Cost Accounting

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OVERHEADS

CLASSIFICATION, ALLOCATION & APPORTIONMENT


TOPICS COVERED

• MEANING
• OVERHEAD ACCOUNTING
• CLASSIFICATION
• ALLOCATION
• APPORTIONMENT
MEANING OF OVERHEAD

• Overhead is the cost of material, labor and expenses which cannot be economically and
conveniently identified with specific saleable cost unit.
• It includes cost of indirect materials, indirect labor and indirect expenses which cannot
be conveniently charged to any job or process cost unit etc.
• Overhead is also known as ‘Overhead Cost’, ‘Overhead charges’, ‘oncost’ etc.
DEFINITION OF OVERHEAD

• CIMA defines overhead cost as ‘the total cost of indirect materials, indirect labor and
indirect expense.’
• Blocker and Weltmer define, “overhead costs are operating costs of a business
enterprise, which cannot be traced directly to a particular unit of output. Further such
costs are invisible or unaccountable.”
OVERHEAD ACCOUNTING

• The ultimate aim is ‘Absorption’ in the production units. The important steps involved in
Overhead are:
(a) Collection, Classification and Codification
(b) Allocation, Apportionment and Reapportionment
(c) Absorption of overheads
CLASSIFICATION OF OVERHEADS

Classification is defined by CIMA as, ‘the arrangement of items in logical groups’.


Basis of classification:
• Based on Elements: Indirect Materials, Indirect labor and Indirect expenses.
• Based on Functions of the organization: Manufacturing overheads, Administrative
overheads, Selling and Distribution overheads, Research & Development overheads.
• Based on Behavior: Fixed Overheads, Variable Overheads & Semi variable overheads.
CLASSIFICATION ACCORDING TO ELEMENTS

• INDIRECT MATERIALS – Those materials which cannot be identified with the given
product unit of cost centre.
• INDIRECT LABOR - As per CAS -3, indirect employee cost is the employee cost,
which cannot be directly attributed to a particular cost object.
• INDIRECT EXPENSES – Expenses such as rent and taxes, printing and stationery,
power, insurance, electricity, marketing and selling expenses etc.
FUNCTIONAL CLASSIFICATION

• When overhead expenses are classified with reference to major activity divisions of a concern,
it is called functional classification of overheads. The main groups of classification are:
a) Manufacturing Overheads
b) Administrative Overheads
c) Selling Overheads
d) Distribution Overheads
e) Research and Development Expenses
CLASSIFICATION BASED ON BEHAVIOR

• FIXED OVERHEADS: The amount of overhead tends to remain fixed for all volumes of production
within a certain range. Examples are: audit fee, interest on capital, Depreciation of plant & machinery,
insurance, rent of buildings, etc.
• VARIABLE OVERHEADS: Those costs which vary in total direct proportion to the volume of output.
These costs per unit remain relatively constant with changes in production. These costs per unit remain
relatively constant with changes in production. Examples are indirect material, indirect labor, lubricants,
cost of utilities, etc.
• SEMI- VARIABLE COST( also called mixed cost or semi fixed cost): It is a cost, containing both fixed
and variable elements and which is thus partly affected by fluctuation in the level of activity. These costs
are partly fixed and partly variable.
ALLOCATION OF OVERHEADS

• Allocation is the process of identification of overheads with cost centers. An expense


which is directly identifiable with a specific cost center is allocated to that center. So it is
the allotment of whole item of cost to a cost center or cost unit or refers to the charging of
expenses which can be identified wholly with a particular department. For example, the
whole of overtime wages paid to the workers relating to a particular department should be
charged to that department. So, the term allocation means the allotment of the whole item
without division to a particular department or cost center.
APPORTIONMENT OF OVERHEAD EXPENSES

• Cost apportionment is the allotment of proportions of items to cost centers or cost units
on an equitable basis. The term refers to the allotment of expenses which cannot identify
wholly with a particular department. Such expenses require division and apportionment
over two or more cost centers or units. So cost apportionment will arise in case of
expenses common to more than one cost center or unit. It is defined as the allotment to
two or more cost centers of proportions of the common items of cost on the estimated
basis of benefit received. Common items of overheads are rent and rates, depreciation,
repairs and maintenance, lighting, works manager’s salary etc.
BASES OF APPORTIONMENT

Following are the main bases of overhead apportionment utilised in manufacturing concerns:
(i) Direct Allocation
(ii) Direct Labour/Machine Hours
(iii) Value of Materials Passing through Cost Centers
(iv) Direct Wages
(v) Number of Workers
(vi) Floor Area of Departments
(vii) Capital Values
(viii)Light Points
(ix) Kilowatt Hours
(x) Technical Estimates
DISTINCTION BETWEEN ALLOCATION &
APPORTIONMENT
• Although the purpose of both allocation and apportionment is identical, i.e. to identify or
allot the costs to the cost centers or cost unit, both are not the same.
• Allocation deals with the whole items of cost and apportionment deals with proportion of
items of cost.
• Allocation is direct process of departmentalization of overheads, whereas apportionment
needs a suitable basis for sub- division of the cost.
• Whether a particular item of expense can be allocated or apportioned does not depends on
the nature of expense, but depends on the relation with the cost center.

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