The document discusses cost allocation and overhead accounting. It defines overhead as indirect costs that cannot be traced to a specific product or service. It covers classifying and types of overheads, the steps in overhead accounting including collection, distribution, and reapportionment. The bases and principles of apportioning overheads are explained along with common reapportionment methods. Absorption of overheads refers to allocating overhead expenses to cost units or centers. Various absorption methods and the concepts of under and over absorption are defined.

1. Cost Allocation
Cost Allocation
 What is overhead?
What is overhead?
 Basis of classifying overheads
Basis of classifying overheads
 Various types of overheads
Various types of overheads
 Steps in overhead accounting
Steps in overhead accounting
 Basis of Apportionment of Overheads
Basis of Apportionment of Overheads
 Principles of Apportionment
Principles of Apportionment
 Methods of Reapportionment
Methods of Reapportionment
 Absorption of overheads
Absorption of overheads
 Methods of absorption
Methods of absorption
 Under absorption
Under absorption
 Over absorption
Over absorption

2. Definition of Overheads
Definition of Overheads
 The CIMA defines overhead cost as “the
The CIMA defines overhead cost as “the
total cost of indirect materials, indirect
total cost of indirect materials, indirect
labor and indirect expenses. In short, it is
labor and indirect expenses. In short, it is
the cost of materials, labor and expenses
the cost of materials, labor and expenses
that cannot be economically identified with
that cannot be economically identified with
specific saleable cost unit.
specific saleable cost unit.

3. Classification of Overhead Costs
Classification of Overhead Costs

4. Element wise Classification
Element wise Classification

5. Steps on Overhead Accounting
Steps on Overhead Accounting
The various steps in an overhead
The various steps in an overhead
accounting are:
accounting are:
 Collection of overhead details
Collection of overhead details
 Distribution of overhead to cost centers
Distribution of overhead to cost centers
 Reapportionment of service department
Reapportionment of service department
costs to production departments
costs to production departments

6. Primary Distribution of Overheads and
Primary Distribution of Overheads and
Reapportionment of Overheads
Reapportionment of Overheads
Refer to the Word file Attached
Refer to the Word file Attached

7. Basis of apportionment of
Basis of apportionment of
overheads
overheads
 Direct Allocation
Direct Allocation
 Direct Labor Hours
Direct Labor Hours
 Direct Wages
Direct Wages
 Number of workers
Number of workers

8. Methods of Reapportionment
Methods of Reapportionment
 Direct Redistribution
Direct Redistribution
• Chances of overcharge or under charge
Chances of overcharge or under charge
• Non accuracy in department overhead rates
Non accuracy in department overhead rates
 Step Method
Step Method
• Apportioning service department costs
Apportioning service department costs
 Reciprocal Service Method
Reciprocal Service Method
• Simultaneous equation method
Simultaneous equation method
• Repeated distribution method
Repeated distribution method
• Trial and error method
Trial and error method

9. Illustrations…
Illustrations…
Refer to the Word file Attached
Refer to the Word file Attached

10. Absorption of Overheads
Absorption of Overheads
“
“Process of allocating the overhead
Process of allocating the overhead
expenses to the cost centers/cost units is
expenses to the cost centers/cost units is
known as overhead absorption”
known as overhead absorption”

11. Absorption rates
Absorption rates
 Actual rate
Actual rate
 Predetermined rate
Predetermined rate
 Moving average rate
Moving average rate
 Blanket and multiple rates
Blanket and multiple rates

13. Rate per unit of production
Rate per unit of production
 OH rate =
OH rate = Budgeted overhead expenses
Budgeted overhead expenses
Budgeted production
Budgeted production
 Features:
Features:
• Simple /easy to use
Simple /easy to use
• Suitable for extractive industries
Suitable for extractive industries

14. Direct Wages Method
Direct Wages Method
 OH rate =
OH rate = Budgeted overhead expenses
Budgeted overhead expenses
Direct wages
Direct wages
 Advantages:
Advantages:
• Consideration of time factor
Consideration of time factor
• Stability of labor rates
Stability of labor rates
• Proportional charge to production
Proportional charge to production
• Easy availability of data
Easy availability of data
• Most appropriate in certain situations
Most appropriate in certain situations
 Limitations:
Limitations:
• Not related to efficiency of workers
Not related to efficiency of workers
• Consideration of time factor (piece rate basis)
Consideration of time factor (piece rate basis)
• Ignores contribution by other factors of production
Ignores contribution by other factors of production
• No distinction between fixed and variable expenses
No distinction between fixed and variable expenses

15. Production hour method
Production hour method
 OH rate =
OH rate = Budgeted overhead expenses
Budgeted overhead expenses
Total productive hours of direct labor
Total productive hours of direct labor
 Advantages:
Advantages:
• When job is labor-oriented
When job is labor-oriented
• Uniform time for various jobs
Uniform time for various jobs
• No impact on rate by the method of wage
No impact on rate by the method of wage
payment/grade/rate of workers
payment/grade/rate of workers
 Limitations:
Limitations:
• Faulty distribution of overhead
Faulty distribution of overhead
• Not suitable where piece rate system is used
Not suitable where piece rate system is used
• Expenses not related to labor hours are ignored
Expenses not related to labor hours are ignored
• No clear distinction between types of labor/costs/workers
No clear distinction between types of labor/costs/workers

16. Machine hour rate method
Machine hour rate method
 OH rate =
OH rate = Total running expenses
Total running expenses
Number of working hours for the machine
Number of working hours for the machine
 Advantages:
Advantages:
• Scientific/practical/accurate
Scientific/practical/accurate
• Comparison of relative efficiencies
Comparison of relative efficiencies
• Decision making by the management
Decision making by the management
• Detection of idle time
Detection of idle time
 Limitations:
Limitations:
• Higher cost
Higher cost
• Not useful when blanket rate is used
Not useful when blanket rate is used
• Inaccurate results if use of labor is equally important
Inaccurate results if use of labor is equally important
• Doesn’t consider expenses that are not proportionate to working
Doesn’t consider expenses that are not proportionate to working
hours
hours

17. Direct material cost method
Direct material cost method
 OH rate =
OH rate = Budgeted overhead expense
Budgeted overhead expense
Expected direct material cost
Expected direct material cost
 Advantages:
Advantages:
• Simple /easy to use
Simple /easy to use
• Suitable when
Suitable when

Output is uniform
Output is uniform

Stable material cost
Stable material cost

Proportion of OH to total cost is significant
Proportion of OH to total cost is significant
 Limitations:
Limitations:
• Unstable and inaccurate
Unstable and inaccurate
• No consideration for time factor
No consideration for time factor
• No distinction between fixed and variable costs
No distinction between fixed and variable costs
• No distinction between production of workers and machines
No distinction between production of workers and machines

18. Prime cost method
Prime cost method
 OH rate =
OH rate = Budgeted overhead expense
Budgeted overhead expense
Prime cost
Prime cost
 Advantages:
Advantages:
 Simple /easy to use
Simple /easy to use
 Suitable when there is no wide fluctuations in
Suitable when there is no wide fluctuations in
processing
processing
 Limitations:
Limitations:
 No consideration for time factor
No consideration for time factor
 No distinction between fixed and variable costs
No distinction between fixed and variable costs

19. Sale price method
Sale price method
 OH rate =
OH rate = Budgeted overhead expenses
Budgeted overhead expenses
Sale price of units of production
Sale price of units of production
 Suitable for the absorption of :
Suitable for the absorption of :
• Administration
Administration
• Selling and distribution
Selling and distribution
• Research and development
Research and development
• Design costs
Design costs

20. Factors to be considered for determining
Factors to be considered for determining
the basis of apportionment
the basis of apportionment
 Adequacy
Adequacy: The OH rate should be in such a way that
: The OH rate should be in such a way that
equitable apportionment can be made to the cost centers
equitable apportionment can be made to the cost centers
or cost units.
or cost units.
 Convenience:
Convenience: The OH rate should be simple and easy
The OH rate should be simple and easy
to understand and also convenient in application.
to understand and also convenient in application.
 Time factor:
Time factor: The OH rate should have some relation to
The OH rate should have some relation to
the time taken by various jobs for completion.
the time taken by various jobs for completion.
 Manual or machine work:
Manual or machine work: There can be different OH
There can be different OH
rates for manual and machine work.
rates for manual and machine work.
 Differential OH rates:
Differential OH rates: If the nature of work done by the
If the nature of work done by the
various departments is not same, different OH rates can
various departments is not same, different OH rates can
be ascertained.
be ascertained.
 Information
Information: The availability of information affects the
: The availability of information affects the
selection of the OH rates.
selection of the OH rates.

21. Under absorption/Over absorption
Under absorption/Over absorption
 The OH costs are fully recovered from
The OH costs are fully recovered from
production, if actual rate method of
production, if actual rate method of
absorption is adopted. If the OH rate
absorption is adopted. If the OH rate
absorbed is less than the overheads
absorbed is less than the overheads
incurred, it is called as under absorption of
incurred, it is called as under absorption of
overheads.
overheads.
 If the OH rate absorbed is more than the
If the OH rate absorbed is more than the
actual overheads incurred, it is known as
actual overheads incurred, it is known as
over absorption of overheads.
over absorption of overheads.

22. Accounting of Under absorption
Accounting of Under absorption
and Over absorption
and Over absorption
 Use of supplementary rates
Use of supplementary rates
To carry out adjustment for the difference between
To carry out adjustment for the difference between
overhead absorbed and overhead incurred
overhead absorbed and overhead incurred
Under or over absorbed overheads/actual base
Under or over absorbed overheads/actual base
 Writing off to costing P/L account
Writing off to costing P/L account
Under/Over absorption due to abnormal situations
Under/Over absorption due to abnormal situations
Distortion in the value of stock
Distortion in the value of stock
Absorption in the accounts of subsequent years
Absorption in the accounts of subsequent years
 Deferred charge
Deferred charge
Suitable when the business period is more than one
Suitable when the business period is more than one
year
year

23. Summary
Summary
 How we can define overhead?
How we can define overhead?
 Classification and types of overheads
Classification and types of overheads
 Major steps involved in overhead accounting
Major steps involved in overhead accounting
 What are the basis for apportioning the
What are the basis for apportioning the
overheads?
overheads?
 What are the principles of apportionment?
What are the principles of apportionment?
 Trace the common methods of reapportionment.
Trace the common methods of reapportionment.
 What do you mean by absorption of overheads?
What do you mean by absorption of overheads?
 Methods of absorption
Methods of absorption
 Under absorption and over absorption.
Under absorption and over absorption.