Methods of Overheads Absorption and Accounting Treatment

OVERHEADS II General overheads

TOPICS TO BE COVERED: Absorption Methods of Absorption Absorption of administrative and office overheads Absorption of selling & distribution overheads Under and over-absorption of overheads and its accounting treatment Activity Based Costing Comprehensive Problems and solution

QUICK RECAP What are overheads Treatment of special items How to absorb Factory overheads Allocation Apportionment Reapportionment Absorption Six methods

OVERVIEW General overhead Absorb office and administrative overheads Absorb selling and distribution overheads Activity Based Costing

OFFICE AND ADMINISTRATIVE OVERHEADS Methods of absorption Percentage of works cost: Overhead rate = [(admin. O.h) / works cost] *100 Percentage of sales Overhead rate = [(admin. O.h) / sales] *100

SELLING AND DISTRIBUTION OVERHEADS Selling cost? Distribution cost? Methods of absorption A rate per unit sold (divide with units produced) A percentage of selling price (divide with selling price) A percentage on work cost

UNDER AND OVER ABSORPTION Meaning: when overheads absorbed () is not equal to amount of actual overhead incurred Over absorption Under absorption Root cause: actual rate versus pre-determined rate

CONT Accounting treatment 1. use of supplementary rates: (difference is divided by the actual base and adjusted accordingly) 2. writing off to costing profit and loss account :when difference is not significant 3. carry over to next years account: largely criticised

PROBLEM 4.13 (M N ARORA) particulars Actual factory o/h absorption Under absorption(over absorption) Net over or under absorption x 48950 y 89200 z 64500 50000 (1050) 90000 (800) 60000 4500 4500-1050-800= 2650

ACTIVITY BASED COSTING Modern approach to determine the total cost of production More refined approach for charging indirect costs to products and computing more accurate product cost Definition

CONT. Terminology Activity Cost object Cost deriver Resource cost deriver Purchase of materials No. of orders placed No. of receipts of material No. of inspections

CONT Steps Identification of main activity Creation of cost pool: Purchase of materials Determination of the activity cost derivers Calculation of the activity cost driver rate

PROBLEM 4.15 Problem no. 17 (maheshwari & mittal) particulars Standing charges: Lubrication Consumable stores Wages amout 40 80 200 (320/8) 40 Standing charges per machine hour Variable costs: Depreciation Repair charges(75% of 40) Power consumed( 10 units @ rs 3 p.u) Variable cost per machine hour Rate per machine hour: 40 30 30 100 Rs. 140

WORKING NOTES Calculation of depreciation (450000+50000)/(5*2500)= 40 per machine hour

PROBLEM 13 (M N ARORA) Calculation of overhead absorption rates: (a) Direct material cost %: =(Factory overheads/ Direct material cost )*100 =(56000/ 84000)*100 66.67% (b) Direct Labour cost %: =(Factory overheads/ Direct labour cost )*100 =(56000/ 112000)*100 50%

(C) Direct labour hour rate =(Factory overheads/ Direct labour hours ) =(56000/ 28000) Rs. 2 per hour (D) Direct Machine hour rate =(Factory overheads/ machine hours ) =(56000/ 56000) Rs. 1 per hour

COMPARATIVE STATEMENT FOR JOB ORDER NO. 707 particulars Materia l C % 40 80 120 Labour C % 40 80 120 Lab Hr Machi. Hr 40 80 120 Direct mat cost Direct lab. Cost Prime cost Factory overheads @material cost % (@66.67% of 40) @labour cost% (50% of 80) @labour hour rate (2 for 40 ) @machine hour rate (1 for 45) Work Cost 40 80 120 26.67 40 80 45 146.67 160 200 165

SUGGESTED READINGS Cost Accounting by M. N. Arora for B.com (prog.) Cost Accounting by Maheshwari and Mittal overhead costing- Cost Accounting Playlist by grooming Education Academy on you tube. #1 Machine hour rate (overhead distribution) ~ Cost Accounting by CA. Naresh Aggarval on you Tube channel CA. Naresh Aggarval

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