OVERHEADS

                                                             OVERHEADS 

                 Cost pertaining to a cost centre or cost unit may be divided into two portions direct and indirect. The indirect portion of the total cost constitutes the overhead cost which is the aggregate of indirect material cost, indirect wages of indirect expenses. indirect costs are those costs which are incurred for the benefit of a no.of cost centres/ cost units. Indirect costs, therefore, cannot be conveniently identified with a particular cost centre/cost unit but they can be apportioned to /absorbed by cost centres/ cost units.

                              Any expenditure over& above prime cost is known as overhead. In general terms, overheads comprise all expenditure incurred for/in connection with the general org. of the whole/ part of the undertaking i.e the cost of operating supplies&services used by the undertaking including the maintenance of capital assets.

DEFINITION: Overhead may be defined as " The cost of indirect material, indirect Labour & such other expenses including services as cannot conveniently be charged to a specific unit. 

 

Steps in overheads: Overheads are incurred for work in general. Overhead is added to the prime cost in order to measure the total cost of production/ cost of the goods sold. For allocation and apportionment of overhead in the cost of production/ cost of goods sold the following procedures are involved.

 

(1) Collection of overhead

(2)Classification of overhead

(3)Allocation and apportionment of overhead(primary distribution )

(4)Re_apportionment(re_distribution)of service department cost to production departments.

(5)Absorption of overhead by production units

  

 (1)Collection of overhead: Production overhead should be collected under separate standing order numbers provided. The primary documents used for this purpose are:

(a) Stores requisitions

(b)Time cards(wages analysis sheet)

(c)Invoice/purchase vouchers

(d)Cash book and journal entries 

(e)Subsidiary records

 

(2)Classification of overheads: Cost classification is the process of grouping costs according to their common characteristics & establishing a series of special groups according to which costs are classified. Thus, it involves two steps :

 (i)The determination of the class/groups in which the costs are subdivided 

(ii) The actual process of classification of the various items of expenses into one /the other of the groups.

      The method to be adopted for the classification of overhead costs depends on the type & size of the business, the nature of the product/services rendered and the policy of the management.

           Classification of Overhead

 (a)On the basis of element-wise

(b) On the basis of functions 

(c) On the basis of behaviour

(a) On the basis of Elements wise: One of the important classifications is on the basis of nature/elements. Based on elements the aggregate of all indirect material costs, indirect labour costs, and indirect expenses are known as overheads. Accordingly, overheads are grouped into (a) Indirect material cost

                           (b) Indirect labour cost

                           (c) Indirect expenses

 (b) On the basis of functions: This method of classification is based on the major business functions i.e., production, administration, selling & distribution.

(i) production overhead

(ii)Administration overhead

(iii) Selling overhead

(iv)Distribution overhead

(c) On the basis of behaviour: This classification is based on the variability of overheads according to the volume of production. On this basis, overheads are classified into fixed overheads, variable overheads & semi-fixed / semi _ variable overheads.

(3) Allocation & apportionment  of overhead : 

       Allocation is the process of identification of overheads with cost centres. An expense which is directly identifiable with a specific cost centre is allocated to that cost centre. So, it is the allotment of the whole item of cost to cost centres/cost units / refers to 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 dept should be charged to that dept. Similarly, the cost of repairs and maintenance of a particular machine should be charged to that particular dept wherein the machine is located. So, the term allocation means the allotment of the whole item without division to a particular department/cost centre.

        'Apportionment' _ cost apportionment is the allotment of proportions of items to cost centres/cost units. The term refers to the allotment of expenses which cannot be identified wholly with a particular dept. Such expenses require division and apportionment over two or more cost centres/units. It is identified as the allotment to two / more costs of proportions of the common items of cost on the basis of benefit received. Common items of overheads are rent & rates, depreciation, repairs & maintenance, lighting, and works manager salary. 

(4) Re_apportionment  of service dept costs to production dept (Secondary distribution): Service dept costs are re-apportioned to the production department / the cost centres where production is going on. This process of apportionment of overhead expenses is known as 'Secondary Distribution '. 

       The following are the important methods of re-distribution of the service dept.

(1) Direct re-distribution method: Service department costs under this method are apportioned over the production departments only, ignoring the services rendered by one service department to the other

(2)Step distribution method: Under this method, the cost of the most serviceable departments is first apportioned to other service departments and production departments. The next service department is taken up and its cost is apportioned this process goes on till the cost of the last service department is apportioned. Thus, the cost of the last service department is apportioned only to the production departments.

(3)Reciprocal service method: in order to avoid the limitation of the step method, this method is adopted. This method recognises the fact that if a given department receives service from another department, the department receiving such service should be charged. If two departments provide service to each other, each department should be charged for the cost of services rendered by the other. There are three methods available for dealing with inter-service departmental transfer:

   (i) Simultaneous equation method: Under this method, the true cost of the service departments is ascertained first with the help of simultaneous equations, these are then redistributed to production departments on the basis of given percentages.

   (ii)repeated distribution method: under this method, the totals as shown in the departmental distribution summary, are put out in a line, and then the service department totals are exhausted in turn repeatedly according to the agreed percentages until the figures become too small to matter.

   (iii)trial & error method: under this method, the cost of one service department is apportioned to another centre. the cost of another centre plus the share received from the first centre is again apportioned to the first cost centre and this process is repeated till the balancing figure becomes too small.

 

(5) Absorption of overhead by production units: The final step in the distribution plan production overhead is to recover/absorb the overheads in the cost of products, individual jobs, processes, batches / other convenient units. The overheads falling to the share of a department through the process of allocation/apportionment is to be absorbed by the cost units of the department. What we require ultimately is to be determined the cost of production & so the overheads are ultimate to be merged by absorption into the cost units. This is known as ''Absorption '' of overheads.