01.Understand the concept of ‘Overheads’. 02.Understand classification, allocation, apportionment and absorption of overheads. 03. Understand the Primary and Secondary Distribution of Overheads. 04. Understand the Traditional & Activity Based Costing methods 05. Identify the value added & non value added activity

1. CHAPTER 05:
OVERHEAD COSTS
CONDUCTED BY:
P. Ayanthi Madumali

2. Intended Learning Outcomes
• At the end of the chapter, you will able to
01.Understand the concept of ‘Overheads’.
02.Understand classification, allocation, apportionment and absorption of
overheads.
03. Understand the Primary and Secondary Distribution of Overheads.
04. Understand the Traditional & Activity Based Costing methods
05. Identify the value added & non value added activity

3. Overhead Costs
• According to CIMA, overhead costs are defined as, the total
cost of indirect materials, indirect labor and indirect expenses
• Examples of overhead expenses are rent, taxes, depreciation,
maintenance, repairs, supervision, selling and distribution
expenses, marketing expenses, factory lighting, printing
stationery etc.

4. Types of Overheads
Overhead Cost
According to
elements
According to functional
classification
According to behavior
Indirect material
Indirect labour
Indirect Expenses
Manufacturing
Administration
Selling & Distribution
Fixed
Semi variable
Variable

5. Steps in overhead accounting
01.Collection of Overheads
02. Allocation of Overheads
03. Apportionment of Overheads
04.Reapportionment of overheads
05.Absorption of Overheads.

6. 01. Collection of Overheads
• Overheads collection is the process of recording each item of cost
in the records for the purpose of ascertainment of cost of each cost
center or unit.
• The following are the source documents for collection of
overheads.
i. Stores Requisition
ii. Wages Sheet
iii. Cash Book
iv. Purchase Orders and Invoices

7. 02.Allocation of overheads
• Before the allocation and apportionment process starts, the first
step is ‘Departmentalization’ of overhead expenses.
• Departmentalization means creating departments in the firm
so that the overhead expenses can be conveniently allocated or
apportioned to these department.
• Ex: Machining, personnel, assembling, maintenance, power,
tool room, stores, accounts, costing

8. Allocation of overheads
• Allocation is the process by which cost items are charged
directly to a cost unit or cost center.
• For example, electricity charges can be allocated to various
departments if separate meters are installed & Salary of stores
clerk can be allocated to stores department, cost of coal used in
boiler can be directly allocated to boiler house division

9. 03.Apportionment of Overheads
• Wherever possible, the overheads are to be allocated. However, if it is
not possible to charge the overheads to a particular cost center or cost
unit, they are to be apportioned to various departments on some
suitable basis.
• Electricity- light point , machine hour
• Rent, repair of building- Floor space
• Insurance & depreciation of machinery -Value of machinery
• Power – horsepower
• Employee insurance ,expenses & canteen expenses – No of Employee
• A statement showing the apportionment of overheads is called as ‘Primary
Distribution Summary’ of overheads. (see Q:01 , part “A” )

10. 04.Reapportionment of Overheads
• The departments are broadly divided into Production
Departments and Service Departments.
• Reapportionment of Overheads means, the overheads of the
service departments are reapportioned to the production
departments
• This process is called as preparation of ‘Secondary Distribution
Summary’ of overheads

11. The methods of reapportionment are divided into two types.
01.Non Reciprocal Method
02. Reciprocal Method
01.Non Reciprocal Methods :- Under this method, the
assumption is that while service departments render services to
the production departments, they do not render services to each
other ( see q.02)

12. • 02.Reciprocal Method :- Under this method, the assumption is
that the service departments do render services to the production
departments, they also render services to other service
departments.
• The following method are used under Reciprocal Methods
i. Repeated Distribution Method
ii. Simultaneous Equation Method

13. i. Repeated Distribution Method
• Under this method, services rendered by services departments to
the production departments and other services departments are
quantified in the form of percentages.
• The services departments costs are reapportioned to the
production departments on the basis of these percentages. The
process is repeated again and again till a negligible figure is
reached (See Q: 01 Part B & Q :04)

14. ii. Simultaneous Equation Method
• This is an algebraic method in which simultaneous equations
are formed and amount of overhead expenses of each service
department are found out, by solving the equations.
• The total expenses thus obtained are then directly transferred to
the production departments
• ( See Q: 03 & Q:04)

15. 05.Absorption of Overheads.
• Absorption means charging equitable share of
overhead expenses to the products.
• The absorption is to be made on some suitable basis.
• The basis is the ‘absorption rate’ which is calculated
by dividing the overhead expenses by the base
selected. ( See Q: 05)
• Overhead Absorption Rate = Overhead Expenses
Units of the base selected.

16. The methods used for absorption are as follows.
• Basis of production units
• Basis of Direct labour hour
• Basis of percentage of direct material
• Basis of percentage of direct labour cost
• Basis of Machine hour
• Basis of percentage of primary cost

17. Value added activity
An activity that increases the worth of a product or
service such as,
• Engineering design
• Assembling
• Painting
• Packing
• Production
• R & D

18. Non Value added activity
An activity that adds to or increases time spent on a
product/service without increasing its market value such
as,
• Repair of machine
• Storage of inventory
• Building maintenance
• Inspections
• Moving materials

19. Traditional Costing Method
• Typically used one rate to allocate overhead to
products. This rate was often based on direct labour
cost or direct labour hour.
• Problems with Traditional costing system,
manufacturing process and products are now more
complex , this results in over costing or under costing
- Complex products are not allocate an adequate
amount of OH costs
- Simple products get too much ( See q: 06)

20. Activity Based Costing (ABC)
• An overhead cost allocation system that allocates overhead to
multiple activity cost pools and assigns the activity cost pools to
products or services by means of cost drivers that represent the
activity used. ( See Q:06)
• Steps of ABC,
1. Identify activities
2. Identify cost drivers
3. Compute overhead rate
4. Assign overhead costs

21. Benefits & Limits ofABC
• Benefits:
- ABC leads to more cost pools
- ABC leads to enhanced control over overhead costs
- ABC leads to better management decisions
• Limits:
- ABC can be expensive
- Some arbitrary allocations continue

22. When to useABC
1. Products line are numerous, divers
2. Products differ greatly in volume & manufacturing
complexity
3. OH costs constitute a significant portion of total
costs
Level of Activity under ABC method:
Unit level
Batch level
Product level
Facility level

23. Thank You….