CHAPTER 18

Overheads
Meaning and Definition

Aggregate of all expenses relating to indirect material cost, indirect labour cost and indirect expenses
is known as Overhead. Accordingly, all expenses other than direct material cost, direct wages and direct
expenses are referred to as overhead.
According to Wheldon, Overhead may be defined as "the cost of indirect material, indirect labour
and such other expenses including services as cannot conveniently be charged to a specific unit."
Blocker and WeItmer define overhead as follows :
"Overhead costs are operating cost of a business enterprise which cannot be traced directly to a
particular unit of output. Further such costs are invisible or unaccountable."
Importance of Overhead Cost

Nowadays business is a dynamic organism. Advancement of technological development and

innovation, economic situations and social considerations are the important factors for modernization of
industries at mass production to meet its more demand. The overhead charges are heavily increased and
they represent major portion of total cost. Therefore, it assumes greater importance for cost control and
cost reduction.

Classification of Overheads

Classification of overheads is the process of grouping of costs based on the features and objectives of
the business organization. The following are the important methods on which the overheads are classified:
(a) On the basis of Nature.
(b) On the basis of Function.
(c) On the basis of Variability.
(d) On the basis of Normality.
(e) On the basis of Control.

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Overheads

The following chart can explain the further classification of overhead :

Classification of Overhead
On the Basis of

Nature

Variability

Normality

(1) Indirect Material

(1) Fixed Overhead

(1) Normal Overhead

(2) Indirect Labour

(3) Indirect Expenses

(2) Variable Overhead

(3) Semi-Variable Overhead

(2) Abnormal Overhead

1
1
(1) Manufacturing Overhead
Function

(2) Administrative Overhead

(3) Selling Overhead
(4) Distribution Overhead

Control

(1) Controllable Overhead

(2) Uncontrollable Overhead

(1) On the Basis of Nature

One of the important classifications is on the basis of nature or elements. Based on nature the
aggregate of all indirect material cost, indirect labour cost and indirect other expenses are known as
overheads. Accordingly, overheads are grouped into (a) Indirect Material Cost (b) Indirect Labour Cost
and (c) Indirect Expenses.
(a) Indirect Material Cost: Indirect materials do not form part of the finished products. Indirect
materials are indirectly or generally used for production which cannot be identified directly. For example,
oil, lubricants, cotton waste, tools for repairs and maintenance etc. are indirect materials.
(b) Indirect Labour Cost: Indirect labour is for work in general. The importance of the distribution
lies in the fact that whereas direct labour can be identified with and charged to the job, indirect labour
cannot be so charged and has, therefore, to be treated as part of the factory overheads to be included in the
cost of production. Examples are salaries and wages of supervisors, storekeepers, maintenance labour etc.
(c) Indirect Expenses: Any expenses that are not specifically incurred for or can be readily charged
to or identified with a specific job. These are the expenses incurred in general for more than one cost
centre. Examples of indirect expenses are rent, insurance, lighting, telephone, stationery expenses etc.
(2) On the Basis of Function
The classification overheads on the basis of the various function of the business concern is known as
function wise overheads. Here there are four important functional overheads such as :
(a) Production Overhead

(b) Administration Overhead

(c) Selling Overhead

(d) Distribution Overhead

(a) Production Overhead: Production overhead is also termed as manufacturing overhead or works
overhead or factory overhead. It is the aggregate of all indirect expenses which are incurred for work in

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operation or factory. These costs are normally incurred during the period when the production process is
carried on. For example, factory rent, factory light, power, factory employees' salary, oil, lubrication of
plant & machinery, etc.
(b) Administrative Overhead: Administrative expenses are incurred in general for management to
discharge its functions of planning organizing, controlling, co-ordination and directing. These expenses are
not specifically incurred and cannot be identified with the specific job. It is also termed as office cost. For
example, office rent, rates, printing, stationery, postage, telegram, legal expenses etc. are the office and
administrative costs.
(c) Selling Overheads: Selling expenses are overheads which are incurred for promoting sales,
securing orders, creating demand and retaining customers. For example, salesmen's salaries, advertisement,
rent and rates of show room, samples, commission etc.
(d) Distribution Overhead: Distribution overhead are incurred for distribution of products or output
from producers to the ultimate consumers. For example, warehouse staff salaries, expenses of delivery van,
storage expenses, packing etc.
(3) On the Basis of Variability
One of the important classifications is on the basis of variability. According to this, the expenses can
be grouped into (a) Fixed Overhead (b) Variable Overhead and (c) Semi-Variable Overhead.
(a) Fixed Overhead: Fixed cost or overhead incurred remain constant due to change in the volume
output or change in the volume of sales. For example, rent and rates of buildings, depreciation of plant,
salaries of supervisors etc.
(b) Variable Overhead: Variable overhead may be defined as "they tend to increase or decrease in
total amount with changes in the volume of output or volume of sales." Accordingly the change is in direct
proportion to output. Indirect materials, Indirect labour, repair and maintenance, power, fuel, lubricants etc.
are examples of variable overhead costs.
(c) Semi-Variable Overheads: Semi-variable overheads are incurred with a change in the volume of
output or turnover. They neither remain fixed nor do they tend to vary directly with the output. These costs
remain fixed upto a certain volume of output but they will vary at other part of activity. Semi-variable
overheads are mixed cost, i.e., partly fixed and partly variable. For example, power, repairs and
maintenance, depreciation of plant and machinery telephone etc.
(4) On the Basis of Normality
Overheads are classified into normal overheads and abnormal overheads on the basis of normality
features. According to this normal overheads are incurred in achieving the target output or fixed plan. On
the other hand, abnormal overhead costs are not expected to be incurred at a given level of output in the
conditions in which the level of output is normally produced. For example, abnormal idle time, abnormal
wastage etc. Such expenses are transferred to Profit and Loss Account.
(5) On the Basis of Control
It is one of important classifications of overhead on the basis of control. Based on control it is
grouped into controllable overhead and uncontrollable overhead. Controllable overhead which can be
controlled by the action of a specified number of undertaking. For example, idle time, wastages etc. can be
controlled. Uncontrollable overheads cannot be controlled by the action of the executive heading the
responsibility centre. For example, rent and rates of building cannot be controlled.

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Overheads

Usefulness of Overhead Classification

(1)

It ensures effective cost control.

(2)

It helps the management for effective decision making.

(3)

The application of marginal costing is essentially for profit planning, cost control, decision
making etc. are based on the classification of overheads.

(4)

On the basis of classification of fixed and variable cost, flexible budgets are prepared at
different levels of activity.

(5)

It facilitates fixing of selling price.

(6)

Cost classification is useful for break-even analysis. Break-even analysis mainly depends on
overall.cost and profi"t which can be useful for making or buying decision.

(7)

It helps to find out the unit cost of production.

Codification of Overhead
Codification is a process of representing each item by a number, the digits of which indicate the
group, the subgroup, the type and the dimension of the item.
Advantages of Codification
(1)

It enables systematic grouping of similar items and avoids confusion caused by long description
of the items.

(2)

It serves as the starting point of implication and standardization.

(3)

It helps in avoiding duplication of items and results in the minimisation of number of items,
leading to accurate records.

(4)

It

(5)

It assists the grouping of overheads for cost control.

(6)

It helps in reducing clerical efforts to the minimum.

~elps

in allocation and apportionment of overheads to different cost centres.

Methods of Codification
There are different methods used for codification. The following are the three important methods
used:
(1)

Numerical Codes Method.

(2)

Decimal Codes Method.

(3)

Codes with a Combination of Numbers and Alphabets.

(1) Numerical Method: Under this method, numerical codes are assigned to each item of expenses.
For example,

100 Indirect labour.

400 Power.
500 Maintenance.
800 Fixed charges.

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(2) Decimal Codes: Under this method, the whole numbers are allotted to indicate master group and
the decimals indicate the sub-group. For example,
Factory Overheads:
1.1.1 Indirect materials.
1.1.2 Consumable stores.
1.1.3 Lubricating oils.
(3) Codes with a Combination of Numbers and Alphabet : Under this method the alphabet
indicates the main group and the type of expenses is indicated by the numerical. For example,
Rl - Repairs to machinery.
R2 - Repairs to plant.
R3 - Repairs to furniture.
Procedure or Steps in Overhead
Overheads are incurred for work in general. Overhead is added tQ the prime cost in order to measure
the total cost of production or cost of goods sold. For allocation and apportionment of overhead in the cost
of production or cost of goods sold the following procedures are involved:
(1)

Classification of Overhead

(2)

Collection of Overhead

(3)

.Overhead Analysis:
:~; "i.;.:~:-

(a) Distribution of overhead to production and service departments, i.e., AllocatiOllnmd

.,,'
Apportionment of overhead to cost centre.
'.
(b) Re-distribution of overhead from service department to production department, i.e.,
Allocation and Apportionment of service centres to production centres or departments.
(4)

Absorption of overhead by cost units, i.e., computation of overhead absorption rates.

(1) Classification Overhead: We have already discussed the classification of overh~ad in the
preceding pages, and the discussion on other procedures would follow in this chapter and the subsequent one.
(2) Collection of Overhead: The production overheads or factory overheads are collected and
identified under separate overhead code numbers or standing order numbers. These overheads are
collected from different sources and documents. The following are the important sources and documents :
Overhead Expenses
(1) Indirect Materials
(2) Power and light
(3) Indirect wages
(4) Salaries
(5) Depreciation
(6) Rates
(7) Rates
(8) Office Stationery
(9) Postage

Sources and Documents Used

Materials Requisition
Meter Reading
Time Cards, Pay Rolls, Wage Analysis
Salaries Sheet
Plant Register, Machinery Register
Lease
Local Government Assessment
Supplier's Invoices
Postage Book

'

Overheads

407

(3) Overhead Analysis : (a) Allocation and Apportionment of Overhead to Cost Centres
The first step of overhead analysis is distribution of overhead to production department and service
department. Before analysing overhead, we should know the concept of Allocation, Absorption and
Apportionment.
Allocation: Cost allocation refers to the allotment of whole item of cost to cost centres. The technique
of charging the entire overhead expenses to a cost centre is known as cost allocation.
Absorption: Cost absorption refers to the process of absorbing all overhead costs allocated to
apportioned over particular cost centre or production department by the unit produced.
Apportionment: Apportionment is the process of distribution factory overheads to cost centres or
cost units on an equitable basis. The term apportionment refers to the allotment of expenses which cannot
be identified wholly with a particular department. Such expenses require division and apportionment over
two or more cost centres in proportion to estimated benefits received.
Allocation Vs Apportionment
(1)

Allocation deals with whole amount of factory overheads while apportionment deals with
proportion of item of cost or proportion to cost centres.

(2)

The item of factory overhead directly allocated and identified with specific cost centers.
Whereas apportionment requires suitable and equitable basis. For example, factory rent may be
allocated to the factory and has to be apportioned among the producing and service departments
on an equitable basis.

Basis of Apportionment
Overhead apportionment depends upon matching with principles. Accordingly the basis for
apportionment should be related to the basis on which the expenditure is incurred. The following are the
usual basis adopted for apportionment of overhead :
Basis of Apportionment
Basis of Distribution

Overhead Cost
(1) Lighting
(2) Rent, Rates and Taxes
(3) Insurance of building
}
Depreciation of building,
Heating
}
(4) Depreciation of plant
and Machinery and
Equipments
(5) E S I, Canteen, Safety,
}
compensation, supervision
welfare, fringe benefits
}
(6) Delivery Van,
Internal Transport
(7) Audit fees
(8) Storekeeper's expenses
(9) Power

No. of light points, floor space or meter reading

Floor Area
Area of floor

Book value

No. of employees

Weight, volume ton

Sales or Total Cost
Weight, value of materials or Number of requisitions
H. P. Hours or K. W. Hours

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408

Illustration: 1

A departmental store has several departments. What bases would you recommend for apportioning
the following items of expenses to its departments :
(I)
(2)
(3)
(4)
(5)
(6)
(7)
(8)
(9)
(10)

Fire Insurance of building

Sales commission
Advertisement
Salesmen's salaries
Commission paid to salesmen
Show room expenses
Depreciation on plant
Rent of finished goods, warehouse
Factory power
Delivery Van expenses

Solution:
Items

Basis of Apportionment

(I) Fire Insurance Building

(2)
(3)
(4)
(5)
(6)
(7)
(8)
(9)
(10)

Floor space or Value

Sales value
Sales value
Sales value
Sales value
Sales value or Total cost
Value of plant
Floor space or Area
H.P. Power (or) K.W. hours
Weight, Volume

Sales Commission
Advertisement
Salesmen's Salaries
Commission paid to Salesmen
Show room expenses
Depreciation on plant
Rent of finished goods warehouse
Factory power
Delivery Van expenses

Illustration: 2

A factory has three production departments and two service departments. The following figures have
been extracted from the financial books :
Rs.

Supervision
Repairs of Plant and Machinery
Rent
Light
Power
Employer's contribution to ESI
Canteen Expenses

6,000
3,000
8,000
2,000
3,000
600
1,000

The following further details have been extracted from the books of the respective departments :
Particulars

Direct Wages (Rs.)

Area of Square feet
No. of Employees
Value of Machinery
Light Points
H.P. of Machines

4,000
2,000
50
10,000
80
200

3,000
1,000
40
5,000
60
100

2,000
500
20
3,000
30
50

2,000
500
20
3,000
30
50

1,000
100
10
1,000
20
20

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Overheads

Solution:
Primary Overhead Distribution Summary
Particulars

Supervision
Repairs of Plant }
and Machinery
Rent
Light
Power
Employers
Contribution to ESI
Canteen Expenses

Basis of

Total

Production Department

Sen'ice Dept.

Apportionment

Rs.

Departments

Department

No. of Employees
5:4:2:2:1
Value Machinery
10:5:3:3:1
Area of square feet
20:10:5:5:1
Light points
8: 6: 3 : 3: 2
H.P. of Machines
20:10:5:5:2
Direct Wages
4: 3 : 2 : 2: 1
No. of Employees
5:4:2:2:1
Total

857

857

429

681

409

409

137

3,902

1,951

976

976

195

2,000

727

545

273

273

182

3,000

1,429

714

357

357

143

600

200

150

100

100

50

1,000

357

286

143

143

71

23,600

10,121

6,044

3,115

3,115

1,207

6,000

2,142

1,715

3,000

1,364

8,000

(b) Re-apportionment (Re-distribution): Re-distribution of overhead from various service departments

to production departments is known as Re-apportionment or Secondary distribution. Accordingly, allocation
and apportionment of overheads from service departments or centres to production centres or departments.
The following are the important bases adopted for apportionment of secondary distribution:

Service Department
(1)

Purchase Department

(2) Maintenance and Repairs Department

(3) Stores Department
(4) Personnel Department
(Canteen, Welfare, Medical,
Employer's liability)
(5) Time Keeping Department
(6) Pay roll Department
(7) Accounts Department
(8) Tool Room

Service Department
(9) Transport Department
(10) Power House
(11) Fire Insurance

Basis of Apportionment
Number of Purchase Orders or Number of
Purchase Requision or Value of Materials
Hours worked
No. of Requisition or Value of Materials
No. of Employees or Direct wages

No. of Employee or Labour Hours or Direct Wages

No. of Employees or Direct Wages
No. of Employees
Direct Labour Hours or Machine Hours or Direct Wages

Basis of Apportionment
Car hours, Truck hours, Tonnage handled
K.W. Hours
Stock Value

Methods or Re-apportionment or Re-distribution

The following are the important methods of re-distribution of service department overheads to
production department :

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A Textbook of Financial Cost and Management Accounting

(1)

Direct Re-distribution Method

(2)

Step Distribution Method

(3)

Reciprocal Service Method -

this method further grouped into:

(a) Repeated Distribution Method

(b) Simultaneous Equiation Method
(c) Trial and Error Method
The following chart explains more about the method of re-apportionment of service department cost:

Methods of Secondary Distribution

!
Direct Re-distribution
Method

Step
Method

Repeated Distribution
Method

1
Reciprocal Service
Method

Simultaneous
Equation
Method

Trial and Error

Method

(1) Direct Re-distribution Method: Under this method, the cost of service department is directed to
re-distribution to the production departments without considering the services rendered by one service
department to another service department.
Illustration: 3
Ramesh Ltd. has three production departments A, Band C and six service departments. The
following figures are extracted from the records of the company :
Production Departmentss
A
B
C

Rs.16,Ooo
Rs.IO,OOO
Rs.12,OOO
Rs.38,OOO

Service Departments
Stores
Timekeeping
Maintenance
Power
Walfare
Supervision
Total

Rs.2,OOO
Rs.3,OOO
Rs. 1,000
Rs.2,OOO
Rs. 1,000
Rs.2,OOO
Rs.49,OOO

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Overheads

The other information available in respect of the production departments :

Production Departments

Particulars

No. of Employees
No. of Stores Requisition
Horse Power of Machines
Machine Hours

40
30
500
2500

30
20
500
1500

20
10
600
1000

You are required to apportion the costs of various service departments to production departments.

Solution:
Departmental Overhead Re-distribution Summary
Expenses

Basis

Total
Rs.

As per primary
}
Departmental summary
S!<rvik~ Del2artm!<!lt ;
Stores

Timekeeping
Maintenance
Power
Welfare
Supervision

No. of Stores
Requisitioned
30: 20 : 10
No. of Employees
40:30:20
Machine Hours
25: 15: 10
Horse Power
5:5:6
No. of Employees
40:30:20
No. of Employees
40: 30: 20

Total

Production Departments
Rs.

B
Rs.

C
Rs.

38,000

16,000

10,000

12,000

2,000

1,000

667

333

3,000
1,000

1,333
500

1,000
300

667
200

2,000

625

625

750

1,000

445

333

222

2,000

889

667

444

49,000

20,792

13,592

14,616

(2) Step Method: Under this method the cost of most serviceable department is first distributed to
production departments and other service departments. Thereafter, the next service department is distributed
and later the last service department until the cost of all the service departments are redistributed to the
production department.

Illustration: 4
A manufacturing company has two production departments A and B and three Service Departments
- Timekeeping, Stores and Maintenance. The departmental summary showed the following expenses for
Dec. 2003.
Production Departments:
Rs.
A
B

32,000
10,000

Service Departments:
Timekeeping
Stores
Maintenance
Total Overhead Expenses

8,000
10,000
6,000
66,000

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A Textbook of Financial Cost and Management Accounting

The following information about departments is available and is used as a basis for distribution :

Particular

Production
Departments
A

No. of Employees
No. of Stores Requisitions
Machine Hours

B
'15
10
800

20
12
1200

Service Departments
Timekeeping

Stores
8

10

Maintenance

5
3

You are required to apportion these costs to production departments :

Solution:
Departments

Primary
Distribution
Rs.

Timekeeping
Stores
Maintenance
A
B

8000
10,000
6,000
32,000
10,000

Total

66,000

(-) 8,000
3,334
2,500
1,333
833

(-) 13,334
1,600
6,400
5,334

(-) 10,100
6,060
4,040

45,793
20,207
66,000

Basis of Apportionment:
Timekeeping: 20 : 15 : 8 : 5 (No. of Employees)
Stores: 12 : 10 : 3 ( No. of Stores Requisition)
Maintenance: 12 : 8 (Machine Hours)

(3) Reciprocal Service Method : This method recognizes the fact that if a service department
receives services from other department, the services should be charged in the receiving department. Thus,
the cost of inter departmental services is taken into account on reciprocal basis. The following are the three
important methods available for dealing with reciprocal distribution :
(a) Simultaneous Equation Method.
(b) Repeated Distribution Method.
(c) Trail and Error Method.

(a) Simultaneous Equation Method: Under this method, the true cost of total overhead of each
service department is ascertained with the help of Simultaneous or Algebraic Equation. The obtained
result reapportioned to production department on the basis of given percentage.
(b) Repeated Distribution Method: Under this method, the total overhead costs of the service
departments are distributed to service and production departments according to given percentage of the
service departments are exhausted, in tum repeatedly until the figures become too small to matter.
(c) Trail and Error Method: In this method, the cost of a service centre is apportioned to another
service centre. Then, the cost of another service centre along with the apportioned cost from the first centre
is again apportioned back to the first service centre. This process is repeated till the amount to be
apportioned becomes zero or negligible.

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Overheads

Illustration: 5
The following particulars related to a manufacturing company has three production departments : P,
Q, : and R and two service departments X and Y :
Production Departments:
P

Q
R

Rs.2,ooO
Rs.l,5oo
Rs.l,ooo

Service Departments:
S
T

Rs. 500
Rs.4oo

The service department expenses are charged on a percentage basis as folIows :

Productions Departments

Service Departments

Service Depts. :

S
T

20%
30%

30%
30%

40%
20%

20%

T
10%

Prepare a statement showing the distribution of the two service departments expenses to three production
departments under (1) Simultaneous Equation Method and (2) Repeated Distribution Method.

Solution:
(1) Simultaneous Equation Method:
Let X be the total expenses of Departments S
Let Y be the total expenses of Department T
X = 500 + 0.20 Y
Y = 400 + 0.10 X
X = 500 + 0.20 (400 + O.IOX)
X = 500 + 80 + 0.02X
X - 0.20X = 580
(or) 0.98 X = 580
580
.. X = - - = 59l.83
0.98
Y = 400 + 0.10 (592)
= 400 + 59
Y =459

Departmental Overhead Distribution Summary

Particulars

Production Departments
Q
R
P
Rs.
Rs.
Rs.

Overhead as per Summary

Department S
Department T

2,000
118
138

1,500
178
137

1,000
237
92

Total

2,256

1,815

1,329

Service Departments
T
S
Rs.
Rs.

500
(-) 592
92

400
59
(-) 459

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414

Repeated Distribution Method

Production Departments
Q
R
P
Rs.
Rs.
Rs.

Particulars

Total Department overhead as per

Primary Distribution
Service Department S
Service Department T
Service Department S
Service Department T

2,000
100
135
18
3

1,500
150
135
27
3

1,000
200
90
36
3

Total

2,256

1,815

1,329

Service Departments
T
S
Rs.
Rs.
500
(-) 500

90
(-) 90

400

50
(-) 450
9
(-) 9

Illustration: 6

You are supplied with the following infonnation and required to work out the production hour rate of
recovery of overhead in Departments X, Y and Z.
Production Deplts.
Particulars
Rent
Electricity
Indirect Labour
Depreciation
Sundries
Estimated working
Hours

Service Deptts.

Total
Rs.

Rs.

Rs.

Z
Rs.

P
Rs.

Q
Rs.

12,000
4,000
6,000
5,000
4,500

2,400
800
1,200
2,500
910

4,800
2,000
2,000
1,600
2,143

2,000
500
1,000
200
847

2,000
400
800
500
300

800
300
1,000
200
300

1,000

2,500

1,400

Expenses of Service Department P and Q are apportioned as under :

P
Q

30%
10%

40%
20%

20%
50%

20%

10%
(C7A Inter, 2Ck71)

Solution:
Departmental Overhead Distribution Summary
Production Deptts.
Particulars
Rent
Electricity
Indirect Labour
Depreciation
Sundries
Total

Service Deptts.

Total
Rs.

Rs.

Rs.

Z
Rs.

P'
Rs.

Q
Rs.

12,000
4,000
6,000
5,000
4,500

2,400
800
1,200
2,500
910

4,800
2,000
2,000
1,600
2,143

2,000
500
1,000
200
847

2,000
400
800
500
300

800
300
1,000
200
300

31,500

7,810

12,543

4,547

4,000

2,600

Overheads

415

Repeated Distribution Method

Service Depts.

Production Depts.
Particulars

Total

Total Departmental
Overheads as per
Primary distribution
Exp. of P Dept

7.810

12.543

4.574

4.000

2.600

1.200

1.600

800

(-4.000)

400

Total
Exp. of Q Dept.

9.010
300

14.143
600

5,437
1.500

600

3.000
(-3000)

Total
Exp. of P Dept.

9.310
180

14.743
240

6.847
120

600
(-600)

60

Total
Exp. of Q Dept.

9.490
6

14.983
12

6.967
30

12

Total
Exp. of P Dept

9,496
4

14.995
5

6.997
3

12
(-12)

9.500
1.000
Rs.9.53

15.000
2.500
Rs.6

7.000
1,400
Rs.5.oo

Total
Working hours
Rate per hour

31.500

(ii) Simultaneous Equations Method

Let p be the expenses of Service Dept. P and

Let q be the expenses of Service Dept. Q
Then p = 1,000 + -

q (service 20% of q wi\1 be apportioned to dept. P) and

q=2,600+ -

10
q = 2.600 + -

(4,000 + -

10
q = 2,600 + 400 + -

1
50

q= 3,000 + -

50

50q = 1,50,000 + q
49q 1,50.000
q = 3,061

P = 4.000 + -

(3061) = 4612

q) (putting the value of p)

60
(-60)

416

A Textbook of Financial Cost and Management Accounting

Departmental Overhead Distribution Summary

Rs.

Rs.

Rs.

Total (given)
Exp. of P Dept. Rs. 4,612
Exp. of Deptt Q Rs. 3,061

7,810
1,384
306
9,500

12,543
1,845
612

4,547
922
1,531

15,000

7,000

Estimated Working Hours

1,000

2,500

1,400

9.50

6.00

5.00

Rate Per Hour Rs.

P
Rs.

4,000
(-4,612)
612

Q
Rs.

2,600
461
(-3,061)

Illustration: 7

RST Ltd. produces machine parts on a job order basis. Most of the business is obtained through
bidding. Most of the firms competing. with RST Ltd. bid full cost plus a 20% markup. Recently, with the
expectation of gaining mbre sales, RST Ltd. reduced its markup from 25% to 20%. The company operates
two service departments and two producing departments. The budgeted costs and the normal levels of
activity for each department are given below:
Particulars

5,00,000
150
32,000
50,000
5,000

2,50,000
150
8,000
5,000
50,000

Overhead Costs
Number of Employees
Maintenance Hours
Machine Hours
Labour Hours

Production Department

Service Department

5,00,000
40
10,000

10,00,000
35
1,000

The direct costs of Department A are allocated on the basis of employees; those of Department B are allocated
on the basis of maintenance hours. Departmental overhead rates are used to assign costs to products. Department C uses
machine hours, and Department D uses labour hours. The firm is preparing to on ajob Gob Z) that requires three machine
hours per unit produced in Department C and no time in Department D. The expected prime cost per unit is Rs. 85.

Required
(1)
(2)
(3)
(4)
(5)
(6)

Allocate the service costs to the production departments using the direct method.
What will be the bid for Job Z, if the direct method of allocation is used?
Allocate the service costs to the production departments using the Sequential or Repeated Method.
What will be the bid for Job Z, if the Sequential Method is used?
Allocate the service costs to the production departments using the Reciprocal Method.
What will be the bid for Job Z, if the Reciprocal Method is used?

(CA Inter., Nov. 2002)

Solution:
(1) Allocation of Service Costs to Production Department (Direct Method)
Particulars

Service Department

Direct Cost (Rs.)

Department A
(No. of Employees 1: 1)
Department B
(Maintenance hours4: 1)
Total Rs.

5,00,000
(5,00,000)

10,00,000

(10,00,000)

Production Department

5,00,000

2,50,000

2,50,000

2,50,000

8,00,000

2,00,000

15,50,000

7,00,000

417

Overheads

Department C Overhead Rate

Total Cost
Machine Hours
15,50,000

=Rs. 31 Per machine hours

50,000

(2) Product Cost and bid price for job Z

Rs.
85

Prime Cost
Overheads
(3 hours x Rs.31 per hour)

93
Rs. 178

Total unit cost

:. Bid Price [Rs. 178 x 1.2]

20% makeup

=Rs. 213.60

(3) Statement Showing allocation of Service Cost to Production Department (Sequential method)
Particulars

Service Departments

'8

A
Over heads
Dept. A Cost allocated
[ No. of Employees ]
40 : 35 : 150 : 150
Dept. B Cost allocated
Maintance Hours
10 : 1 : 32 : 8
Dept. A Cost allocated

Dept. B Cost allocated

5,00,000

2,50,000

(5,00,000)
53,333

46,667

2,00,000

2,00,000

(l0,46,667)
20,523

6,56,732

1,64,183

24,132
(44,655)
875
3,391
(4,266)
84

1,03,425
28,019

1,03,425
7,005

14,535

14,534

2,677

669

440
(524)
10

1,884

1,885

329

82

56
(66)

243

242

41

12

2,05,229
(2,58,562)
27,580
8,756
(36,336)
3,876
836
(4,172)
503
103
(606)
65

Dept. A Cost allocated

Dept. B Cost allocated
Dept A Cost allocated
Total Costs

10,00,000

Dept. A Cost allocated

Dept. B Cost allocated

5,00,000

Dept. A Cost allocated

Dept. B Cost allocated

Production Departments

13
(78)

39

39
15,07,924

7,42,076

A Textbook of Fi1Ul1lciai Cost and Management Accounting

418

Department C Overhead Rate

Total Cost of Dept. C

Machine Hours

15,07,924

=Rs. 30.16 per hour

50,000

(4) Product cost and bid price for job Z

Prime Cost
Overheads
(3 hours x Rs.30.16)
Total unit cost
Profit

20% of 175.48

Total

Rs.85.00

=
=
=
=

Rs.90.48
Rs. 175.48
Rs.35.10
Rs.210.58

(5) Allocation of Service costs to production department (Reciprocal Method)

Working Notes:
Allocation of Ratios
Proportion of output used by

'A'
(based on number of
Employees)
'B'
(based on maintenance hours)

44.78%

44.78%

64%

16%

10.45%

20%

A Rs.5,00,000 + 20% of B
B = Rs.IO,OO,OOO + 10.45% of A
A = Rs.5,00,000 + 20% [10,00,000 + 10.45% of A]
A = Rs.5,00,000 + Rs.2,00,000 + 2.09% of A
0.9791 A

=
=
=
=

Rs.7,OO~OOO

7,00,000
0.9791

=Rs.7,14,942

Rs.IO,OO,OOO + 10.45% (7,14,942)

10,00,000 + 74,711
Rs.IO,74,711

Statement of allocation of Service Department cost to Production Department

Particulars
Direct Cost
Dept. B
(as per note above)
Dept. A
(as per note above)
Total Costs

Rs.5.00,000 Rs.IO,OO,OOO

(7,14,942)

(10,74,711)

Rs.5,00,000

Rs.2,50,000

6,87,815
(64%)

1,71,954
(16%)

3,20,151
(44,78%)

3,20,151
(44.78%)

15,07,966

7,42,105

Overheads

419

Total Cost

Department C Overhead Rate

=-----Machine Hours
15,07,966

50,000

=Rs. 30.16 per machine hour

(6) Product cost and Bid price for job Z

Prime cost Overheads

Rs.85

(3 hours x Rs.30.16 per machine hours)

Total unit cost

=
=

Rs.175.48

Bid Price (Rs.l75.48 x 1.20)

Rs.210.58

Rs.90.48

Illustration: 8
e-books is an online book retailer. The Company has four departments. The two sales departments
are Corporate Sales and Consumer Sales. The two support-departments are Administrative (Human
resources, Accounting), and Information systems. Each of the sales departments conducts merchandising
and marketing operations independently.
The following data are available for October, 2003 :
Departments
Corporate Sales
Consumer Sales
Administrative
Information Systems

Revenues

Number of Employees

Rs. 16,67,750
Rs. 8,33,875

42
28
14
21

Processing TIme used

(in minutes)
2,400
2,000
400
1,400

Cost incurred in each of four departments for October, 2003 are as follows:
Corporate Sales
Consumers Sales
Administrative
Information Systems

Rs. 12,97,751
Rs. 6,36,818
Rs.
94,510
Rs. 3,04,720

The company uses number of employees as a basis to allocate Administrative costs and processing time as a
basis to allocate Information systems costs.
Required:
(I) Allocate the support department costs to the sales departments using the direct method.
(II) Rank the support departments based on percentage of their services rendered to other support
departments. Use this ranking to allocate support costs based on the step-down allocation method.
(III) How could you have ranked the support departments differently?
(IV) Allocate the support department costs to two sales departments using the reciprocal allocation
method.
(CA PE II, Nov., 2003)

A Textbook of Financial Cost and Management Accounting

420

Solution:
(i) Direct and step-down allocation
(i) Support Departments
Admn. Information Systems

Costs incurred
Allocation of Admn.
(42nO,28nO)
Allocation of
Information Systems
(24/44,20/44)

(ii) Operating Departments

Corporate
Consumer

Rs.

Rs.

Rs.

Rs.

94,510

3,04,720

12,97,750

6,36,818

56,706

37,804

1,66,211

1,38,509

15,20,667

8,13,131

(94,510)

(3,04,720)

(ii) Rank on percentage of services rendered to other support departments.

Administration provides 23.077% of its services to information systems

21
42+28+21

= -

21
91

,= 23.077%

Information system provides 8.333% of its services to administrative

400

departmen~.

400

2,400+2,000+400

x 100 = - - x 100 = 8.33%

4800

Thus 23.07% of Rs. 94,510 Admn. Dept costs is = Rs. 21,810

Thus 8.33% of Rs. 3,04,720 Information systems dept. cost is Rs. 25,392
(i) Support Departments
Admn. Information Systems
Rs.
Rs.

Costs incurred
Allocation of Admn. }
(42n0,28nO)
Allocation of
Information Systems}
(24/44,20/44)

(iii)

(ii) Operating Departments

Corporate
Consumer
Rs.
Rs.

94,510

3,04,720

12,97,750

6,36,818

(94,510)

21,810

43,620

29,080

3,26,530
(3,26,530)

1,78,107

1,48,423

Rs. 15,19,477

Rs. 8,14,321

An alternative + ranking is based on the Re-amount of services rendered to other service departments,
using the numbers from requirement 2, this approach would use the following sequence.

Allocation of information systems overheads first (Rs. 25,383 provided to a4ministrative).

Allocated administrative overheads second (Rs: 21,810 provided to information systems).

Overheads

421

(iv) Administrative (AD)

=Rs.94,510 + 0.08333 IS
Information Services (IS)
= Rs.3,04,720 + 0.23077 AD
AD =94,510 + 0.08333 {3,04,720 + 0.23077 AD}
AD = 94,510 + 25,392.32 + 0.01923 AD
0.98077
AD = 1,19,902.32
AD = Rs. 1,22,253
Rs. 3,04,720 + 0.23077 x 1,22,253
IS
= Rs. 3,32,932

(i) Suppon Depanments

Admn. Information Systems
Costs incurred
Allocation of Admn. }
(42170,28nO)
Allocation of
Information }
Systems
(24/44,20/44)

( it ) Operating Departments
Corporate
Consumer

Rs.

Rs.

Rs.

Rs.

94,510

3,04,720

12,97,750

6,36,818

(1,22,253)

28,212

56,424

37,616

27,744

(3,32,932)

1,66,466

1,38,722

15,20,640

8,13,156

QUESTIONS

1.
2.
3.
4.
S.
6.
7.
8.
9.
10.

What do you understand by overhead charges?

"Overheads may be classified according to their nature and a number of other charactertics." Discuss this statement
while classifying cost.
Define overhead charges. Explain the different methods of classification of overhead.
Discuss the usefulness of overhead classification.
What do you understand by codification of overhead charges?
Discuss in brief the different methods used in codification of overhead.
What is meant by allocation and apportionment? Distinguish between a\1ocation and apportionment of overhead.
What basis you would adopt for apportionment of the fo\1owing items of overhead expenses to different departments?
(a) Power and light. (b) Depreciation on building. (c) Rent and Rates. (d) Postage. (e) Indirect Wages.
Explain the different methods of re-apportionment of overheads.
The following particulars were obtained from the books of a light Engineering Company for the half year ended 30th
September, 2003. Calculate the departmental overhead rate for each of the production departments assuming the
overheads are recovered as a percentage of direct wages.

Particulars

Production Departments

Direct wages
Direct materials
Employees
Electricity
Light points
Assets value
Area occupied

Service Departments

Rs.

Rs.

Rs.

Rs.

Rs.

S,OOO
2,000
ISO
6,000
IS
20,000
600

1,000
I,SOO
SO
2,000
S
10,000
200

7,000
3,000
200
8,000
10
SO,OOO
800

6,000
2,SOO
ISO
6,000
IS
30,000

600

The expenses for 6 months were :

Stores overhead
Motive power
Electric lighting
Labour welfare

Rs.
Rs.
Rs.

400
IS00
200
3000

Depreciation
Repairs & Maintenance
General overheads
Rent and Taxes

Rs.
Rs.
Rs.
Rs.

6,000
1,200
10,000

600

1,000
1,000
SO
3,000
S
10,000
200

422

A Textbook of Financial Cost and Management Accounting

11.

12.

13.

Apportion the expenses of Department X in the ratio of 4 : 3 : 3 and that of department Y, in proportion of direct wages,
to departments A, B, and C respectively.
[ ADS: Total overheads cost: A - Rs.1l396, B - Rs.8663, C - Rs.7341
Dept. overhead rate: A - 162.8%, B - 144.4%, C - 146.8%]
A company has three departments A, B, and C and two service departments X and Y. The expenses incurred by them
during the month of may 2003 are incurred by them during the month of may 2003 are :
A- 8000
B -7000
C - 5000
X - 2340
Y - 3000
The expenses of service departments are apportioned to the production departments in the following basis :
Particulars
ABC
X
Y
Expenses of X
20%
40%
30%
10%
Expenses of Y
40%
20%
20%
20%
Show clearly as to how the expenses of X and Y departments would be apportioned to A, Band C departments under
Simultaneous Equitation Method
[Ans : Total cost of service department X = Rs. 3000
Total cost of service department Y = Rs. 3300]
You are supplied with the following information and required to work out the production hour rate of recovery of
overheads A, B, and C under the Repeated Distribution Method.
Service Departments
Production Departments
ABC
P
Q
Rs.
Rs.
Rs.
Rs.
Rs.
As per primary
}
Distribution summary
7,810
12,543
4,547
2,600
4,000
Expenses of service departments P and Q are apportioned as under:
ABC
P
Q
30%
40%
20%
P
10%
Q
10%
20%
50%
20%
Estimated working hours of production are as under:
Departments :
A-l,ooo hours
B - 2,500 hours
C - 1,400 hours
[Ans : Total Overhead cost of
Dept. A - Rs. 9,500
Dept. B - Rs. 1,5000
Dept. C - Rs. 7,000
Overhead Rate: A - Rs. 9.50; B - Rs. 6; C - Rs. 5]
A factory consists of three Production Departments, viz., Turning. Milling and Grinding. Though maintenance is done
by the departments, the factory keeps four service departments too, viz., Stores, Planning, Canteen and Time Office.
For the month of November 2003 the Direct Departmental Expenses were recorded as follows:
Turning
Rs. 72,000
Stores
Rs. 36,000
Milling
Rs. 84,000
Planning
Rs. 60,000
Grinding
Rs. 1,08,000
Canteen
Rs. 48,000
Time Office
Rs. 12,000
The expenses of stores are to be distributed on a percentage basis, viz., 20%, 40% to Turning. Milling and Grinding
respectively. The expenses of Planning are to be apportioned on the basis of Machine Hours worked and those of
Canteen and Time Office according to number of men employed in Production Departments.
Men employed
No. of hours worked
22
10,000
Turning
15,000
Milling
32
46
25,000
Grinding
Prepare a statement showing the distribution of the Service Department's Expenses to the Production Departments and
also determine the final absorption rate.
[Ans: Total of Turning Rs. 1,04,400; Milling Rs. 1,35,600; Grinding Rs. 1,80,000; Aborption rate per hour 10.44:9.04
and 7.20]

Overheads

423

14.

The following particulars relate to a manufacturing company which has three production departments, A, B, C and two
service departments X and Y :

Total departmental
Overhead as primary distribution

Depanments
A

Rs.63,OOO

74,000

28,000

45,000

20,000

The company decided to charge the service departments cost on the basis of the following percentages:

Service Dept.
Production Depts.
ABC

15.

X
40%
30%
20%
10%
Y
30%
30%
29%
20%
Find the total overheads of production departments charging service departmental costs to production on the repeated
distribution method.
[Ans : A Rs. 90,500; B Rs. 96,500; C Rs. 43,000]
In a factory, there are two service departments P and Q and three production departments A, Band C. In April 1988 the
departmental expenses were:
Depanments
Rs.
A
B
C
P

6,50,000
6,00,000
5,00,000
1,20,000
1,00,000

16.

Service Dept.
Y

The service departments, expenses are allocated on a percentage basis as follows :

Service Dept.
Production Depts.
Service Dept.
ABC
X
Y
X
30%
40%
15%
15%
Y
40%
30%
25%
5%
Prepare a statement showing the distribution of the two service departments expenses to the tree departments under the
"Repeated Distribution Method."
[Ans : Rs. 7,35,340; Rs. 6,86,045; Rs. 5,48,615]
A manufacturing concern has three production departments and two service departments. In July 2003, the
departmental expenses were as follows :

Production Departments
X

Rs.
16,000
13,000
14,000

Z
Service Depanments
p

4,000
6,000
The service department expenses are charged out on a percentage basis, viz. :

17.

Q
X
"
Z
P
20%
25%
35%
20%
Expenses of dept. P
Expenses of dept. Q
25%
25%
40%
10%
Prepare a statement of secondary distribution under repeated distribution method.
[Ans: Total Cost of Dept. X Rs. 18,674; Dept. Y Rs. 15,908; Dept. Z Rs. 18,418]
A Company has three production departments and two service departments and distribution summary of overhead is as
follows:
Production Depanments

Rs.

A
B
C

30,000
20,000
10,000

Service Depanment

Rs.

X
Y

2,340
3,000

A Textbook of Financial Cost and Management Accounting

424

18.

The expenses of service departments are charged on a percentage basis which is as follows :
ABC
X
Y
Service Dept. X
20%
40%
30%
10%
40%
20%
20%
20%
Service Dept. Y
[Ans: Dept. A Rs. 65,340; Dept. B Rs.31,920; Dept. C Rs. 11,560]
In a factory, there are two service departments, P and Q and three production departments A, Band C. In March 2003
the departmental expenses were.
A
Rs .6,50,000
P
Rs. 1,20,000
B
Rs.6,oo,ooo
Q
Rs. 1,00,000
C
Rs. 5,00,000
The service department expenses are allocated on a percentage basis as follows.
X
Y
Z
P
Q
Dept. P
3%
40
15%
15%
Dept. Q
40%
30%
25%
5%
Prepare Q statement showing the distribution of two service departments expenses to three departments under
simultaneous equation method.
[Ans: Dept. A Rs.7,35,342; Dept. B Rs.6,86,046 Dept. C Rs.5,48,612]

000