Overheads in Cost Accounting

OVERHEADS

Introduction 

Overhead can be defined as the aggregate of indirect material cost, indirect labour cost and indirect expenses. These are costs not incurred solely and beneficially for a particular cost centre or cost unit and, as a result, cannot be traced easily and in full to those cost centres or cost units.

Overhead analysis can be divided into six stages. These are

1.      Overhead Collection

2.      Overhead Classification

3.      Overhead Codification

4.      Overhead Allocation

5.      Overhead Apportionment

6.      Overhead Absorption

Overhead Collection

Overhead is said to be collected when it is incurred. This also means the gathering or aggregation of overhead cost in respect of a particular activity, process or department.

Overhead Classification: This is the logical grouping of overhead into the major activities undertaken by a business such as production, selling, distribution, administration, etc. This is also known as functional analysis of overhead.

a.       Production overhead is the sum of indirect material costs, indirect labour cost and indirect expenses incurred by the production department. Examples are cost of lubricating oil, cleaning materials, lighting, depreciation of production machines, production supervisors’ salaries, etc.

b.      Administration overhead is the costs incurred in the formulation of policies, directing and controlling of the activities of a business. Examples include salaries of office staff, cost of office stationery and other costs incurred for administrative purposes.

c.       Selling overhead is the costs incurred in securing orders, providing customer services and increasing sales. Examples are advertising expenditure, showroom expenses, sales representatives’ salaries, etc.

d.      Distribution overhead is the cost incurred in transferring the final product or service to the consumer. It includes warehouse costs, salaries of motor van drivers, other motor van running expenses, etc.

Overhead Codification: This refers to the use codes for the identification of overhead costs of different kinds. The use of codes makes it easier to identify and refer to overhead cost items. The codes may be in the form of numbers, letters, symbols or a mixture of these.

Overhead Allocation: This is the charging of whole item of overhead to a single cost centre. Overhead allocation is used where the overhead is incurred solely for a particular cost centre or cost unit and should be allotted to that department only. Example, buying indirect material used by one department only or the salary of a supervisor who works for a particular department only.

Overhead Apportionment: This is the charging of proportions of overhead to different cost centres using fair and equitable bases. This is used where the overhead is incurred for more than one cost centre and each cost centre is to be charged with a fair share of the overhead.

Overhead Absorption: This is the charging of overhead to cost units using carefully calculated predetermined overhead rates. That is the final stage when overheads are allotted to the product produced or service provided

Overhead apportionment

Overhead is apportioned to different cost centres using bases of apportionment that are considered equitable with respect to the benefit each cost centre has enjoyed from the cost being apportioned. The following are some of the bases used and examples of overhead items that can be apportioned using such bases.

  

Bases of Apportionment	Overhead Cost
1.      Cost or value of asset	Depreciation, insurance cost, repairs and maintenance, etc.
2.      Floor space occupied	Building depreciation, building insurance and repairs, rent and rates, electricity cost, cleaning cost, etc
3.      Number of employees	Canteen, personnel administration, welfare, supervision, etc.
4.      Production or working hours	Working hours affect almost all types of overhead. Therefore many overhead costs can be apportioned on this basis. Typically, this is used to apportion overhead such as miscellaneous expenses, supervision cost, depreciation, etc where no specific basis is known or has been given.
5.      Number of light bulbs and  sockets	Electricity
6.      Metre reading	Electricity, heating, air conditioning, etc.
7.      Machine capacity or horse power	Electrical power
8.      Number of requisitions or material issued	Stores costs

Exercise 1

Inacom Enterprise has an administration department and four production departments . The overheads below relate to the departments:

	Production Departments				Administration Department	Total
	A	B	C	D
	$	$	$	$	$	$
Indirect material and labour	20,000	34,000	50,000	25,000	38,000	167,000
Other overheads:
Lighting and heating						80,000
Depreciation of building						78,000
Depreciation of equipment						50,000
Insurance of building						58,000
Canteen cost						120,000
Equipment repairs & maintenance						46,000
Electrical power						90,000

The following information is also relevant:

	Production Departments				Administration Department
	A	B	C	D
Number of light bulbs	5	6	10	8	10
Floor area occupied (square metre)	200	250	220	300	260
Cost of equipment ($000)	14,000	20,000	12,000	15,000	8,000
Metre reading (KWh)	1,000	1,200	900	1,100	800
Number of employees	6	10	12	5	8
Horse power (KWh)	20,000	15,000	18,000	12,000	-

You are required to ascertain the total overhead for each department.