Overheads Allocation, Assignment and Absorption

Overheads Allocation, Assignment and Absorption

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). 1 Objective 1 Explain under-costing and over-costing of products and services Under-costing and Over-costing

Example Ram, Anil and Nitin order separate items for breakfast. Rams order amounts to Anil consumed Nitins order is Total 14 30 16 60 What is the average cost per breakfast? Undercosting and Overcosting Example 60 3 = 20 Ram and Nitin are over-costed. Anil is Under-costed. Assigning indirect costs using blanket overhead rates

Some firms use a single overhead rate (i.e.blanket or plant-wide) for the organization as a whole. Example Total overheads Direct labour (or machine hours) Overhead rate = 900 000 = 60 000 = 15 per hour 2000 Colin Drury 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 managers 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 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 C 19,000 4,000 40,000 10,000 10 30

2,000 D E 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 Direct Materials Direct Wages Indirect Material

Indirect Wages Dep. of Machinery Dep. of Building Rent, Rates, etc. Electric Power For Machinery For Lighting General Expenses Basis Total Production Dept. A B Service Dept. C D E Given

given Direct Material Direct Wages Machine Value Floor Area Floor Area 60,000 40,000 15,000 12,000 20,000 10,000 10,000 20,000 15,000 5,000 4,500 4,800 3,000 3,000 10,000 15,000 2,500

4,500 8,000 2,000 2,000 19,000 4,000 4,750 1,200 3,200 2,000 2,000 6,000 2,000 1,500 600 2,000 1,000 1,000 5,000 4,000 1,250 1,200 2,000

2,000 2,000 H.P. Light Points Labor Hours. 15,000 300 21,000 5,000 90 7,000 6,000 60 7,000 3,000 60 2,800 500 30 1,400

500 60 2,800 20,810 2,03,300 67,390 57,060 42,010 16,030 (16030) Expenses of Dep. D between A,B,C In ratio to Direct Wages -------

7,072 7,072 1,886 Expenses of Dep. E between A,B,C In ratio to Direct Wages ------- 9,180 9,180 2,450 83,635 73,305 46,360

2,03,300 (20810) 0000 0000 Budgeted overhead rates Therefore, costs should be allocated as follows: Budgeted unit rate X Actual hours of computer time used

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