Overheads

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					Overheads




            1
Overheads

n Overhead includes a large number of types
  of indirect costs
n Direct cost are identifiable to cost units, but
  overhead which are often considerable,
  cannot be related directly to cost units




                                                    2
Two-stage method to allocate
overhead to products
n Overheads are assigned to the cost centres
  such as department
n An allocation base is selected for allocating
  production centre expenses to products




                                                  3
Procedures of overhead
allocation to product
n Assign all factory overheads to cost centres
n Reallocate service-centre overheads to
  production cost centres
n Calculate separate overhead absorption rate
  for each cost centre
n Assign cost-centre overhead to products



                                                 4
Assign all factory overheads to
cost center




                                  5
Assign all factory overhead to
cost centres
n Cost allocation
n Cost apportionment




                                 6
Cost allocation

n   Where a cost can be clearly identified with a
    cost center or cost unit, then it can be
    allocated to that cost center or cost unit




                                                7
Cost apportionment

n   It is not possible to identify a discrete item
    of cost with a cost center and it is necessary
    to split a cost over several cost centers on
    some agreed basis




                                                     8
Bases of apportionment

n Apportionment of indirect expenses to cost
  centers must be made on fair and reasonable
  bases
n Different types of expense require different
  bases according to their individual
  characteristics


                                             9
Base of apportionment    Costs

Area                     Rent and rates, heat and
                         lighting, insurance of
                         lighting
Machine value            Depreciation, machine
                         insurance
No. of employees         Wages of supervisors,
                         canteen cost

Example textbook P.183
                                                    10
Reallocate service-center
overheads to production center




                                 11
Reallocate service-centre
overheads to production cost
centres
n   Service departments are not directly involved in
    production
n   They only support service to other production
    departments in order to facilitate the production
    process
n   Therefore, it is necessary to reallocate the service-
    centre overheads to production departments so that
    all production costs can be absorbed into
    production.
n   Typical bases are listed as follows:
n                                                      12
nTypical   bases are listed as follows:
  Service departments       Possible bases of
                            apportionment
  Maintenance               Maintenance labour hours,
                            machine value
  Stores                    Value or weight of materials
                            issued, number of
                            requisitions
  inspection                No. of employees, no. of jobs


Example textbook P.183
                                                     13
Calculate separate overhead
absorption rate for each cost
center




                                14
Calculate separate overhead
absorption rate for each cost centre
n   To determine the overheads to be absorbed
    by a cost centre, it is necessary to establish
    an overhead absorption rate (OAR)

              Total overhead of cost centre
    OAR =
            Total number of units of absorption base applicable
            to cost centre



                                                           15
n An appropriate OAR should reflect the
  effort or time taken to produce the products
n Some commonly used absorption bases are
  listed as follows:
Direct labour hours   It is frequently used in the labour
                      intensive department because
                      overheads assigned to this department
                      are closely related to the direct labour
                      hours worked
Machine hours         It is most appropriate for the
                      appropriate for the machining
                      department since most of the
                      overheads are closely related to
                      machine hours                      16
Direct wages             It is only suitable in the department
                         where the uniform wage rate is
                         applied
Direct materials         This method is not recommended
                         unless the majority of overheads
                         incurred in a department are related
                         to materials instead of time
Units of output          This method is suitable only where
                         all units produced in a period are
                         identical in the production process
                         and time. Therefore, this application
                         is very rare


Example textbook P.183
                                                            17
Example 1

  Refer to textbook P.183 and P.184




                                      18
O/H Apportionment      Total    Production dept.           Service dept.
item Basis                      Maching Assembly Finishing Stores Maintenance
                       $000     $000      $000   $000      $000     $000
Indirect Actual         727     200       199      185     20      123
material
Indirect Actual         510     200       200      80       10     20
wages
Rent& Area               200    40        20       60       60      20
Rates
Machine Machine          30     16        10       2         1       1
Insurance Value
Dep.     Machine         300    160       100      20       10      10
          Value
Heat & Area              100    20        10       30       30      10
Light
Production No. of        160    48        32       48       16      16
Supervisor Employees
                         2027   684       571      425      147      200
                                                                         19
O/H Apportionment     Total       Production dept.           Service dept.
item Basis                        Maching Assembly Finishing Stores Maintenance
                      $000        $000      $000   $000      $000     $000

                       2027       684      571     425       147      200
Reallocation
of service-centre
overheads
Stores  Materials issued          100      40        7        (147)
Maintenance Maintenance           100      60        40               (200)
           Work
                           2027   884      671        472      -         -




                                                                         20
 n   Calculation of overhead absorption rates:
              Maching       Assembly        Finishing

Overhead      Machine       Machine hours   Labour hours
absorption    hours
basis

Overhead      $884000/200   $671000/100000 $472000/40000
absorption    000 hrs       hrs            hrs
rates         = $4.42/hr    = $6.71 /hr    = $11.8/hr
                                                        21
Assign cost-center overhead to
products




                                 22
Assign cost-centre overheads to
products
n   The final step is to charge the overheads to
    the products passing through the production
    departments




                                               23
Example




          24
n   The facts are the same as those in Example
    on slide no. 18. The number of hours
    needed to finish the products are listed as
    follows:
    Departments      Product A   Product B
    Machining        4 hours     5 hours


    Assembly         2 hours     1 hour


    Finishing        1/10 hour   1/10 hour

                                                  25
Departments Product A                                  $

Machining        4 hours at $4.42 per mach. hr.        17.68
Assembly         2 hours at $6.71 per mach. hr.        13.42
Finishing        1/10 hour at $11.88 per labour hr.    1.19
Total overhead charged per unit                        32.29

 Departments Product A                                  $

 Machining        5 hours at $4.42 per mach. hr.        22.10
 Assembly         1 hours at $6.71 per mach. hr.        6.71
 Finishing        1/10 hour at $11.88 per labour hr.    1.19
 Total overhead charged per unit                        30.00
                                                                26
Predetermined overhead
absorption rates (POAR)




                          27
Predetermined overhead
absorption rates (POAR)
n   The overhead absorption rates are usually
    computed in advance of operations
n   In practice, most absorption rates are only
    predetermined because the actual overheads are not
    known until the end of the period
n   If the actual overheads are used to compute the
    OAR, the product cost can only be obtained at the
    end of the accounting period
n   A delay in product cost calculation will also affect
    the pricing setting, the profit calculation and stock
    valuation                                            28
The formula of POAR
 The formula are as follows:
                    Budgeted total overheads
 POAR =
          Budgeted total number of units of absorption base




                                                        29
Under-absorption and over-
absorption base
n    Since the POAR are based on the estimated
    production and estimated overheads, the
    overheads absorbed seldom agree with the actual
    overheads incurred for the period
n   Under-absorption occur when overhead absorbed
    are small than the actual overheads
n   Over-absorption occurs when the overhead
    absorbed are greater than actual overheads

                                                      30
n   For financial accounting, under- or over-
    absorption of overheads should be treated as
    period cost and written off against the profit and
    loss account in the current accounting period
n   The under- or over-absorption of overheads should
    be debited or credited to the profit and loss
    account
n   The under-absorbed overheads should be deducted
    from profit and vice versa
                                                    31
Example




          32
Example

n   Estimated annual overheads $400
n   Estimated machine hours    200 machine hour

n   POAR =     $400
               200 hrs
          = $2 per machine hour




                                                  33
                Product 1       Product 2   Product 3   Product 4
Actual          $400            $400        $300        $500
overheads
incurred
Actual          250 hrs         160 hrs     200 hrs     200 hrs
machine hours

Overhead         $2 * 250 hrs $2 * 160 hrs $2 * 200 hrs $2 * 200 hrs
absorbed                                   = $400       = $400
                 = $500       = $320
Under- or       Over-absorbed Under-        Over-        Under-
over-
                $100          absorbed      absorbed     absorbed
absorption
                              $80           $100         $100s




                                                                  34
Blanket Overhead Rate




                        35
Blanket overhead rate
n   According to the overhead allocation procedure,
    the overheads are allocated to departments and
    each department calculate its own OAR and
    allocate the overheads to products passing through
    that department
n   Alternatively, some firms do not assign overheads
    to departments. Rather, they adopted a single
    overhead rate, i.e. a blanket overhead rate, that is
    assigned to all products produced within the whole
    factory
                                                      36
n   The use of the blanket overhead rate is not
    recommended as many products are
    produced in different production centres,
    and products consume cost-centre
    overheads in different proportions




                                                  37
Example




          38
The annual overhead costs of a factory with three
production departments are shown as follows:

                   Dept. A   Dept.B Dept. C         Total
Overheads          $20000    $400000 $180000        $600000

Direct machine     100000    100000     100000      300000
hours
Departmental      $0.2       $4         $1.8
overhead rate per
direct machine
hour
Blanket overhead                                    $2
rate pre machine
hour                                                          39
If the production of product X only requires 10 direct machine
hours in department A, the overheads absorbed will be computed as
follows:
                      Using               Using blanket
                      departmental        overhead rate
                      overhead rate
 Overhead absorbed $0.2 *10               $2 *10
                   = $2                   = $20
In this example, the production of product X does not consume
Large amounts of overheads in department B and C. Therefore,
there will be over-absorption of overheads if the blanket overhead
                                                             40
rate is used

				
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