Management Accounting(MA)

BBA Sem 3
Assistant Professor | Santushti Gupta

1
Overheads
 Introduction

Such expenses are incurred

Overheads are the for output generally Overheads are also very
expenditure which cannot be
e.g., wages paid to watch and important cost element along
conveniently traced to or
ward staff, heating and with direct materials and
identified with any particular
lighting expenses of factory direct employees.
cost unit.
etc.

On this account, it would be a

Often in a manufacturing Overheads are incurred not
grave mistake to ignore
concern, overheads exceed only in the factory of
overheads either for the
direct wages or direct production but also on
purpose of arriving at the cost
materials and at times even administration, selling and
of a job or a product or for
both put together. distribution.
controlling total expenditure.
 Description Example
By Function
Factory or Manufacturing overhead is (i) Stock keeping expenses,
Manufacturing the indirect cost incurred for (ii) Repairs and maintenance of
or Production manufacturing or production plant, (iii) Depreciation of
Overhead activity in
Manufacturing
a factory.
overhead
factory building, (iv) Indirect
labour, (v) cost of primary
CLASSIFICATION OF OVERHEADS
includes all expenditures packing (vi) Insurance of plant
incurred from the procurement and machinery etc. Production
of materials to the completion overhead includes
of finished product. administration costs relating
to production, factory, works
or manufacturing.
Office and Office and Administrative (i) Salary paid to office
Administrative overheads are expenditures staffs, (ii) Repairs and
Overheads incurred on all activities maintenance of office building,
relating to general (iii) Depreciation of office
management and building (iv) postage and
administration of an stationery, (v) Lease rental in
organisation. It includes case of operating lease (in case
formulating the policy, of finance lease, lease rental
directing the organisation excluding finance cost) (vi)
and controlling the accounts and audit expenses
operations of an undertaking etc.
which is not related directly to
production, selling, distribu-
tion, research or development
activity or function.
Selling and (i) Selling overhead: expenses (i) Salesmen commission, (ii)
Distribution related to sale of products Advertisement cost, (iii) Sales
 directing the organisation excluding finance cost) (vi)
and controlling the accounts and audit expenses
operations of an undertaking etc.
which is not related directly to
production, selling, distribu-
tion, research or development
Description Example
activity or function.
By Function
Selling and (i) Selling overhead: expenses (i) Salesmen commission, (ii)
Factory or Manufacturing overhead is (i) Stock keeping expenses,
Distribution related to sale of products Advertisement cost, (iii) Sales
Manufacturing
Overheads
the indirect cost incurred for
and include orallproduction
indirect
(ii) Repairs and maintenance of
office CLASSIFICATION OF OVERHEADS
or Production manufacturing plant, expenses etc.
(iii) Depreciation of
Overhead expenses
activity in ina sales
factory. factory building, (iv) Indirect
Manufacturing overhead labour, (v) cost of primary
includes all expenditures packing (vi) Insurance of plant
incurred from the procurement and machinery etc. Production
of materials to the completion overhead includes
of finished product. administration costs relating
to production, factory, works
or manufacturing.
Office and Office and Administrative (i) Salary paid to office
Administrative overheads are expenditures staffs, (ii) Repairs and
Overheads incurred on all activities maintenance of office building,
relating to general (iii) Depreciation of office
management and building (iv) postage and
administration of an stationery, (v) Lease rental in
organisation. It includes case of operating lease (in case
formulating the policy, of finance lease, lease rental
directing the organisation excluding finance cost) (vi)
 ACCOUNTING AND CONTROL OF MANUFACTURING OVERHEADS

**Nature of Overheads**: **Challenge** - **Issue with Waiting for Actual

• Costs that cannot be directly • Overheads need to be distributed Overheads**:
attributed to a specific product or across production units. • Delaying cost sheets until
cost unit. • Actual overheads are only known overheads are finalized reduces
• Must be included to determine after financial accounts are their usefulness (Control).
the total cost of a product or closed. • Management requires timely cost
service. sheets for decision-making.

- **Need for Immediate Overhead - **Goal**:

Allocation**:
• Ensure overheads are accounted
• A method to include overheads as for without waiting for actual
soon as the prime cost is known.. financial closure.
So, how to go about it?
**Pre-determined Overhead - **Application of Rates**:
Rates**: • Overheads are charged to products/jobs
• - Overhead absorption rates are estimated as soon as the prime cost is available.
before the accounting period starts. • Overheads are applied on an estimated
• Calculated by estimating both overheads basis throughout the period.
and activity levels for the upcoming
period.

- **Adjustment for Actual

Overheads**:
• Once actual overheads are known, the
difference between estimated and actual
overheads is calculated.
• Necessary adjustments are made to
account for any variances.
Manufacturing/Factory Overheads:
Typically form a significant portion of total overheads.
Must be carefully absorbed into production costs to ensure accurate costing.

Procedure

1. Estimation and collection of manufacturing overheads: The first stage is to estimate the
amount of overheads, keeping in view the past figures and adjusting them for known future
changes.
The sources available for the collection of factory overheads may include:
(a) Invoices, (b) Stores requisition, (c) Wage analysis book (d) Journal entries. etc.
 Treatment of overheads

Assignment Absorption

Allocation

Apportionment

Re-apportionment
 2. Assignment of Manufacturing Overheads:
The guiding principle for assignment of manufacturing overheads to a cost object is the
traceability of the overheads in an economically feasible manner

Assignment of the manufacturing overhead is done on the basis of either of the following two
principles:
Cause and Effect: Cause is the process or operation or activity and effect is the incurrence of cost.
(where incurring OH is needed for the production cost object to start)
Benefit received: Manufacturing overheads are to be apportioned to various cost objects in
proportion to the benefits received by them. (where many cost objects receive the benefit: steam
boiler used for various production units of various types)
2. Assignment of Manufacturing Overheads:
• Cost Allocation:
• The term ‘allocation’ refers to the direct assignment of cost to a cost object
which can be traced directly.
• It implies relating overheads directly to departments. The estimated amount of
various items of manufacturing overheads should be allocated to various cost
centres or departments.
• For example- if a separate power meter has been installed for a department, the
entire power cost ascertained from the meter is allocated to that department.
BUT The salary of the works manager cannot be directly allocated to any one
department since he looks after the whole factory. It is, therefore, obvious that
many overhead items will remain unallocated after this step.
2. Assignment of Manufacturing Overheads:
• Cost Apportionment:
• There are some items of estimated overheads (like the salary of the works
manager) which cannot be directly allocated to the various departments and cost
centres.
• Such unallocable expenses are to be spread over the various departments or cost
centres on the basis of two principles. This is called apportionment.
• Thus, apportionment implies “the allotment of proportions of items of cost to cost
centres or departments”. After this stage, all the overhead costs would have been
either allocated to or apportioned over the various departments.
 4. General overhead Direct labour hour, or Direct wages, or
Machine hours.
5. (i) Depreciation of plant and Capital values
Overhead Cost Bases of Apportionment machinery
1. (i) Rent and other building Floor area, or volume of department (ii) Repairs and maintenance
expenses of plant and machinery
(ii) Lighting and heating (iii) Insurance of stock
(conditioning)
(iii)
(iv)
Fire precaution service
Air- conditioning
Base of Apportionment
6. (i)

(ii)
Power/steam
consumption
Internal transport
Technical estimates

2. (i) Perquisites Number of workers (iii) Managerial salaries

(ii) Labour welfare expenses 7. Lighting expenses (light) No. of light points, or Area or Metered
(iii) Time keeping units
(iv) Personnel office 8. Electric power (machine Horse power of machines, or Number of
(v) Supervision operation) machine hour, or value of machines or
3. (i) Compensation to workers Direct wages units consumed.
(ii) Holiday pay 9. (i) Material handling Weight of materials, or volume of
(iii) ESI and PF contribution (ii) Stores overhead materials, or value of materials or unit of
materials.
(iv) Perquisites
4. General overhead Direct labour hour, or Direct wages, or
Machine hours.
5. (i) Depreciation of plant and Capital values
machinery
(ii) Repairs and maintenance
of plant and machinery
(iii) Insurance of stock
6. (i) Power/steam Technical estimates
consumption
(ii) Internal transport
(iii) Managerial salaries
7. Lighting expenses (light) No. of light points, or Area or Metered
units
8. Electric power (machine Horse power of machines, or Number of
Practice
• Excel
 2. Assignment of Manufacturing Overheads:
• Re-apportionment: Upto the last stage all overheads are allocated and apportioned
to all the departments- both production and service departments.
BUT Service departments are those departments which do not directly take
part in the production of goods or providing services.
Such departments provide auxiliary services across the entity and renders services
to other cost centres and in some cases to outside parties.
Examples of such departments are engineering, quality control and assurance,
laboratory, canteen, stores, time office, dispensary etc.
The overheads of these departments are to be shared by the production
departments since service departments operate primarily for the purpose of
providing services to production departments.
The process of assigning service department overheads to production
departments is called reassignment or re-apportionment.
Practice
• Excel
3. Absorption:
• After completing the distribution as stated above the overheads charged to the
department are to be recovered from the output/jobs/processes produced in respective
departments.
This process of recovering overheads of a department or any other cost center from its
output is called recovery or absorption.

Methods of absorption:
• Either to individual products or job or process, OR on an equitable basis.
• The rate which is used to charge overhead cost to the products or jobs is known as
absorption rate
 Methods/Rates of absorption
Percentage of direct materials= Factory overhead/Direct materials X 100%
Percentage of direct wages= Factory overhead/Direct wages X 100%
Percentage of prime cost= Factory overhead/prime cost X 100%
Units of production= Factory overhead/ Units of production
Production hour Rate or Labour hour rate= Factory overhead/Direct labour
Hours

*Machine Hour rate= Factory overhead/Machine hours

most popular, but data isn’t readily available and some calculation is needed.
Practice
• Excel
END