OVERHEADS - PowerPoint Presentation

Slide1

OVERHEADS

Allocation, Apportionment

& AbsorptionSlide2

ObjectiveSlide3

Relationship with cost object

Direct

Indirect

Factors influencing classificationSlide4

Objectives of Allocation*

To obtain a mutually agreeable price

To compute product-line profitability

To predict the economic effects of planning and control

To value inventory

To motivate managers

*As identified by the IMASlide5

Overheads/Burden

Indirect Material + Indirect Labour + Indirect other expenses= OHs

Cannot be conveniently charged to any job, process or cost unit

Slide6

Types of Departments

Producing departments

are directly responsible for creating the products or services sold to customers.Slide7

Types of Departments

Supporting departments

provide essential support services for producing departments.

Maintenance, engineering, personnel, storageSlide8

Departmentalisation

For collection, allocation and apportionment of overheads

Allocation: charging identifiable cost items to cost centers or cost units

Examples:

Depreciation of a machine in machining department - machining department Salary of stores clerk - stores department Slide9

Examples of

Departmentalisation

for a Manufacturing Firm

Production Departments Support Departments

Assembly: Materials Storeroom:

Supervisors’ salaries Clerk’s salary

Small tools Depreciation on forklift Indirect materials Cafeteria: Depreciation on machinery FoodFinishing: Cooks’ salaries Sandpaper Depreciation on stores Depreciation on sanders Maintenance: Janitors’ salaries Cleaning supplies Machine oil and lubricantsSlide10

Apportionment

Common costs (non-allocable) allotted to two or more cost centers or cost units on some rational basis (a matter of judgment)Slide11

Sample apportionment

OH Item:

Rent, rates, heating, repairs, depreciation of building

Lighting

PowerDepreciation, repair, insurance and maintenance of plantPersonnel, staff welfare, canteen

Carriage inwards

Marketing and distributionDelivery expensesRemuneration of works directorBasis:Floor AreaFloor Area / number of light pointsHP of machinesBook value or original costNumber of employeesValue of materialSales valueWeight, volume, milesDLHs/Wages/Number of employeesSlide12

Criteria for allocation and apportionment

Neutrality: should not distort decision making

Ability to bear: sales value, gross profit, asset value, total costs

Cause and effect relationship: maintenance cost on the basis of hours spent for different cost objects

Benefits received: cost of power plant on the basis of power used by diff. cost objects Equity/fairnessSlide13

Apportionment of service center costs

OH allocated or apportioned to production and service departments: primary distribution

Service department costs apportioned to production departments: secondary distributionSlide14

Secondary distribution

Direct method

Step-down (sequential)

ReciprocalSlide15

Direct Method of Allocation

Power

Maintenance

Grinding

Assembly

Support Departments

Producing DepartmentsSlide16

Direct Method of Allocation

Power

Maintenance

Grinding

Assembly

Support Departments

Producing DepartmentsSlide17

Step-down Method of Allocation

STEP 1: Rank service departments

Maintenance

1

Grinding

2

Assembly

3Slide18

Step-down Method of Allocation

Power

Maintenance

Assembly

Grinding

STEP 2Slide19

Sequential Method of Allocation

Maintenance

Assembly

Grinding

STEP 2Slide20

The

reciprocal method

of allocation recognizes all interactions among support departments.Slide21

Absorption

Allocated or apportioned overhead absorbed by cost units

Methods:

Production unit method:

Budgeted/Actual OH Budgeted/Actual units% of DM cost Budgeted/Actual OH Budgeted/Actual DM cost

% of DL cost

% of Prime costDLH rateMH rateSlide22

Praxis

Manless Limited does job order processing which involves manual and machine operations.The budgeted P&L Account is as under:

Sales 75 lacs

Cost: DM 10

DL 5Prime cost 15Production overhead 30

Production cost 45

Admin, S&D cost 15 60Profit 15Other budgeted data: LHs: 2500, MHs:1500, Number of jobs: 300A job enquiry has come and the prime cost estimation is as under:DM:Rs.2,500; DL:Rs.2,000; DLHs: 8, MHs:5Use different methods of OH absorption and recommend to the company. Slide23

Blanket rate v Departmental rate

A plant wide rate for every job irrespective of the department in which it is processed

Not correct in case all jobs don’t pass through all departments/ different jobs spend unequal time in different departments

Then departmental rates are requiredSlide24

Praxis

Refer to excel Sheet - 2Slide25

Predetermined OH rate

Actual OH will be known after the time period is over

So absorbed on estimated basis taking expected level of activitySlide26

Under/Over absorption

Predetermined rate X actual production = absorbed amount

May be less than or more than the actual OH

Treatment:Application of supplementary rate

Transfer to costing P&L AccountCarry forward to the next periodSlide27

Support department cost allocation to operating departments

Support department Cost pool Cost object (operating department)

Single rate (no distinction between variable and fixed cost)

Dual rate (variable cost pool + fixed cost pool)

Under both the rate methods, allocation can happen by usingBudgeted rate and budgeted hours to be used by operating divisionBudgeted rate and actual hours used by operating divisions

Actual rate and actual hours used by operating divisionsSlide28

Data for both the methods

Sand Hill Company’s Central Computer Department renders service to Microcomputer division and Peripheral equipment division

Budgeted Fixed cost for 2009 for operating central computer dept.: Rs.30,00,000 and variable cost per hour:Rs.200 (relevant range: 6000 to 18750 hours)

Practical capacity: 18750 hours

Budgeted usage in hours:Microcomputer division: 8,000Peripheral equipment division: 4,000Actual usage in 2009:

Microcomputer division: 9,000

Peripheral equipment division: 3,000Slide29

Single rate

Sand Hill uses budgeted rate and actual usage

Total budgeted cost = Rs.30,00,000 + 12000 X Rs.200 = Rs.54,00,000

Budgeted hours= 12,000

Rate per hour = Rs.450Allocation: Microcomputer: 9,000 X Rs.450 = Rs.40,50,000Peripheral equipment: 3,000 X Rs.450 = Rs.13,50,000 Single rate sends a signal that Rs.450 is VCU. What if an outside vendor offers the same service @Rs.340?Slide30

Dual rate

Sand Hill uses actual hours for VC and budgeted hours for FC

Allocation:

Microcomputer: 8,000 X Rs.250 + 9,000 X Rs.200 = Rs. 38,00,000

Peripheral: 4,000 X Rs.250 + 3,000 X Rs.200 = Rs.16,00,000Slide31

Allocation based on supply of capacity

Budgeted FC per hours (18750 hrs): Rs.160/hr

Budgeted VC per hr.: Rs.200/hr

Single rate method:

Microcomputer: 9,000 X Rs.360 = Rs.32,40,000Peripheral equipment: 3,000 X Rs.360 = Rs.10,80,000Fixed cost of unused capacity: 6750 X Rs.160 =Rs.10,80,000Slide32

Cont..

Dual Rate Method:

Microcomputer:

Fixed cost: 8,000 X Rs.160 = Rs.12,80,000

VC: 9,000 X Rs.200 = Rs.18,00,000 Rs. 30,80,000Peripheral equipment: Fixed cost: 4,000 X Rs.160 = Rs. 6,40,000

VC: 3,000 X Rs.200 =

Rs. 6,00,000 Rs.12,40,000Fixed cost of unused capacity: 6750 X Rs.160 =Rs.10,80,000Slide33

Cont…

Using practical capacity highlights the unused capacity cost and its management

It also reduces the burden on the users

But if FC is allocated on budgeted or actual use, total FC is passed on to users!

In case unused capacity arises only because of one division, it makes sense for allocating the unused capacity cost to that departmentSlide34

Budgeted v. Actual rate

Affects the uncertainty faced by user departments

Budgeted rate:

users know the rate in advance and decide whether to use internal service or external service

cost variance or inefficiency to be borne by supplier of serviceSlide35

Budgeted and Actual usage, Practical Capacity level allocation

See excel Sheet 3Slide36

Common cost allocation

A cost of a common facility, activity or cost of cost object shared by more than one user

Stand-alone cost-allocation method

Incremental cost allocation: primary user, incremental users (everybody claims to be incremental user)

Cost plus contracts: fertile ground for litigation (bring clarity)Slide37

Revenue allocation & Bundled Products

When department managers have revenue or profit responsibilities, allocation is called for

Shaving gel + shaving brush + razor

Stand-alone price 30 25 15

Bundled price: gel + brush Rs.50 gel + razor Rs.38 gel + brush + razor: Rs.64Slide38

Stand-alone allocation methods

Selling price: considers customers’ willingness to pay

Unit cost

Physical units: used when selling prices are unstable and unit costs are difficult to calculateSlide39

Incremental allocation method

Products to be ranked by:

Product in the bundle with most sales can be ranked first

Customer survey can reveal importance of the products

Stand-alone performance of individual products Top managers knowledge or intuition