wages : Department A 1,000

Department B 1,100
Department C 900
Department D 1,200

Repairs : Machine 2,400

Depreciation : Machine 1,800
Light Expenses 1,400
Insurance of Stock 2,000
Employers Contribution to P.F. 1,700
Power / Energy 1,500
Supervision Charges 1,800
Fire Precaution Expenses 800
Canteen Expenses 1,500
Rent, Rates and Taxes 4,000
Sundry Expenses 3,400

The following data are also available in respect of four departments.

Basis Departments
A B C D
Number of Workers 48 32 24 16
Floor Area (Square Feet) 300 220 180 100
Value of Machine Rs. 48,000 36,000 24,000 12,000
Value of Stock Rs. 30,000 18,000 12,000 ---
Direct Labour Hours 100 120 80 40
Horse Power of Machine 800 500 200 ---
Number of Light Points 60 50 20 10
Apportion the above overheads to the various departments on the most equitable basis and
prepare a Statement of Primary Distribution of Overheads.
Answer:
Statement of Primary Distribution of Overheads
Items Basis Ratio Total Department
A B C D
Indirect Materials Allocation -- 5,100 900 1,200 1,000 2,000
Indirect Wages Allocation -- 4,200 1,000 1,100 900 1,200
Repairs of Machine Value of 4:3:2:1 2,400 960 720 480 240
Machine
Depreciation of Value of 4:3:2:1 1,800 720 540 360 180
Machine Machine

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Light Expenses Light 6:5:2:1 1,400 600 500 200 100

Points
Insurance of Stock Value of 5:3:2 2,000 1,000 600 400 ---
Stock
Employers Direct 5:6:4:2 1,700 500 600 400 200
Contribution to P. F. Wages
Power / Energy H. P. of 8:5:2 1,500 800 500 200 ---
Machine
Supervision Charges No. of 6:4:3:2 1,800 720 480 360 240
Workers
Fire Precaution Exp. Floor 15:11:9: 800 300 220 180 100
Area 5
Canteen Expenses No. of 6:4:3:2 1,500 600 400 300 200
Employee
Rent, Rates & Taxes Floor 15:11:9: 4,000 1,500 1,100 900 500
Area 5
Sundry Expenses Direct 5:6:4:2 3,400 1,000 1,200 800 400
Lab.Hours
Total Rs. 31,600 10,600 9,160 6,480 5,360

II. RE-APPORTIONMENT OF SERVICE DEPARTMENT COST TO PRODUCTION

DEPARTMENTS (SECONDARY DISTRIBUTION OF OVERHEADS)
The primary distribution of overheads apportions all overhead costs to the different departments
Production and Service Departments both. Service Departments do not themselves manufacture
anything but it is the Production Departments which are involved in manufacturing. Therefore, it is
necessary that overhead costs of Service Departments should further assign to Production
Departments. The process of re-assignment or re-apportionment of Service Departments overhead
to Production Departments is termed as Secondary Distribution. There are various methods for
secondary distribution of overheads.

METHODS OF RE-APPORTIONMENT OR RE-DISTRIBUTION:

The following are the important methods of re-apportionment of Service Department costs to
other Production Departments:

(A) Re-Apportionment to Production Department only: (Direct Redistribution Method)

In this method, Service Department costs are directly apportioned to various Production
Departments only. This method does not consider the service provided by one Service
Department to another Service Department.

(B) Re-Apportionment to both Production and Service Department:

Following methods take into account the service rendered by one service department to other
service department and vice versa in addition to the service rendered to the production
department. These inter-departmental services are taken into consideration and are not ignored
in redistributing expenses of the service departments.
1. Repeated Distribution Method
2. Trial and Error Method
3. Simultaneous Equation Method

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1. Repeated Distribution Method:

Steps for Distribution:

a. The costs of first service department are apportioned to other service department and
production department according to the given percentages. This will close the account of first
service department.
b. Then apply the given percentage for the apportionment of Second service department costs
which includes its own costs plus share of first service department. This closes the account of
second service department but re-opened the account of first service department.
c. The same procedure should be followed in case of all other service department. In the process
of repeated distribution costs, the costs of each service department will reduce with each
process of distribution because each time a substantial amount is charged to the production
department. This is continued until the amounts become too small to be further apportioned
to the departments.

2. Trial and Error Method :

Under this method, the cost of first service department (S1) is apportioned to another service
department (S2) in the given ratio. The cost of another service department (S2) plus its share in the
cost of the first service department (S1) is again apportioned to first service department. The
amount so apportioned to the first service department (S1) will again be apportioned to the
second service department (S2) and this distribution process will continue till the amount to be
distributed negligible.

3. Simultaneous Equation Method :

Under this method, the total costs of service departments are expressed in the form of algebraic
equations. The equations are to be developed on the basis of the primary distribution overheads
and the percentages of service rendered to each other. By solving the equations, total costs of
service departments can be obtained. Then these total costs are distributed to production
departments applying the percentage given.

EX.2 ABB Ltd. had five department. A, B and C are Production Departments and D (Time Keeping
Department) and E (Stores Department) are Service Departments. The actual cost for a period is
as follows:
Overheads Rs.
Repairs of Factory Building 4,000
Insurance of Machine 3,000
Depreciation of Machine 60,000
Lighting 1,000
Stores Overhead 4,000
Time Keeping Expenses 15,000
Power 5,500
Amenities to Staff 15,000
Other Overheads 6,000

The following information is available in respect of the five departments:

Basis Departments
A B C D E
Area Sq. Meters 1,000 1,000 1,000 500 500
Number of Light Points 5 8 2 3 2

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Number of Employees 30 45 45 15 15
Direct Wages Rs. 30,000 45,000 45,000 15,000 15,000
Value of Machine Rs. 2,40,000 1,80,000 80,000 60,000 40,000
Value of Direct Material Rs. 10,000 20,000 20,000 15,000 15,000
Machine Hours 4,000 3,000 2,000 1,000 1,000
Prepare a Statement of Primary Distribution of Overheads. Also prepare a statement of Secondary
Distribution of Overheads as per Direct Distribution Method, by apportioning the expenses of
Department D in the ratio of 2:3:3 and that of Department E in the ratio of 1:2:2 to production
department A, B and C respectively.
Answer :
Statement of Primary Distribution of Overheads
Items Basis Ratio Total Departments
A B C D E
Direct Wages Allocation Actual 30,000 -- -- -- 15,000 15,000
Direct Materials Allocation Actual 30,000 -- -- -- 15,000 15,000
Building Repairs Area Sq. Mt. 2:2:2:1:1 4,000 1,000 1,000 1,000 500 500
Insurance of Value of 12:9:4:3:2 3,000 1,200 900 400 300 200
Machine Machine
Dep. of Machine Value of 12:9:4:3:2 60,000 24,000 18,000 8,000 6,000 4,000
Machine
Lighting No. of Light 5:8:2:3:2 1,000 250 400 100 150 100
Points
Stores Overhead Value of 2:4:4:3:3 4,000 500 1,000 1,000 750 750
Material
Time Keeping No. of 2:3:3:1:1 15,000 3,000 4,500 4,500 1,500 1,500
Employees
Power Machine Hours 4:3:2:1:1 5,500
2,000 1,500 1,000 500 500
Amenities to Staff No. Employee 2:3:3:1:1 15,000
3,000 4,500 4,500 1,500 1,500
Other Overheads Direct Wages 2:3:3:1:1 6,000
1,200 1,800 1,800 600 600
Total Rs. 1,73,500 36,150 33,600 22,300 41,800 39,650
Note: As service departments do not manufacture any goods but provides valuable services to
production departments for the smooth functioning of production process. Thus, Direct Wages and
Direct Material Costs directly allocated to Service Departments form part of total indirect costs i.e.
overheads of these departments.
Statement of Secondary Distribution of Overheads
(Direct Redistribution Method)
Particulars Ratio of Re- Production Department Service
Apportionment Department
A B C D E
Primary O/H - 36,150 33,600 22,300 41,800 39,650
Distribution
Service Department-D 2:3:3 10,450 15,675 15,675 -41800 -
(Time Keeping)
Service Department-E 1:2:2 7,930 15,860 15,860 - -39650
(Stores)
Total 54,530 65,135 53,835 -- --

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EX.3 Tushar Ltd. has three production departments and two service departments. For the month of
March 2015, the primary overhead distribution summary of each department is as follows:
Production Departments : Service Departments :
Department X Rs. 6,300 Department J Rs. 4,500
Department Y Rs. 7,400 Department K Rs. 2,000
Department Z Rs. 2,800
The expenses of the service departments are charged to the production and other service
departments on the basis of the following percentages :
Departments X Y Z J K
J 40% 30% 20% -- 10%
K 30% 30% 20% 20% --
Apportion the expenses of service departments to production departments by Repeated
Distribution Method.
Answer :
Statement of Secondary Distribution of Overheads
(Repeated Distribution Method)
Particulars Production Department Service Department
X Y Z J K
Primary Overhead 6,300 7,400 2,800 4,500 2,000
Distribution
Re-Apportionment of 1,800 1,350 900 -4,500 450
cost of Service Dept. J
(40 : 30 : 20 :10)
Re-Apportionment of 735 735 490 490 -2,450
cost of Service Dept. K
(30 : 30 : 20 :20)
Re-Apportionment of 196 147 98 -490 49
cost of Service Dept. J
(40 : 30 : 20 :10)
Re-Apportionment of 14 15 10 10 -49
cost of Service Dept. K
(30 : 30 : 20 :20)
Re-Apportionment of 5 3 2 -10 --
cost of Service Dept. J
(40 : 30 : 20 :10)
Total Rs. 9,050 9,650 4,300 -- --

EX.4 Paras Ltd. has three production departments and two service departments. For the month of
January 2015, the primary overhead distribution summary of each department is as follows:
Production Departments : Service Department :
Department A Rs. 7,810 Department D Rs. 4,000
Department B Rs. 12,543 Department E Rs. 2,600
Department C Rs. 4,547

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The cost of the service departments X and Y are to be charged on the basis of the following
percentages :
Departments A B C D E
D 30% 40% 20% -- 10%
E 10% 20% 50% 20% --

Prepare a Statement of Secondary Distribution of Overheads using following methods:

(1) Repeated Distribution Method
(2) Trial & Error Method
(3) Simultaneous Equation Method.

EX.5 Earth Ltd. has three production departments and two service departments. For the month of April
2015, the primary overhead distribution summary of each department is as follows:
Production Departments : Service Department :
Department A Rs.6,50,000 Department D Rs.1,20,000
Department B Rs.6,00,000 Department E Rs.1,00,000
Department C Rs.5,00,000
The cost of the service departments D and E are to be charged on the basis of the following
percentages:
Departments A B C D E
D 30% 40% 15% -- 15%
E 40% 30% 25% 5% --
Apportion the expenses of service departments to production departments by using following
methods:
(1) Repeated Distribution Method
(2) Trial & Error Method
(3) Simultaneous Equation Method.

ABSORPTION OF OVERHEADS
The main objective of primary and secondary distribution of overheads is to charge the costs to
production department and then the total indirect costs of the production department should be
charged to different cost units, which pass through the department. Charging the overheads to cost
units or products is known as overhead absorption. Overhead absorption can also be called recovery
of overheads. The basic purpose of absorption of overheads is to absorb total overheads of a
production department in the products manufactured by that department, so that the cost of each
unit of product produced by the department includes an equitable share of the total overhead of that
department.

Methods of Absorption:
For the purpose of absorption (charging) of overheads of a production department to the products
manufactured, the Overhead Absorption Rate is used.

There are several methods in use for determining overhead absorption rate, the important method
are as under:

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1. Percentage on Direct Wages or Direct Labour Cost Method:

Overhead Absorption Rate = Total Overheads X 100
Total Direct Wages

2. Direct Labour Hour Rate Method:

Overhead Absorption Rate = Total Overheads
Total Labour Hours

3. Direct Machine Hour Rate Method:

Overhead Absorption Rate = Total Overheads
Total Machine Hours

4. Rate per unit of Production Method:

Overhead Absorption Rate = Total Overheads
Total No. of Units Produced

EX.6 The following information relates to the Production Department - A in the factory for the month of
May, 2015:
Direct Material Consumed: Rs.75,000
Direct Wages: Rs.50,000
Production Overheads: Rs.1,50,000
Labour Hours: 30,000 Hours
Machine Hours: 25,000 Hours

The relevant data for one order (Order No. 51) carried out in the department during this month, are
as under:
Direct Material consumed: Rs. 14,000
Direct Wages: Rs. 11,000
Machine Hours Worked: 5000 Hours
Labour Hours Worked: 7000 Hours

You are required to:

(A) Determine Overhead Absorption Rate using following methods:
1. Percentage on Direct Wages
2. Direct Labour Hour Rate
3. Direct Machine Hour Rate
(B) Prepare a comparative statement of the total cost of order No.51 under each of the above
method of overhead absorption.

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