Overhead | Sahithyan's Notes

Total cost of indirect materials, indirect labour, and indirect expenses.

Production overhead cost is allocated to each unit of production through allocation, apportionment, and absorption.

Allocation

The allotment of all the items of cost to cost centres or cost units. An expense directly identifiable with a specific cost centre is allocated to that centre.

Examples:

Indirect materials issued to a specific department.
Wages of a supervisor working solely in one department.
Depreciation of a machine used only by one department.
Power cost metered separately for a department.

Apportionment

The allotment of proportions of items of cost to cost centres or cost units, based on an equitable basis.

Basis of Apportionment

Floor area occupied
Rent, rates and taxes, lighting and heating, insurance and depreciation of building, air conditioning.
Capital value
Insurance and depreciation on plant and machinery, maintenance of plant and machinery.
Number of employees
Welfare expenses, time-keeping, payroll office, canteen, recreation, supervision, medical expenses.
Machine hours
Repairs and maintenance of plant and machinery, power.
Value or weight of materials
Store keeping expenses.
Truck mileage or tonnage or number of packages
Transport service expenses.

Worked Example

Consider production departments $P_1$ and $P_2$ , with 3 overhead items to apportion.

Item	Amount	Basis	$P_1$	$P_2$
Rent	$6000$	Floor area	$600$ sq. ft	$400$ sq. ft
Depreciation of machinery	$4000$	Capital value	$30000$	$20000$
Canteen expenses	$2000$	Number of employees	$30$ employees	$20$ employees

Each item is apportioned in the ratio of its basis.

Rent is apportioned in the ratio $600:400$ .

P_1 = 6000 \times \frac{600}{1000} = 3600, \qquad P_2 = 6000 \times \frac{400}{1000} = 2400

Depreciation of machinery is apportioned in the ratio $30000:20000$ .

P_1 = 4000 \times \frac{30000}{50000} = 2400, \qquad P_2 = 4000 \times \frac{20000}{50000} = 1600

Canteen expenses are apportioned in the ratio $30:20$ .

P_1 = 2000 \times \frac{30}{50} = 1200, \qquad P_2 = 2000 \times \frac{20}{50} = 800

	$P_1$	$P_2$
Rent (600:400)	3600	2400
Depreciation (30000:20000)	2400	1600
Canteen (30:20)	1200	800
Total apportioned overhead	7200	4800

Reapportionment

Service department costs are reapportioned to production departments, since service departments do not carry out production directly.

There are different methods for reapportioning overhead costs from service departments to production departments.

For all the examples in this note, consider production departments $P_1$ and $P_2$ , and service departments $S_1$ and $S_2$ , with overheads before reapportionment: $P_1 = 10000$ , $P_2 = 8000$ , $S_1 = 4000$ , $S_2 = 2000$ .

Direct Method

Costs of service departments are apportioned directly to production departments, without considering any service from one service department to another. Proper apportionment cannot be done, so production departments may be overcharged or undercharged.

Good when service departments do not provide service to other service departments.

Consider $S_1$ serves $P_1$ 60% and $P_2$ 40%. $S_2$ serves $P_1$ 50% and $P_2$ 50%.

	$S_1$	$S_2$	$P_1$	$P_2$
Before reapportionment	4000	2000	10000	8000
$S_1$ distributed	(4000)		2400	1600
$S_2$ distributed		(2000)	1000	1000
After reapportionment	0	0	13400	10600

Step Down Method

Best used where some service cost centres provide services to other service cost centres, but these services are not reciprocated.

$S_1$ is apportioned first, serving $S_2$ 10%, $P_1$ 60%, $P_2$ 30%. $S_2$ ’s cost then includes what it received from $S_1$ , and is apportioned to $P_1$ and $P_2$ only, without going back to $S_1$ , split $P_1$ 50%, $P_2$ 50%.

	$S_1$	$S_2$	$P_1$	$P_2$
Before reapportionment	4000	2000	10000	8000
$S_1$ distributed	(4000)	400	2400	1200
$S_2$ distributed		(2400)	1200	1200
After reapportionment	0	0	13600	10400

Reciprocal Method

Used where service departments provide services to each other reciprocally.

Consider $S_1$ serving $S_2$ 10%, $P_1$ 60%, $P_2$ 30%, and $S_2$ serving $S_1$ 20%, $P_1$ 40%, $P_2$ 40%.

Simultaneous Equation Method

Sets up the overhead reapportionment process as a set of equations, letting $A$ be the total overhead apportioned to department $A$ , $B$ the total overhead apportioned to department $B$ , and so on.

\begin{aligned} S_1 &= 4000 + 0.20 S_2 \\ S_2 &= 2000 + 0.10 S_1 \end{aligned}

Solving the above equations results in $S_1 = 4489.80$ and $S_2 = 2448.98$ .

	$S_1$	$S_2$	$P_1$	$P_2$
Original overhead			10000	8000
Solved total	4489.8	2448.98
From $S_1$ (60/30)	(4489.8)		2693.88	1346.94
From $S_2$ (40/40)		(2448.98)	979.59	979.59
After reapportionment			13673.47	10326.53

Repeated Distribution Method

Each service department’s total cost is repeatedly reallocated among other departments, based on a given percentage basis, until the cost of each service department becomes negligible.

Uses the same percentages as the Simultaneous Equation Method.

	$S_1$	$S_2$	$P_1$	$P_2$
Opening balance	4000	2000	10000	8000
$S_1$ distributed (10/60/30)	(4000)	400	2400	1200
$S_2$ distributed (20/40/40)	480	(2400)	960	960
$S_1$ distributed (10/60/30)	(480)	48	288	144
$S_2$ distributed (20/40/40)	9.6	(48)	19.2	19.2
$S_1$ = 9.6, negligible, stop
Total			13667.2	10323.2

Further rounds converge these towards the Simultaneous Equation Method’s result.

Basis of Reapportionment

Purchase department
Number of purchase orders, or value of materials purchased for each production department.
Stores
Value or quantity of materials issued, or number of materials requisitions.
Internal transport
Weight and distance.
Inspection
Inspection hours devoted to each department.