MANAGEMENT ACCOUNTING

CHAPTER 7

OVERHEADS

Learning Objectives
After going through this unit, you will be able to:
Explain the meaning of overheads, classification, allocation,
apportionment, distribution and absorption of overheads.
State the method and techniques of allocating overhead costs to
different products and cost centers.

Structure
7.1 Introduction
7.2 Meaning of Overheads
7.3 Classification of Overheads
7.4 Allocation and Apportionment of Overheads
7.5 Distribution of Overheads
7.6 Absorption of Overheads
7.7 Summary

7.1 Introduction

In every business two types of costs are involved, direct and indirect . Direct
costs are related to output but indirect costs i.e. overheads are incurred even if
output is reduced or there is no output. It is thus important for management to
pay more attention to overhead costs. In order to control these costs it is
necessary to classify properly allocate them on equitable basis to different
products, processes or activities. This unit deals with various aspects of
overhead accounting and control and their equitable allocation.

7.2 Meaning Of Overheads

Total cost of indirect material, indirect labour and indirect expenses

When expense is for specific product it is called as chargeable expense but
when expense is for all products it is treated as overhead.
e.g. Machine hired for specific product is charged to that product but it is for
general purpose it is treated as overheads.

7.3 Classification Of Overheads

Elementwise:Indirect Material, Indirect labour, Indirect expenses

Functionwise: Production, Administration, Selling, Distribution, Research

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Elementwise:Indirect Material, Indirect labour, Indirect expenses

Functionwise: Production, Administration, Selling, Distribution, Research
and Development.
Behaviour wise : Fixed, Variable, Semi-variable.
[These terms have already been explained in Unit no. 5]

7.4 Allocation And Apportionment Of Overheads

Allocation means charging overheads to particular product, process, or

activity. Apportionment means division of overheads among two or more cost
centers or departments using appropriate base. Choice of base is a matter of
judgment with reference to particular circumstances of each company.
Following bases are generally used

Overhead Expense Base for Alloca on

Rent, property taxes, heating and Area occupied
depreciation of bldg.
Lighting No. of light points
Power Kwh
Depreciation, insurance, repairs and M/cs and vehicles
maintenance of Book value
Personnel, staff welfare, Canteen No. of employees
Advertising Sales value/sales qty.
M.D. Salary Sales value
Works directors salary No. of workers or Prodn. units.

Personnel, Stores, Canteen etc. are service centers providing service to

production departments. Service departments may provide service to other
service departments and to itself. These overheads are also to be apportioned
on the basis of services taken by various departments.

7.5 Distribution Of Overheads

Primary distribution of overheads means allocating total overheads of

company to all the cost centers using appropriate base.
Secondary distribution of overheads means allocating overheads of service
cost centers in proportion to the services taken by various production cost
centers from service cost centers

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Company
O/Hs (100)

Primary Distribution

P1 P2 P3 S1 S2
(40) (20) (20) (12) (8)

10 5 5 secondary distribution
100 = 50 25 25
Hrs = 10 20 25
5.0 1.25 1.0 O/H Absorption Rate/Hr.
2,000 2,000 1000 Monthly Hrs worked
10,000 2,500 1000 O/Hs Absorbed (a)
12,000 2,500 1,800 Actual O/Hs (b)
b>a b=a b<a
O/Hs O/Hs O/Hs
Under Rightly Over
absorbed absorbed absorbed.

7.6 Absorption Of Overheads

Refers to Charging of overheads to individual products or jobs.

Process of distribution of overheads allocated to a particular department
or cost center over the units produced.
Done by applying overhead absorption rate
Rate = Budgeted or actual overheads / Budgets or actual Hours
Selling and distribution overheads rate is calculated with reference to
sales quantity or sales value.
Overhead absorption rate is useful to calculate overheads to be absorbed
in a particular product e.g. if overhead rate is Rs 50 per labour hour and
product requires 3 labour hours, then overheads to be absorbed in product
cost is 3x 50 = Rs150.
Predetermined overhead rates: These rates are determined in advance to be
applied in future periods for product costing. At the end of the period actual

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overheads are found and compared with overheads absorbed on basis of pre
determined rates and over / under absorded overheads are determined to
correct pre determined rate. At the end of year under and over absorbed
overheads are adjusted to costing P and L A/C.

Example:
1/04/2015 – M/C Hr. rate =Rs 100 Per Hour In April 2015
M/C Hrs. used =2,000
Overheads Absorbed =2,000 X 100=Rs 2, 00,000
On 30/4/2015 following are actual position
If actual overheads = 2,20,000
i.e. Actual > Predetermined (under absorbed)
If actual overheads =1,80,000
i.e. Actual < Pre-determined (over absorbed)

Illustrations on Overheads
Illustration 1:
Semi-Variable cost is `50,000 when production is 5,000 units and `
80,000 when production is 10,000 units. Decide fixed and variable cost
Solution:
Variable Cost per unit =Change in semi-variable cost
Change in output

= [80,000] – [50,000]
[10,000] – [ 5,000 ]

= R`6 per unit

Total fixed cost = [Total semi-variable cost] – [No. of units x V.C. per unit]
= [50,000] – [5,000 x 6] ( for production. of 5,000 units )
= 20,000
Illustration 2:
Mayur Industries Limited is a single product company. Production capacity is
6,000 units per week. Cost data is available for 3 weeks:
Units Produced Material Cost(Rs) Labour Cost(Rs) Fty. Overheads(Rs)
[Variable cost] [Variable cost] [Semi-variable cost]
2,400 4,800 6,000 37,200
2,800 5,600 7,000 38,400
3,600 7,200 9,000 40,800
Decide selling price at activity level of 4,000 units per week if
Profit required is 20% on selling price.

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Solution:
Variable Factory Overheads per unit = Change in semi-variable cost
Change in output

=[40,800] – [37,200]
[3,600] – [2,400]

=Rs 3 per unit

Total fixed cost =[Total semi-variable cost] – [No. of units x V.C.
per unit]
=[40,800] – [3,600 x 3] ( for production. of 3,600 units )
= Rs 30,000
Profitability statement at activity level of 4,000 units per week

Per Unit(`) Total(`)

Direct Material 2.0 [4,800/2,400] 8,000
Direct Labour 2.5[6,000/2,400] 10,000
Fty.Overheads 3.0 12,000
Total variable cost (a) 30,000
Total Fixed Fty Overheads (b) 30,000
Total Cost [a+b] 60,000
+ Profit [25% on cost] 15,000
= Selling Price per unit 75,000
Note: 20% on selling price means 25% on cost
Illustration 3:
A,B,C are production departments andX,Y are service departments.
Overhead expenses for July,2015
Rent Rs 12,000
Depreciation Rs 50,000
Repairs Rs 5,000
Travelling Rs 15,000
Supervision Rs 68,000
Other details
Department A B C X Y
Area(sq.mtr.) 500 300 100 50 50
Machine cost(lacs) 5 2 2 1 -
Employee(Nos.) 10 5 20 5 10
No. of Hours. 200 150 100 - -
X [ distribution %] 20 30 40 - 10
Y [ distribution %] 40 20 30 10 -

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Decide overhead absorption rate per hour

If direct material cost is Rs 2,500 ,direct labour Rs1,500 and direct expenses
are Rs 200 and product passes through Deptt A for 0.5 hours, B for 1.2 hours
and C for 1.5 hours decide cost of product.
Solution:
[A] Primary distribution of overheads
Expens Total Basis of Dept.A Dept.B Dept.C Dept.X Dept.
Amt allocation (Rs) (Rs) (Rs) (Rs) Y
(Rs) (Rs)
1.Rent 12,000 Area 6,000 3,600 1,200 600 600
2.Depreciation 50,000 m/c cost 25,000 10,000 10,000 5,000 -
3.Repairs 5,000 m/c cost 2,500 1,000 1,000 500 -
4.Travelling 15,00 Employees 3,000 1,500 6,000 1,500 3,000
5.Supervision 68,000 Employees 13,600 6,800 27,200 6,800 13,600
TOTAL 1,50,000 50,100 22,900 45,400 14,400 17,200

Allocation :
1) Rent : Ratio is 500 : 300 : 100: 50 : 50 total
i.e. 5 : 3 : 1 : 0.5: 0.5
For Dept.A = 5/10 x 12,000 =
6,000
B = 3/10 x 12,000 = 3,600
C = 1/10 x 12,000 = 1,200
X = 0.5/10 x 12,000 = 600
Y = 0.5/10 x 12,000 = 600
2) Depreciation : Ratio is 5: 2: 2:1: - Total = 10
For A = 5/10 x 50,000 = 25,000
B = 2/10 x 50,000 = 10,000
C = 2/10 x 50,000 = 10,000
X = 1/10 x 50,000 = 5,000
Y = Nil

3) Repairs (same as above )

For A = 5/10 x 5,000 = 2,500
B = 2/10 x 5,000 = 1,000
C = 2/10 x 5,000 = 1,000
X = 1/10 x 5,000 = 500
Y = Nil.

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4) Travelling :
Ratio 10:5 :20 :5 :10
For A = 10/50 x 15,000 = 3,000
B = 5/10 x 15,000 = 1,500
C = 20/50 x 15,000 = 6,000
X = 5/5 x 15,000 = 1,500
Y = 10/50 x 15,000 = 3,000
5) Travelling (same as above)
For A = 10/50 x 68,000 = 13,600
B = 5/50 x 68,000 = 6,800
C = 20/50 x 68,000 = 7,200
X = 5/ 50 x 68,000 = 6,800
Y = 10/50 x 68,000 = 13,600

[B] Secondary distribution of overheads

There are many methods of this distribution. We are going to use repeated
distribution method which is most logical .
A B C X Y
Total overheads 1,50,000 50,100 22,900 45,400 14,400 17,200
Distribution X 2,880 4,320 5,760 (14,400) 1,440
(as per given %)
Distribution Y 7,456 3,728 5,592 1,864 (18,640)
(as per given %)
Repeated 373 559 746 (1,864) 186
distribution of X (as
per given %)
Repeated 74 37 56 19 (186)
distribution of Y (as
per given %)
Repeated 4 6 7 (19) 2
distribution of X (as
per given %)
Distribution of y 1 - 1 - (2)
1,50,000 60,888 31,550 57,562 - -

NOTE :
1) In allocation figures are to be rounded off to nearest complete
rupee and total is to beadjusted accordingly
2) Do not continue process indefinitely . When small figure is left
in service departments it is logical allocated to production
departments without applying actual % ages given in
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problems.
[C] Deciding overhead absorption rate: Deptt.A Deptt B Deptt. C
Total overheads (Rs) (a) 60,888 31,550 57,562
Total Hrs. worked (Nos.)(b) 200150 150 100
Overhead Rate / Hour (Rs [a/b] 304.44 210.33 575.62

[D] Deciding cost of a product , Amt. (Rs)

Direct material 2,000
+ Direct labour 1,500
+ Direct Expenses 200
= Prime Cost (I) 3,700
Overheads in Deptts.
A - 304.44 x 0.5 152.22
+B - 210.33 x 1.2 252.40
+C - 575.62 x 1.5 863.43
=Total Overheads (II) 1,268.05
Total Cost (I + II ) 4,968.05

Illustration 4 :
Actual overheads in Deptt. A,B, and C are Rs 19,300, 4,200 and 4,000
respectively.
Predetermined overheads are :
Deptt. A Rs 1.5 per machine hour for 14,000 hours
Deptt. B Rs 1.3 per labour hour for 3,000 hours
Deptt. C Rs 80% of direct labour cost of Rs 6,000
Decide department wise under or over absorbed overheads.

Solution :

Rate Overheads Overheads Overheads Under

absorbed actual /Over absorbed (Rs)
(Rs)
(Rs) (Rs)

A 1.5 per machine Hr. 21,000(1.5 x 19,300 Over absorbed

14,000)

B 1.3 per labour Hr. 3,900 (1.3 x 3,000) 4,200 Under absorbed

C 80% of labour cost 4,800 (80% x 4,000 Over absorbed.

6,000)

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Illustration 5
Pre determined overhead rate per machine hour is Rs 50 for dept. A Rs 60 for
dept. B and Rs 80 for dept.C. Hours worked during the month are A(20,000) B
(40,000)and C (30,000). Actual overheads for the month are A (11.5 lakhs. )
B(22 Lakhs.) C(28lakhs) . Decide priority of control with the assumption that
overhead rates have been accurately determined.
Solution :
Deptt. Hrs. Rate/Hr.( Overheads Overheads Under/over Priority
worked Rs) absorbed actual (Rs) absorption of
(Rs) control

A 20,000 50 10,00,000 11,50,000 1,50,000 (Under ) II

B 40,000 60 24,00,000 22,00,000 2,00,000 ( Over ) III

C 30,000 80 24,00,000 28,00,000 4,00,000 (Under ) I

7.7 Summary

· When expense is for specific product it is called chargeable expense

but when it is for all product it is treated as overheads.
· Overheads are classified as per elements i.e. material, labour and
expenses, as per functions i.e. administration, selling, distribution,
research and development and as per behavior i.e. fixed , variable and
semi-variable
· Allocation is a process of allocating overheads directly to a product,
process or cost centre .Apportionment is division of overhead cost to
two or more cost centers or departments using appropriate base
· Total overheads are first allocated to all production and service cost
centers, This is known as primary distribution. Subsequently
overheads pertaining to service departments are allocated to
production departments using appropriate base.This is known as
secondary distribution of overheads.
· Finally overheads are absorbed to products or services produced by
company using appropriate absorption rate.

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