CAG 102
ADVANCED COST ACCOUNTING - II
YASHWANTRAO CHAVAN MAHARASHTRA OPEN UNIVERSITY
Dnyangangotri, Near Gangapur Dam, Nashik 422 222, Msharashtra
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YASHWANTRAO CHAVAN MAHARASHTRA OPEN UNIVERSITY
Vice-Chancellor : Dr. M. M. Salunkhe
Director (I/C), School of Commerce & Management : Dr. Prakash Deshmukh
State Level Advisory Committee
Dr. Pandit Palande
Hon. Vice Chancellor
Dr. B. R. Ambedkar University
Muaaffarpur, Bihar
Dr. Suhas Mahajan
Ex-Professor
Ness Wadia College of Commerce
Pune
Dr. V. V. Morajkar
Ex-Professor
B.Y.K. College, Nashik
Dr. Mahesh Kulkarni
Ex-Professor
B.Y.K. College, Nashik
Dr. J. F. Patil
Economist Kolhapur
Dr. Ashutosh Raravikar
Director, EDMU,
Ministry of Finance
New Delhi
Dr. A. G. Gosavi
Professor
Modern College, Shivaji Nagar, Pune
Dr. Madhuri Sunil Deshpande
Professor
Swami Ramanand Teerth Marathwada
University, Nanded
Dr. Prakash Deshmukh
Director (I/C)
School of Commerce & Management
Y.C.M.O.U., Nashik
Dr. Parag Saraf
Chartered Accountant Sangamner
Dist. AhmedNagar
Dr. S. V. Kuvalekar
Associate Professor and
Associate Dean (Training)(Finance )
Dr. Surendra Patole
Assistant Professor
School of Commerce & Management
National Institute of Bank Management ,
Y.C.M.O.U., Nashik
Pune
Dr. Latika Ajitkumar Ajbani
Assistant Professor
School of Commerce & Management
Y.C.M.O.U., Nashik
Author
Editor
Instructional Technology Editing &
Programme Co-ordinator
1) Prof. V. V. Morajkar
Dr. Mahesh A. Kulkarni
10, Vidya Society, Shikhare Wadi, Research Guide,
Nashik Road - 422 101.
BYK College of Commerce,
2) Dr. Suhas Mahajan
Nashik - 422 005.
Research Guide,
Ness Wadia College of Commerce,
Pune - 411 001.
Dr. Latika Ajitkumar Ajbani
Assistant Professor
School of Commerce & Management
Y.C.M.O.U., Nashik
Production
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Y.C.M. Open University, Nashik - 422 222.
Copyright © Yashwantrao Chavan Maharashtra Open University, Nashik.
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First Publication
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September 2015
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CONTENTS
Topic 1
Unit 1
Labour Costing
Methods of Remuneration
1-16
1.0 Introduction 1.1 Unit Objectives 1.2 Meaning of remuneration 1.3 Methods of remuneration 1.3.1
Factors affecting selection of method 1.3.2 Time rate method 1.3.3 Piece rate method 1.4 Illustrations on
Time rate and piece rate methods 1.5 Summary 1.6 Key Terms 1.7 Questions and Exercise 1.8 Further
Reading
Unit 2
Incentive Plans
17-36
2.0 Introduction 2.1 Unit Objectives 2.2 Incentive Plans : meaning and necessity 2.3 Different incentive plans
2.3.1 Halsey incentive plan 2.3.2 Halsey – weir incentive plan 2.3.3 Rowan incentive plan 2.3.4 Taylor’s
differential wage rate system 2.3.5 Emerson’s incentive plan 2.4 Summary 2.5 Key Terms 2.6 Questions
and Exercises 2.7 Further Reading
Unit 3
Preparation of Wage Sheets and Pay - Rolls
37-46
3.0 Introduction 3.1 Unit Objectives 3.2 Wage-sheets and pay-rolls - meaning 3.3 Necessity and importance
3.4 Preparation of wage-sheets and pay-rolls 3.5 Types of frauds and their prevention 3.6 Control on labour
cost 3.7 Summary 3.8 Key Terms 3.9 Questions 3.10 Further Reading
Topic 2
Unit 4
Expenses
Meaning and Definition
47-52
4.0 Introduction 4.1 Unit Objectives 4.2 Expenses - meaning and definition 4.3 Types of Expenses 4.3.1
Direct expenses4.3.2 Indirect expenses 4.4 Summary 4.5 Key Terms 4.6 Questions and Exercises 4.7
Further Reading
Topic 3
Unit 5
Overheads
Classification Overheads
53-66
5.0 Introduction 5.1 Unit Objectives 5.2 Meaning and definition of overheads 5.3 Classification of overheads
– meaning and necessity 5.4 Methods of classification of overheads 5.4.1 Classification according to function
5.4.2 Classification according to elements 5.4.3 Classification according to behavior or variablility 5.5 Summary
5.6 Key Terms 5.7 Questions 5.8 Further Reading
Unit 6
Collection and Codification
67-74
6.0 Introduction 6.1 Unit Objectives 6.2 Collection - meaning and sources 6.3 Codification of overheads 6.3.1
Meaning and necessity 6.3.2 Methods of codification of overheads 6.4 Summary 6.5 Key Terms 6.6 Questions
6.7 Further Reading
Unit 7
Allocation, Distribution and Primary Distribution
75-90
7.0 Introduction 7.1 Unit Objectives 7.2 Stages in absorption of overheads 7.3 Allocation of overheads 7.4
Distribution of overheads 7.5 Primary distribution of overheads 7.6 Summary 7.7 Key Terms 7.8 Questions
and Exercises 7.9 Further Reading
Unit 8
Secondary Distribution of Overheads
91-128
8.0 Introduction 8.1 Unit Objectives 8.2 Secondary Distribution of Overheads 8.2.1 Non-reciprocal basis of
apportionment 8.2.2 Reciprocal basis of apportionment 8.3 Methods used for secondary distribution of overheads
8.3.1 Simultaneous Equation Method 8.3.2 Repeated Distribution Method 8.3.3 Trial and Error Method 8.4
Summary 8.5 Key Terms 8.6 Questions and Exercises 8.7 Further Reading
Unit 9
Absorption of Overheads, Absorption of Factory Overheads
129-164
9.0 Introduction 9.1 Unit Objectives 9.2 Absorption of overheads 9.2.1 Actual Overhead Rate 9.2.2 Predetermined Overhead Rate 9.3 Methods of absorption of overheads 9.4 Methods of absorption of factory
overheads 9.4.1 Percentage of direct materials cost 9.4.2 Percentage of direct wages 9.4.3 Percentage of
prime cost 9.4.4 Direct labour hour rate 9.4.5 Machine hour rate 9.4.6 Rate Per unit of production 9.5
Summary 9.6 Key Terms 9.7 Questions and Exercise 9.8 Further Reading
Unit 10 Absorption of Office and Administration and Selling and Distribution
Overheads
165-172
10.0 Introduction 10.1 Unit Objectives 10.2 Methods of absorption of office and administration overheads
10.2.1 Percentage of works / factory cost 10.2.2 Percentage of sales 10.2.3 Apportionment between
manufacturing and selling divisions 10.2.4 Transfer to costing Profit and Loss Account 10.3 Methods of
absorption of selling and distribution overheads 10.3.1 Rate per unit 10.3.2 Percentage of selling price
10.3.3 Percentage of works/factory cost 10.4 Summary 10.5 Key Terms 10.6 Questions 10.7 Further
Reading
Unit 11 Under and Over Absorption of Overheads
173-184
11.0 Introduction 11.1 Unit Objectives 11.2 Meaning of under and over absorption of overhead 11.3 Causes
of under and over absorption 11.4 Treatment of under and over absorption 11.5 Illustrations 11.6 Summary
11.7 Key Terms 11.8 Questions and Exercises 11.9 Further Reading
Unit 12 Some Special Items of Overheads
185-201
12.0 Introduction 12.1 Unit objectives 12.2 Special items of overheads and treatment to be given to them
12.2.1 Interest on capital 12.2.2 Cash discount 12.2.3 Packing expenses 12.2.4 Defective or spoiled work
12.2.5 Depreciation 12.2.6 Obsolescence loss 12.2.7 Idle capacity cost 12.2.8 Research and development
cost 12.2.9 Cost of fringe benefits to employees 12.2.10 Drawing and designing office cost 12.2.11 Expenses
of cost accounting department 12.3 Summary 12.4 Key Terms 12.5 Questions 12.5 Further Reading
INTRODUCTION
This book of self - instructional material is based on the syllabus for the
subject Advanced Cost Accounting (M.Com : ACG 102), This book is written
after taking into consideration the revised syllabus prescribed for the M.Com
students of Yashwantrao Chavan Maharashtra Open University, Nashik from June,
2015. We hope that the book will help the students in understanding the theory as
well as the practical part related to the topics included in the syllabus for the
subject.
The information provided in this book is given in easy language to enable
the students to understand the theorotical as well as practical problems related to
the various topics. We have kept in mind the fact that the students are not able to
have constant interaction with the subject teachers and sufficient illustrations have
been provided for the benefit of these students. While giving the theoratical
information at appropriate stages, we have provided charts and figures to enable
the students to understand and remember the information easily.
The authors welcome any valuable suggestions made by the students and
teachers.
The authors and editors are greatful to the authorities of YCMOU guidence
and co-operation provided by them.
Editor
Authors
TOPIC 1 Labour Costing
Unit 1
Methods of Remuneration
Unit 2
Incentive Plans
Unit 3
Preparation of Wage Sheets and
Pay - Rolls
Unit 1
Methods of Remuneration
Methods of Remuneration
Structure
1.0
Introduction
1.1
Unit Objectives
1.2
Meaning of remuneration
1.3
Methods of remuneration
NOTES
1.3.1 Factors affecting selection of method
1.3.2 Time rate method
1.3.3 Piece rate method
1.4
Illustrations on Time rate and piece rate methods
1.5
Summary
1.6
Key Terms
1.7
Questions and Exercise
1.8
Further Reading
1.0
Introduction
In the previous Units information has been provided about labour, types of
labour, time-keeping, time-booking and reconciliation of time-kept with time booked.
In this unit, we shall now consider information about the reward given to labour.
Such reward is known as wages, salaries and collectively as remuneration. It can
be paid by using certain methods of remuneration and amount of remuneration is
considered as the cost of labour.
1.1 Unit Objectives
After studying the information given in this Unit you should understand :
•
Meaning of remuneration;
•
Time-rate method and its advantages and disadvantages;
•
Piece- rate method and its advantages and disadvantages; and
•
How amount of remuneration is calculated under time-rate method and
piece – rate method.
Advanced Cost Accounting - II
1
Methods of Remuneration
NOTES
1.2
Meaning of Remuneration
As per the Oxford Dictionary, ‘remuneration money paid for work done’.
It is a reward given to an employee who has done work assigned to him by his
employer. Remuneration paid to workers in the factory is know as ‘wages’. The
workers have to use physical strength / labour and skills for doing the work get
wages form the employer. They perform work of operating machinery, mixing
and heating of materials and shaping or moulding of materials to manufacture a
product or products and in return for it receive wages. There are other employees
who perform clerical or similar type of work and are employed in the office or the
sales department. They use intelligence, thinking, power and skills to perform
clerical work or typing work or operating of computers or work of recording
accounting or other information needed for decisions making and for implementation
of policies. Remuneration paid to these employees in known as salaries.
Remuneration thus includes wages as well as salaries. However, when we use
the term ‘ labour cost’. It includes wages and cost of monetary and non-monetary
ammenities provided to direct and indirect workers employed to work in the factory.
Wages paid to direct workers are direct wages and they are included in the amount
of prime cost while wages paid to indirect workers are recorded as indirect labour
cost and are included in the calculation of the amount of Factory Overheads.
salaries paid to the office employees is one of the items of office and Administration
Overheads and salaries paid to the employees doing the work of selling and
distribution of finished product is one of the items of Selling and Distribution
Overheads.
In this Unit, the term remuneration is used as wages of workers.
1.3
Methods of Remuneration
Owner of a factory or management of an industrial concern employs required
number of and required type of workers for performing certain work which results
in producing certain product or products needed by customers in the society. The
workers use their physical power, intelligence and skills for doing the work of
production assigned to them. The work done by them may be completion of jobs,
operations or processes which lead to manufacture of products or rendering of
services and for such work the owner or the management has to pay remuneration
to them. For calculating the amount of remuneration payable to the workers there
are basically two methods as under :
2
Advanced Cost Accounting - II
1.
Time Rate Method, &
2.
Piece Rate Method
In order to encourage and reward increase in efficiency and productivity
among workers some incentive plans have been introduced by relying on time
factor or quantity of work done or combination of both these factors. However,
before obtaining detail information about the two basic methods and the various
incentive plans it will be proper to consider the factors which help in section of a
good method of remuneration.
Methods of Remuneration
1.3.1 Factors Affecting Selection of Method
Management of every concern is required to select method of remuneration
which it uses for paying remuneration to its employees. While selecting a method
of remuneration it should take into consideration many factors such as the nature
of work performed by workers, measurability of work done, risk involved in
performance of the work, whether quantity of output is dependent on the speed
of machine or on the productivity of worker, whether the work is to be done in
factory premises under the supervision of foreman or whether it is done by the
worker at his home independently. After considering the information related to
these factors it should be decided whether time rate method or piece-rate method
or a particular incentive plan of remuneration should be followed for calculating
wages payable to the workers.
NOTES
A method of remuneration to be regarded as a satisfactory or good method
should fulfill the following conditions :
1.
It should be acceptable to both- employer and workers. If workers or their
union does not accept the selected method of remuneration it will result into
slowdowns and stoppages of work.
2.
It should be flexible so that it can be adjusted to the changing situation
easily.
3.
It should possess stability and the need to change it should arise only in
exceptional situation. Frequent changes made in the method of remuneration
make the workers suspicious about honesty of the management.
4.
It should be easy to understand. Once it is explained as to how remuneration
amount is calculated, it should enable the workers to calculate and verify
the amount paid to them as remuneration for work done by them.
5.
It should assured payment of a certain minimum amount of wages to the
workers. This enables the workers to concentrate their attention on the
work they perform.
6.
It should encourage the workers to increase their efficiency and productivity.
7.
It should help the management to control labour turnover as well as labour
absenteeism.
1.3.2 Time Rate Method
Time rate method is the oldest method of remunerating the labour. In this
method remuneration is agreed to be paid to labourers at agreed rate per unit of
time. The unit of time may be an hour, a day, a week, a month or more than that,
i.e. quarter of a year, half year or a year. Taking into consideration the time
worked by a worker and the rate pre-determined for the time unit the remuneration
payable to him is calculated. If a worker is paid at R 8 per hour and if he has
Advanced Cost Accounting - II
3
Methods of Remuneration
worked for 8 hours in a day, according to the time rate method his remuneration
for the day will be 8 hours x ` 8 per hour = ` 64.
Time rate method is a simple and easy to understand method and it is
regarded as a suitable method under the following situations :-
NOTES
1.
When the work is such that the quantity of work cannot be exactly and
accurately measured.
2.
When the quality of work is more important than the quantity produced,
e.g. In case of an artistic painting the quality of painting is more important
and the artist may take a few days or a few weeks to complete the painting.
3.
When the nature of work is such that the outcome of the work cannot be
seen or shown. Watchman or security man working in a factory or mall
does his work but cannot show how much work he has done. Therefore, he
is paid remuneration on time rate basis only.
4.
A worker completing a certain stage in the process of production, he cannot
decide the quantity which he can produce. His work is dependent upon the
flow of the process and the speed of his predecessor and successer worker.
Time rate becomes a suitable method of remuneration in such case.
5.
When the work to be done needs more intelligence and thinking than the
physical energy time rate method of remuneration is the proper method. An
employee drafting a report or a mechanic who has to repair a machine by
finding out the fault in it cannot decide how much time they will need for
their work.
6.
When the quantity of work of the workers is governed by the speed of the
machine and the speed cannot be altered by the workers, they should be
paid remuneration on time rate basis.
Advantages of time rate method :
4
Advanced Cost Accounting - II
1.
It is simple to understand and easy to calculate wages.
2.
As workers are paid wages on the basis of time and not by counting quantity
of work done, the workers take proper time for completing all operations.
They avoid haste in doing the work and so quality of work is ensured in
this method.
3.
Guarantee of wages is provided to the workers. If the workers are present
for work they are paid for that time even though they may not be able to
work due to power failure, breakdown of machinery or an accident that
has taken place in the factory.
4.
Since workers operate the machines and equipment by taking proper
precautions and at proper speed, cost of repairs and maintenance is reduced
and the possibility of accident and injury to workers is minimised.
5.
Time rates can be fixed according to the nature, importance, responsibility
to be taken and skill and intelligence needed for different types of work.
Thus justice can be done in paying remuneration to different grades of
workers. Senior and experienced workers get more remuneration because
of their seniority, increments and promotions. This helps in reducing labour
turnover in the concern.
Methods of Remuneration
Disadvantages of time rate method :
1.
Wages are paid on the basis of time and not by considering the quantity of
work done. As a result of this there is no encouragement provided to the
workers to increase their productivity.
2.
If an average worker and efficient worker are doing the same type of work
and work for the same time they get the same amount of wages even
though the quantity of work done by the efficient worker is more in quantity
compared to work done by the average worker. The efficient worker
therefore, either joins another concern which rewards his efficiency by
paying him on piece-rate basis or he also tends to reduce the quantity
produced. Both these things affect the concern adversely.
3.
Labour cost per unit increase in time rate of wages. Wages paid remain
the same for a certain time but if output produced in that time reduces the
labour cost per unit of product increase and competitive strength of the
concern becomes less.
4.
As the workers get wages even for the idle time the workers develop the
tendency to increase idle time. They may not take proper care of the
machines used by them because breakdown of the machinery does not
reduce the amount of their wages. They may waste time in chit-chatting,
visiting the canteen etc. and if this is to be controlled strict and close
supervision arrangement will have to be made by the management.
NOTES
1.3.3 Piece rate method
Piece rate method which is also known as ‘piece-work rate’ or ‘payment
by results’ is a method in which the wages are paid to the workers according to
the quantity of work / output is completed by them. Per unit rate is fixed for each
type of output and the amount of wages payable to a worker is calculated by
multiplying the number of units produced and accepted by the piece-rate applicable
to him. The piece-rate may be stated as per unit, per kg. per square-foot, per
brass etc. according to the nature of the output. Thus if the piece- rate is fixed for
a painter at `70 per brass of coloring and if the painter has colored 8 brass of
a wall in 3 days, his remuneration for 3 days will be calculated as 8 brass x `70
per brass = ` 560.
Piece-rate method is found suitable in the following situations :1.
Work is standardised and can be measured easily and accurately.
2.
Where worker can increase his output by using his skill and efficiency.
3.
Work performed is of repeatitive nature.
Advanced Cost Accounting - II
5
Methods of Remuneration
4.
Where standard time for doing work can be decided accurately.
5.
Where encouragement is to be provided to the workers to increase their
productivity.
Advantages of piece rate method :
NOTES
Check Your Progress
i)
What is the meaning of
‘remuneration’ ?
1.
As wages are paid on the basis of unit of production, the direct labour cost
remains same and is known in advance.
2.
Efficient workers get more amount of wages according to more quantity
produced by them. This gives encouragement to the workers to increase
their efficiency still further.
3.
Piece-rate method is easy to understand and simple to operate.
4.
Amount of idle time is reduced because the workers concentrate on their
work and try to increase their output. They do not waste their time in
unnecessary activities.
5.
Workers take proper care of their tools and machines because they know
that breakdown of tools and machines will result in stoppage of production
and reduction in their wage amount.
6.
Efficient workers earn more wages while inefficient workers earn less
wages. So inefficient workers leave their jobs and join another concern
which pays wages on time rate method. Thus efficient workers only are
retained in the concern.
7.
When output increase due to piece-rate wages, the proportionate amount
of fixed costs incurred on time basis is spread over a larger quantity thus
beginning down the fixed costs per unit of production. This helps in reducing
the cost of production per unit.
Disadvantages of piece rate method :
1.
In this method remuneration of a worker depends on the quantity of work
done by him. With the objective of increasing his remuneration the worker
may try to increase his output without taking rest and this adversely affects
his health.
2.
Fixation of a correct piece-rate per unit is a difficult task. A lot of time and
motion studies will have to be conducted before it is fixed. If the rate is
fixed high it becomes difficult for the management to lower it subsequently
as this will create conflict between workers and management.
3.
There is no guaranteed wage payable to workers under this method. Due
to any reason if the output of the worker reduces in any period, remuneration
of the worker also decreases and it may be insufficient to satisfy even the
basic requirements of the worker and his family.
4.
To increase his output the worker may use his tools and machines in a
reckless manner. This increase wear and tear of the machine and tools and
ii) Which are the main
methods of remuneration?
iii) Which factors should be
considered
selecting
method of remuneration ?
iv) How Time Rate Method is
applied ? State advantages
and disadvantages of the
Time Rate Method.
v ) What is the meaning of
‘price-rate Method’ ? What
are the advantages and
disadvantages of the Piecerate Method ?
6
Advanced Cost Accounting - II
increase expenditure on repairs and maintenance. Risk of accident also
increases in such situation.
5.
Due attention may not be given by workers to the specifications and quality
of the product. Loss due to defective production, spoilage and wastage of
materials takes place and the cost of production of good units increases.
6.
Workers receive different amounts of remuneration as per the quantity of
work done by them and this may cause riv. among the workers and the
trade union may find it difficult to bring unity among them. There is, therefore,
opposition from the trade union leaders to the piece-rate remuneration
method.
7.
Management is required to make proper arrangements for inspection of the
units produced by the workers to make sure that the units are as per the
standard quality of the product fixed by it.
1.4
Methods of Remuneration
NOTES
Illustrations on Time Rate and Piece Rate
Methods
ILLUSTRATION 1
Three workers, A, B, and C work in a factory. They are paid wages on
time-rate basis
A
` 45 Per hour
B
` 40 per hour
C
` 50 per hour
In a week of the month in August, 2014 they have worked for following
hours :
A 40 hours, B 48 hours, C 42 hours. Assuming that the factory pays
dearness allowance of `200 per week to each worker, you are required to
calculate total wages payable to each worker for the week.
SOLUTION
Statements showing Total wages payable for a Week
Name of the
Hours Worked
Worker
Wage Rate
Wages
D.A.
Total
per hour
for the
per week
Wages
`
week
`
`
A
40
45
1800
200
2000
B
48
40
1920
200
2120
C
42
50
2100
200
2300
Advanced Cost Accounting - II
7
Methods of Remuneration
NOTES
ILLUSTRATION 2
In X Co. wages are paid to the workers on time-rate basis. In addition to
the basic wages they are paid Dearness Allowance of `350 per week each. The
employer contributes 8% basic wage to the Provident Fund of each worker and
Medical Allowance at 2 % of the basic wage of each worker.
Vilas has worked for 45 hours in a week and his wage rate is ` 20 per hour,
Calculate total amount payable to Vilas for the week and also calculate labour
cost per hour for him.
SOLUTION
`
Calculation of total amount payable to Vilas for the week
Basic wages for 45 hours @ ` 20 per hour
900
Add :
Dearness Allowance for the week
350
Add :
Employer’s Contribution to Provident Fund of
Add :
Vilas @ 8% of his basic wages
72
Medical Allowance @ 2% of basic wages
18
Total Wages `
1,340
Calculations of Labour Cost per hour :Vilas has worked for 45 hours in the week and labour cost incurred for
him amounts to ` 1,340 for that period
Labour cost per hour incurred for him
=
` 1340
45 hrs.
=
` 29.777
ILLUSTRATION 3
From the following details provided to you about a factory worker calculate
this wages (consisting of normal working and overtime working) for a week :
Day
Hours Worked
Day
Hours Worked
Monday
8
Friday
11
Tuesday
9
Saturday
6
Wednesday
10
Thursday
8
The factory follows a week of 6 days and except on Saturday daily hours
of work are 8 and on Saturday the working hours are 4.
The hourly rate of wages is `10 per hour during the normal hours of work
and overtime rate is the normal rate for 9th hour and double the normal rate if a
worker works on a day for more than 9 hours or upto 48 hours in a week at the
normal rate and beyond 48 hours at double the normal rate, whichever is more
beneficial to the worker.
8
Advanced Cost Accounting - II
Methods of Remuneration
SOLUTION
Day
Hours
Normal Wages
Over Time
Overtime
Worked
for the day
Hours At
Hours At
@ ` 10 per
Single Rate
Double Rate
Wages
`
hour `
Monday
8
80
-
-
-
Tuesday
9
80
1
-
10
Wednesday
10
80
1
1
30
Thursday
8
80
-
-
-
Friday
11
80
1
2
50
Saturday
6
40
1
1
30
Total
52
440
4
4
120
Total wages for the week
NOTES
= Normal wages + Overtime wages
= ` 440 + ` 120
= ` 560
As per alternative available to the worker :For 48 hours at single rate of ` 10 per hour
= ` 480
Overtime for 4 hours at double rate of ` 20 per hour
= ` 80
Total Wages
= ` 560
The worker receives total wages of ` 560 for the week under both the
alternatives and so his total weekly wages are ` 560
ILLUSTRATION 4
Workers X and Y do the work of manufacturing a certain component of a
machine. They work individually and are paid on piece- rate basis which is fixed
at `4 per piece manufactured by them. In a week X has produced 130 components
and Y has produced 138 components, calculate amount of wages payable to X
and Y for the week
.
SOLUTION
Amount of wages under piece- rate method is calculated as under :Wages = No. of units produced x Piece–rate wage
X has produced 130 components in the week
Wages payable to X
= 130 components x `4
= ` 520
Advanced Cost Accounting - II
9
Methods of Remuneration
Y has produced 138 components in the week
Wages payable to Y = 138 components x ` 4
= ` 552
NOTES
ILLUSTRATION 5
In an assembly shop of an engineering concern four workers A, B, C and
D work together as a group and are paid on group piece-rate at ` 4 per unit for
the units produced by the group. They also work on other jobs for remaining hours
and are paid on time rate basis which is as follows :A - ` 2 , B - ` 3 , C - ` 4 and D ` 4
In a week of 44 hours, the hours spent for group work by the four workers
are as under :A - 40, B - 40, C - 30 and D - 20
In the week, the group has produced 150 units. Calculate total weekly
earnings of each worker taking into consideration their individual relative
efficiencies.
SOLUTION
Statement showing calculation of weekly earnings
A
B
C
D
Hours spent on group work
40
40
30
20
Hours spent on individual jobs
4
4
14
24
Total hours worked in the week
44
44
44
44
Hourly rate for individual jobs
`2
`3
`4
`4
Time rate wages for individual jobs
`8
` 12
` 56
` 96
ratio of 2 : 3 : 3 : 2
` 120
` 180
` 180
` 120
Total earnings for the week
` 128
` 192
` 236
` 216
Share in group wages for
150 units at ` 4 per unit in the
Working Notes
1)
It is mentioned in the problem that group earnings should be divided among
the four workers by taking into consideration their individual relative efficiencies
Hourly rate for individual jobs done by A, B, C, and D is not same. A is paid `2, B
is paid ` 3, C – ` 4, and D is paid ` 4 per hour. The difference in the hourly rate
indicates their relative efficiency. But the hours spent for group work are also
different for these four workers. So the individual relative efficiency and hours
spent for the group work by each worker are both to be considered for dividing
the group wages of ` 600 ( 150 units x 4 per units).
10
Advanced Cost Accounting - II
Methods of Remuneration
The ratio for dividing group wages is worked out as under :Worker
Hourly Rate in `
Hour Worked
A
40
x
2
=
80
B
40
x
3
=
120
C
30
x
4
=
120
D
20
x
4
=
80
NOTES
Group Wages of ` 600 are divided in the ration of 80 :120:120:80 i.e. 2:3:3:2
among A, B, C, and D respectively
Thus, A’s Share = ` 600 x 2 /10
=
`
120
B’s Share = ` 600 x 3 /10
=
`
180
C’s Share = ` 600 x 3 /10
=
`
180
D’s Share = ` 600 x 2 /10
=
`
120
2) Alternatively, the weekly earnings of A, B, C and D can be calculated as
Under :`
Group Wages for 150 units @ ` 4 per unit
Less :
600
Individual Wages :A 40 hrs x ` 2
=
`
80
B 40 hrs x ` 3
=
`
120
C 30 hrs x ` 4
=
`
120
D 20 hrs x ` 4
=
`
80
Group Bonus
=
400
200
Distribution of group bonus of `200 among A, B, C, D in the ratio of their
individual wages of 80 : 120 : 120 : 80 i.e. 2 : 3 : 3 : 2 is done.
So, A’s Share of Group Bonus
= ` 200 x 2 /10 = ` 40
B’s Share of Group Bonus
= ` 200 x 3 /10 = ` 60
C’s Share of Group Bonus
= ` 200 x 3 /10 = ` 60
D’s Share of Group Bonus
= ` 200 x 2 /10 = ` 40
Statement showing calculations of weekly earnings
Name of the Worker
Time wages for group work
Time wages for individual jobs
Share in Group Bonus
Total earnings for the week
A
B
C
D
`
`
`
`
80
120
120
80
8
12
56
96
40
60
60
40
128
192
236
216
Advanced Cost Accounting - II
11
Methods of Remuneration
NOTES
1.5
Summary
Remuneration is the reward for the work done by the employees. For the
workers employeed to work in the factory the remuneration paid is known as
wages. Wages paid to direct workers who perform the work of manufacturing by
mixing, heating, cutting, shaping, moulding or by operating machines in the factory
are treated as ‘direct wages’ and are included in the calculations of the prime cost
of a product or job or operation or process. Wages paid to indirect workers are
called ‘indirect wages’ and they are included in the amount of factory / production
overheads. Remuneration paid to other employees who work in office or sales
department are called salaries and they are treated as office overheads or selling
and distribution overheads depending upon work performed by them in office or
sales department, wages are paid for physical labour and skills used by the workers
in performing work assigned to them by the owner or management of the industrial
concern.
There are two basic methods of paying wages to workers. First method is
‘Time Rate Method’ and second method is ‘Piece-rate Method’. In time rate
method wages are calculated on the basis of time unit which may be hour, day,
week, fortnight or month. Wages are calculated for the time for which the workers
were present and the wage rate is different for different categories of workers.
In time rate wages depend upon the time and wage rete applicable to a worker
and output or quantity of work done by a worker is not taken into consideration. A
piece-rate implies rate of wage per piece or unit and according to the quantity of
work done by a worker his wages are calculated for that quantity. For each type
of production work, a separate piece- rate has to be decided in advance.
1.6
i)
Time Rate Method : It is the oldest method of remunerating workers and
wage rate is fixed with reference to time unit which may be an hour, day,
week, fort night, month, wages are calculated by considering the wage rate
applicable to the worker and the time for which the worker has worked.
ii)
Piece Rate Method : It is a method of remuneration and wage rate is
fixed for a unit, price, job, quantity or weight of a product. Remuneration of
a worker is calculated by considering the piece-rate applicable to him and
the pieces or quantity produced by him.
1.7
12
Advanced Cost Accounting - II
Key Terms
Questions & Exercises
A)
Theory Questions :
1.
What are the essential features of a good wage method ?
2.
Explain Time Rate Method of remuneration stating advantages and
disadvantages of it ?
3.
What do you mean by Piece-rate method of remuneration ? Under which
situation it becomes suitable ?
4.
Explain Piece - Rate Method of remuneration and state advantages and
disadvantages of it.
B)
Multiple Choice Questions
1.
Efficient ------- booking help to minimise idle time.
Methods of Remuneration
NOTES
(a) time
(b) wage
(c) work
(d) activity
2.
Under piece rate system, there is always -------- of income
(a) fixed rate
(b) uncertainty
(c) certainty
(d) no change
3.
Under piece wage system due to careless handling -------- of machinery
increases substantially.
(a) wear & tear
(b) appreciation
(c) fixed cost
(d) cost
4.
‘The work which demands high degree of skill.’ A -------- system is more
suitable.
(a) Time-rate
(b) piece rate
(c) minimum rate
(d) part time work
Ans. : (1 - a), (2 - b), (3 - a), (4 - a).
Advanced Cost Accounting - II
13
Methods of Remuneration
C)
Exercises
1.
Calculate the normal and overtime wages payable to a workman from the
following data :
Days
NOTES
Hours Worked
Monday
8
Tuesday
10
Wednesday
Thursday
9
11
Friday
9
Saturday
4
Normal Working Hours : 8 hours per day
Normal Rate
: 50 paise per hour
Overtime Rate
: Upto 9 hours in a day at single rate and over
9 hours in a day at double rate
or
upto 48 hours in a week at a single rate and
over 48 hours at double rate, whichever is
more beneficial to the workman.
2.
A factory pays wages to its workers on time rate basis. The time rate of
wage is ` 12 per hour. It also pays Dearness Allowance to each worker at
the rate of ` 300 per week. In a week ending on 31st December, four
workers, P, Q, R, and S have worked as indicated below :P 44 hours
R 45 hours
Q 42 hours
S 48 hours
You are required to calculate amount of wages payable to each worker
and also the total amount payable to each of the four workers.
3.
In a company wages are paid to workers on straight piece rate basis. The
piece- rate fixed is ` 7.50 per unit produced. In May, 2014, Parag has
produced 370 units and Santosh has produced 350 units. The company
pays Dearness Allowance to each worker at a fixed rate of ` 1200 per
month and Medical Allowance of ` 150 per worker per month.
Calculate : i) Wages payable to Parag and Santosh, and
ii) Total earnings of Parag and Santosh for the Month of May, 2014
4.
14
Advanced Cost Accounting - II
In a factory four workers A, B, C, and D work as a group and they are paid
` 3 per article as wages for the articles produced by the group. In a week
of 42 hours the group has produced 278 articles and for this production they
have worked for following hours in the group :
A
20 Hours
B
30 Hours
C
40 Hours
D
42 Hours
The remaining hours in the week are spent by them for working on
individual jobs for which the factory pays them on time rate basis. The time
rates for them are as under :A
` 6 per hour
B
` 5 per hour
C
` 4 per hour
D
` 3 per hour
Methods of Remuneration
NOTES
Calculate the earnings of each worker separately for the group work
and also for individual jobs performed by them. Group wages are to be
divided among the workers by taking into consideration their individual relative
efficiency.
1.8
Further Reading
i)
‘Cost Accounting’ - Jawahar Lal
ii)
‘Cost Accounting’ - Principles and Practice’ - N. K. Prasad
ii)
‘Cost Accounting’ - B. K. Bhar
iv)
‘Advanced Cost Accounting’ - Nigam and Sharma
Advanced Cost Accounting - II
15
Unit 2
Incentive Plans
Incentive Plans
Structure
2.0
Introduction
2.1
Unit Objectives
2.2
Incentive Plans : meaning and necessity
2.3
Different incentive plans
2.3.1
Halsey incentive plan
2.3.2
Halsey – weir incentive plan
2.3.3
Rowan incentive plan
2.3.4
Taylor’s differential wage rate system
2.3.5
Emerson’s incentive plan
2.4
Summary
2.5
Key Terms
2.6
Questions and Exercises
2.7
Further Reading
2.0
NOTES
Introduction
In the previous Unit, you have studied the basic method of remuneration,
viz. Time Rate Method and Piece-rate Method. In this Unit information is provided
regarding some incentive plans and how total wages including basic wages and
bonus payable to workers are calculated. Incentives plans are introduced by the
owners of industrial concerns to encourage the workers to increase their efficiency
and productivity. Total wages received by workers, to whom incentives plans are
applicable, are more than the amount of wages they would have received under
straight time rate method or straight piece-rate method of remuneration. Information
provided in this unit helps to understand how the amount of incentive/ bonus payable
to workers is calculated under each incentive plan.
2.1
Unit Objectives
Study of information provided in this Unit should enable you to understand :
•
Meaning and necessity of incentive plans;
•
Different incentive plans in existence, and
Advanced Cost Accounting - II
17
Incentive Plans
•
2.2
How calculations of incentive amount is done under each incentive wage
plan.
Incentive Plans : Meaning and Necessity
NOTES
Incentive wage plan means a wage plan adopted by the owner or
management of an industrial concern according to which it is agreed that workers
will be paid an extra amount of wage in addition to the amount of basic wage
calculated under time rate method or piece rate method applied in the concern.
When worker produces a product in less than the standard time allowed to him, he
saves some time and uses it for producing extra units of the product. Thus he
helps the owner to obtain more output in the same time and by selling the extra
output the owner earns additional amount of profit. This becomes possible because
of more efficiency shown by the worker and he appreciates this efficiency by
sharing the benefit with the worker. Incentive wage plans give encouragement to
the workers to increase their efficiency and at the same time total earnings of the
workers also increase, thereby improving their financial position. If incentive wage
plans are not in existence, the efficient workers will find that they receive same
amount of wages as are received by less efficient workers working with them. In
such situation one of the following two things will happen :i)
Efficient workers will become disinterested in maintaining and increasing
their efficiency.
ii)
Efficient workers will leave their present jobs and will join other concerns
which are implementing incentive wage plans for their workers.
Either of the above two alternative will cause loss to the present employer
because he will be having only less efficient workers working in his concern.
Output will reduce, labour cost per unit of output will increase and the employer
will find in difficult to sell his products in the competitive market.
2.3
Difference Incentive Plans
Incentive wage plans are possible under time rate method as well as under
piece-rate method of wages. Under time rate method, wage amount for time
saved is shared in different proportions by worker and owner. Accordingly incentive
plans under time rate method are as under :i)
Halsey Incentive Plan,
ii)
Halsey –Weir Incentive Plan,
iii)
Rowan Incentive Plan,
iv)
Emerson’s Incentive Plan.
Under piece-rate method, the incentive plans are as under :18
Advanced Cost Accounting - II
1)
Taylor’s differential wage rate plan,
2)
Gantt task and bonus plan.
[Gantt task and bonus plan is actually a combination of guaranteed time
rate, time rate plus bonus and a high piece-rate. Under Gantt task and bonus plan
a standard for each type of work is set based on careful time and motion study. A
worker who completes the work in standard time is regarded as 100% efficient. A
worker having efficiency below 100% is paid a guaranteed time rate wages. A
worker having 100 % efficiency is paid time rate wages plus a bonus of 20 % of
the time rate wages and a worker giving more than the standard output, he is paid
at the high piece- rate already fixed in advance.]
Incentive Plans
NOTES
Information about the incentive plans, the formulae to be used for calculating
total earnings under each incentive plan, advantages and disadvantages of the
incentive plan and illustrations showing calculation of total wages payable to
workers under the incentives plans is provided below.
2.3.1 Halsey incentive plan
This incentive plan was introduced by F. A. Halsey in 1891. Halsey was an
American engineer. In this plan a standard time is fixed for each job in advance.
A worker who completes the job in the fixed standard time or in more than the
standard time is paid time rate wages at a fixed time rate per hour. This guarantees
the worker that he will receive wages at guaranteed hourly rate for actual hours
worked by him. Since the worker has taken standard or more than standard time
it is obvious that he is not an efficient worker and so is not entitled to receive any
bonus or incentive wages. Incentive wages are given to the workers who complete
the job in less than the standard time. The amount of wages for the time saved by
the workers is the total benefit and this benefit is shared by the worker and the
employer. In Halsey incentive plan the sharing is done 50 -50 between the worker
and the employer though it may be changed in some concerns following this incentive
plan.
The amount of incentive received by a worker to whom Halsey incentive
plan is applicable is, thus 50 % of the wages for the time saved by him. He, of
course, receives his time wages for the actual hours worked by him, his total
wages can be calculated as follows :Total wages
=
Time actually worked x Time rate + 50% of wages
for the time saved
It can be put in a formula as under :TE
=
AH x HR + ½ (SH-AH) x HR
Where, TE
=
Total Earnings
AH
=
Actual Hours Worked
HR
=
Hourly Rate of Wages
SH
=
Standard Hours
Advanced Cost Accounting - II
19
Incentive Plans
NOTES
ILLUSTRATION 1
In KD factory workers are paid incentive according to Halsey Incentive
plan. For a particular job standard hours for completion are 50 hours and the wage
rate is `12 per hour. Worker Kiran has completed the job in 48 hours Bhima and
workers has completed the same job in 46 hours.
Calculate total earnings of Kiran and Bhima from the jobs.
SOLUTION
Standard time for the job
50 hours
Time rate of wages
` 12 per hour
Time taken by Kiran
48 hours
Time taken by Bhima
46 hours
Calculation of total earnings of Kiran :
TE
= AH x HR x ½ (SH – AH) x HR
= 48 x 12 + ½ ( 50-48) x 12
= 576 + ½ ( 2 x 12)
= 576 + 12
= ` 588
Calculation of total earnings of Bhima :
TE
= AH x HR x ½ (SH – AH) x HR
= 46 x 12 + ½ ( 50 - 46) x 12
= 552 + ½ ( 4 x 12)
= 552 + 24
= ` 576
It should become clear from the formula that the first part of calculations,
viz., AH x HR shows the normal wages for the actual hours worked by the
worker and the second part of calculations shown as addition is the amount of
incentive given to the worker.
The amount of total earnings of Kiran who has completed the job in 48
hours appear more than the total earnings of Bhima who has taken only 46 hour to
complete the job. An impression is likely to be created that more efficient worker
gets less amount of total earnings. But the impression is wrong because kiran’s
total earnings are for 48 hours of work while Bhima’s total earnings are for 46
hours. Kiran can spend remaining 2 hours on some other job and Bhima cab
spend 4 remaining hours on some other job and earn wages. If effective rate of
wage is calculated it is `588 / 48 hours = `12.25 for Kiran whereas for Bhima,
It comes to ` 576 / 46 hours = `12.52
20
Advanced Cost Accounting - II
Incentive Plans
ILLUSTRATION 2
In a factory standard time allowed for producing one unit is 3 hours. Basic
wage rate is `5 per hour worked and dearness allowance is `0.80 per hour
worked. Incentive payment is made to workers as per Halsey incentive plan. In a
working week of 48 hours, A worker has produced 20 units and B worker has
produced 18 units.
NOTES
Calculate the total earnings of A worker and B worker for the week.
SOLUTION
A worker has produced 20 units and the standard time allowed for these
units is 20 units x 3 hours per unit = 60 hours.
A has worked for 48 hours in the week.
Time saved by A worker = 60 hours – 48 hours = 12 hours
Calculation of the Total earning of A worker for the week
`
Basic wages for 48 hours x ` 5
=
240.00
Dearness allowance for 48 hours x `0.80
=
38.40
Incentive wages @ 50% of time saved which
=
30.00
=
308.40
are 12 hours (50% of `60)
Total Earnings of A worker for the week
B worker has produced 18 Units
 Standard time for 18 units x 3 hours
=
54 hours
=
6 hours
B worker has worked for 48 hours in the week.
So he has saved ( 54 hours – 48 hours)
Total Earnings of B worker :`
Basic wages for 48 hours x ` 5
=
240.00
Dearness allowance for 48 hours x `0.80
=
38.40
are 12 hours (50% of ` 30)
=
15.00
Total Earnings of B worker for the week
=
293.40
Incentive wages @ 50% of time saved which
Advanced Cost Accounting - II
21
Incentive Plans
NOTES
2.3.2 Halsey - Weir incentive plan :
This incentive plan is put forward by Mr. Halsey and Mr. Weir. It is similar
to Halsey incentive plan with the only difference in the sharing of the bonus.
Under Halsey plan, the amount of wages for time saved by a worker is shared by
the employer and the equally and so the worker receives incentive at 50% of
wages for the time saved by him. In Halsey Weir incentive plan the incentive
amount given to the worker is at 30% of wages for time saved by him. It means
the employer receives benefit at 70% of wages for the time saved by the worker.
For calculating total earnings of a worker under Halsey-Weir plan the formula
used is as under :E = T x R + 30% (S – T) x R
Where,
E = Total Earnings of worker
T = Time taken by worker to complete work
R = Time Rate of Wages
S = Standard Time allowed for completion of work.
ILLUSTRATION 3
In an industrial concern, Halsey-Weir incentive plan is followed for
calculating wages payable to workers. Standard time allowed for completion of a
certain job is 30 hours and the time wage rate is `5 per hour. Pravin has completed
the job in 26 hours .
Calculate his total earnings for the job.
SOLUTION
E = T x R + 30 % (S – T) x R
= 26 x 5 + 30% ( 30 -26 ) x 5
= 130 + 30 % (4) x 5
= 130 + 6
= ` 136
2.3.3 Rowan Incentive Plan
This incentive plan was introduced by James Rowan in Glasgow. This
incentive plan is also based on time rate of paying wages to workers. The bonus
or incentive wages are calculated by taking into consideration the time saved by
the worker but there is no fixed percentage as in case of Halsey premium plan. In
Rowan plan for calculating bonus the proportion of time saved to standard time is
calculated and bonus amount is the amount of wages for hours worked multiplied
22
Advanced Cost Accounting - II
Incentive Plans
by this percentage. This method of incentive also gives assurance of wages to the
worker for actual time worked by him at the time rate of wage.
Calculation of wages including incentive wages payable to a worker is done
as follows :-
NOTES
Time saved
Total Wages = Time worked x Time Rate +
x Time worked x Time Rate
Standard time
In formula form it can be stated as under :
(ST - AH)
TE
=
AH x HR +
x AH x HR
ST
Where,
TE
=
Total Earning
AH
=
Actual Hours worked
HR
=
Hourly Rate of wage
ST
=
Standard Time allowed
ILLUSTRATION 4
In a factory standard time allowed for doing a job is 50 hours. Hourly wage
rate is `10. Incentive wage plan applicable to the workers is Rowan incentive
wage. Harish has completed the job in 45 hours Kumar has taken 48 hours and
Sudhakar has completed it in 40 hours.
Calculate the total earnings of Harish, Kumar and Sudhakar, also calculate
the effective rate of earnings per hour for the three workers.
SOLUTION
Formula for calculating total earnings of a worker under Rowan Incentive
Plan :TE = AH x HR +
ST – AH
x AH x HR
ST
Where,
TE
= Total Earning
AH
= Actual Hours taken for doing the job
HR
= Hourly Rate of wage, and
ST
= Standard Time allowed for doing the job
Advanced Cost Accounting - II
23
Incentive Plans
Calculation of Total Earning of Harish
TE
NOTES
=
45 x 10 +
=
450 +
5
50 - 45
50
x 45 x 10
x 450
50
=
450 + 45
=
` 495
Effective Rate of Earning per hour
=
Total Earning
Actual hours worked
` 495
=
45 hours
=
` 11
Calculation of Total Earnings of Kumar
TE
= 48 x 10 +
50 - 48
x 48 x 10
50
2
= 480 +
x 480
10
= 480 + 19.20
= ` 499.20
` 499.20
Effective rate of earnings per hour for kumar
=
48
= ` 10.40
Calculations of Total earnings of Sudhakar :TE
= 40 x 10 +
50-40
x 40 x 10
50
= 400 +
1
5
x 400
= 400 + 80
= ` 480
Effective rate of earnings per hour for Sudharkar =
` 480
40 hours
24
Advanced Cost Accounting - II
= ` 12
Incentive Plans
ILLUSTRATION 5
Modern Electronics Company is a factory engaged in manufacturing various
electronics units. The Co. has 48 hours working in a week. For workers producing
a certain part time rate of wage is `12 per hour. Standard time for producing one
part is 40 minutes. A worker has worked for 48 hours in the week and has produced
90 parts all of which have been accepted by the company as good parts.
NOTES
Calculate total wages of the worker for the week under :
1)
Time Rate method of remuneration,
2)
Piece- rate method of remuneration,
3)
Halsey incentive plan, and
4)
Rowan incentive plan.
SOLUTION
1) Total wages under Time Rate Method :Total Wages
=
Hours worked x Hourly rate of wages
=
48 x 12
=
` 576
2) Total Wages under piece Rate Method :Standard time for producing one part is 40 minutes
60
1
 Standard output in 1 hour of working is
x 1 = 1 parts
40
2
Wages for 1 hour are ` 12
 Piece Rate of wages is ` 12 / 1 ½ parts = ` 8 per part
The worker has produced 90 parts in the week, so his
Total wages for the week = No. of parts produced x Piece Rate
= 90 x ` 8
= ` 720
3) Total wages under Halsey Incentive Plan :Standard time for 90 parts at 40 minutes per part is
90 x 40
= 60 hrs
60
Actual time taken by the worker for producing 90 parts is 48 hours. It
means the worker has saved 60 - 48 = 12 hours while producing the parts in the
week.
His total wages under Halsey Incentive Plan will be :TE = AH x HR + 50% ( ST – AH ) x HR
Advanced Cost Accounting - II
25
Incentive Plans
NOTES
=
48 x 12 + ½ (60-48) x 12
=
576 + ½ x 12 x 12
=
576 + 72
=
` 648
4. Total wages under Rowan Incentive Plan :TE = AH x HR +
ST – AH
x AH x HR
ST
=
48 x 12 +
60-48
x 48 x 12
60
=
576 + ( 1/ 5 x 576)
=
576 + 115.20
=
` 691.20
[ Note that the worker gets maximum amount of total wages under piece
rate method and minimum amount under time rate method because under piecerate he gets full benefit of his efficiency, does not receive any benefit under time
rate method and he shares the benefit with his employer under Halsey Incentive
Plan as well as Rowan Incentive Plan.]
Comparison between Halsey Incentive Plan and Rowan Incentive Plan :
i)
Under both these incentive plans time saved out of the standard time allowed
to the worker is considered for calculating bonus amount payable to the
worker. However in Halsey Plan bonus is equal to 50 % of wages for the
time saved while in Rowan Plan there is no such fixed percentage and
bonus amount is calculated by deciding the proportion of time saved to the
standard time and applying this proportion to the amount of wages of the
worker for the time worked by him.
ii)
Under Halsey plan when time saved by the worker is less than 50 % of the
standard time, the amount of bonus is less and bonus amount increase when
time saved starts increasing over 50 % of the standard time. In Rowan
plan the amount of bonus increase upto 50 % of the standard time saved by
the worker and when he saves more than 50 % of the standard time
allowed, the bonus amount goes on decreasing. When time saved by a
worker is 50% of the standard time allowed, the bonus amount receivable
by the worker under Halsey plan and Rowan plan is equal.
2.3.4 Taylor’s differential wage rate system
26
Advanced Cost Accounting - II
F. W. Taylor, the father of scientific management, has introduced this system
of wage payment. He fixed standard time or standard output on the basis of time
and motion studies carried out for each type of production work. Taylor believed
in penalising an inefficient worker and reward and efficient worker. So he suggested
two separate wage rates for payments of wages to the workers. The lower rate
of 80 % of the normal piece-rate or time rate is used for calculating wages of
workers whose efficiency is below 100% and the higher rate o f 120% of the
normal piece-rate or time rate is used for calculating wages of workers whose
efficiency is at a or above 100 %.
ILLUSTRATION 6
Incentive Plans
NOTES
In a factory standard output fixed for a day is 20 units and piece-rate is `
5 per unit. Workers are paid wage according to Taylor’s differential piece- rate
system.
In a day’s time X has produced 17 units, Y has produced 20 units and Z has
produced 24 units.
Calculate the amount of wages for X, Y, and Z.
SOLUTION
X worker has produced 17 units and the standard output is 20 units.
So X’s efficiency is
17
x 100 = 85%
20
X’s efficiency is below 100% and so he will be paid at lower piece- rate
which is 80% of ` 5 = ` 4 per unit
X’s wages
=
17 units x ` 4
=
` 68
Y has produced 20 units which are equal to the standard output. So Y will
be paid at higher piece rate which is 120 % of ` 5 = `6 per unit.
Y’s Wages =
=
20 units x ` 6
` 120
Z worker has produced 24 units which means his efficiency is
24
x 100 = 120%
20
Z’s efficiency is above 100% and so he will be paid wages at the higher
piece – rate of ` 6 per unit.
 Z’s wages = 24 units x ` 6
= ` 144
ILLUSTRATION 7
In Zed ltd. A manufacturing company standard time for producing one unit
is 30 minutes. The hourly rate of wage is `20.
Worker Prabhakar has worked for 6 hours on a day and has produced 10
Advanced Cost Accounting - II
27
Incentive Plans
units; worker Keshav has worked for 8 hours on the same day and has produced
18 units.
You are required to calculate wages payable to Prabhakar and Keshav
under following methods.:-
NOTES
i)
Time rate method,
ii).
Straight piece rate method, and
iii)
Taylor’s differential wage rate method.
SOLUTION
1. Time Rate Method :
Prabhakar has worked for 6 hours in day.
His wages for the day will be
= Hours worked x Hourly wage rate
= 6 hours x ` 20
= ` 120
Keshav has worked for 8 hours and so his wages for the day will be
= 8 hours x ` 12
= ` 96
2. Wages under straight piece–rate method :
standard time for producing one unit is 30 minutes.
so standard output in one hour is 2 units
For one hour wages paid amount to ` 20
Piece–rate wage is ` 20 ÷ 2 units = ` 10
Calculations of wages of Prabhakar :
Wages = Units produced x Piece-rate of wages
= 10 x ` 10
= ` 100
Calculations of wages of Keshav :
Wages = Units produced x Piece-rate of wages
= 18 x ` 10
= ` 180
28
Advanced Cost Accounting - II
3. Wages Under Taylor’s Differential Wage Rate Method :
Incentive Plans
Normal Piece – rate is `10 per unit.
A worker whose output is below the standard output is to be paid at a low
piece–rate which is 80 % of normal piece-rate and a worker who is able to produce
standard or above standard output is to be paid at high piece-rate i.e at 120 % of
normal piece rate.
NOTES
Calculations of wages of Prabhakar :
Prabhakar has worked for 6 hours and so the standard output for him is 12
units, But actual output of Prabhakar is only 10 units. His efficiency is below
100% and so he will be paid at 80 % of ` 10 = ` 8 per unit.
His wages
= 10 units x `8
= `80
Calculations of wages of Keshav :
Keshav has worked for 8 hours and so standard output for him is 16 units.
Actual output of keshav is 18 units which is more than the standard output. So
keshav will be paid wages at 120 % of normal piece–rate. Therefore he will be
paid wages at ` 12 per units.
His wages
= 18 units x ` 12
= ` 216
Advantages of Taylor’s Differential wage rate system :
i)
There is incentive provided to the efficient workers. Workers who have
efficiency at 100 % or more are paid wages at 120 % of the normal piecerate and so the workers try to increase their efficiency.
ii)
Workers having efficiency below 100% are paid at 80% of the normal
piece-rate and they are thus penalised. Once the inefficient workers becomes
aware of this. They will either try to bring up their efficiency upto 100 %
level or will leave their present employment and join some other concern
where Taylor’s differential wage rate method is not adopted for wage
payment.
iii)
Workers do not waste their time because the are interested in increasing
their output and so there is no need for strict supervision on them.
iv)
When more production is done the amount of fixed overheads is divided on
a larger number of units and thus per unit amount of fixed overheads and
thereby the cost of production per unit is reduced.
Disadvantages of Taylor’s Differential wage rate system
i)
There is no guaranteed amount of wages for the days work done by the
workers.
Advanced Cost Accounting - II
29
Incentive Plans
NOTES
Check Your Progress
i)
What do you Understand
by the term ‘Incentive
Plans’ ? Why incentive
plans are necessary ?
ii) Mention the incentive
plans you are studying in
this book ?
iii) Give the Formula for the
following plans :a) Halsey Incentive Plan,
b) Halsey
Pla n,
Weir
Incentive
c) Rowan Incentive Plans, and
d) Emerson’s Incentive Plan
e) Taylor’s Differential Wage
Pla n
ii)
The difference in the low piece-rate and high piece- rate is very wide
(40% of normal piece-rate ). The difference in the wages amount of efficient
and inefficient workers is a large one and this may cause discontent among
the inefficient workers.
iii)
Trade unions of workers dislike this method because unity of workers is
lost due to difference in the rate of which wages are paid to them.
2.3.5 Emerson’s Incentive Plan
In this incentive plan, which is introduced by Mr. Emerson, there is
combination of guaranteed time rate with incentive above certain percentage of
efficiency. For every job or operation a certain standard time is fixed. If the Job or
operation is completed by a worker in the standard time fixed for it, the efficiency
of the worker is regarded as 100%. A worker having efficiency below 66.67% is
given wages at the guaranteed time rate but no bonus. Bonus is payable from
66.67 % efficiency to 100% efficiency at pre-determined increasing percentage
in such a way that at 100% efficiency the worker receives 20% bonus. If efficiency
is above 100% the worker gets 1% additional bonus for every 1%, increase in
efficiency above 100%. It means if the actual efficiency of a worker is 125% he
will get 20% bonus for efficiency upto 100% and additional bonus of 25% since
his efficiency above 100% is 25%. Thus the worker will get this time rate wages
+ 45% of time rate wages as bonus amount. Workers achieving more than 100%
efficiency thus are benefitted and they need not be contended with the objective
of achieving 100% efficiency only.
ILLUSTRATION
In PQR company standard output fixed for a week 48 working hours is 200
units and time rate of wages is ` 20 per hour.
In a week of 48 hours working actual output of 3 workers A , B, C is as
under:A
120 Units
B
200 Units
C
220 Units
Assuming that Emerson’s efficiency plan is applicable to the workers,
calculate the total wages of A, B and C.
SOLUTION
In Emerson’s efficiency plan it is necessary to calculate the efficiency
percentage of each worker to decide whether he is eligible to get any bonus and
if he is eligible how much bonus he will get.
Standard output for 48 hours working is 200 units which is 100% efficiency
120 Units
 A’s efficiency
30
Advanced Cost Accounting - II
=
=
200 Units
60 %
x 100
Since A’s efficiency is below 66.67 % efficiency he will get only guaranteed
time rate wages but no bonus.
 A’s Total Wages
Incentive Plans
= Hours worked x Hourly time rate
= 48 hours x ` 20
= ` 960
NOTES
B has produced 200 units in 48 hours, therefore his efficiency is
=
200
x 100
200
=
100%
B will get his time rate wages plus 20% of time rate wages as bonus
 B’s Total Wages
= 48 x 20 + (20% of 48 x 20 )
= 960 + 20 % of 960
= 960 + 192
= ` 1152
C has produced 220 units in 48 hours.
220 units
x 100 = 110%.
C’s efficiency =
200 units
C will get his time rate wages + 20% bonus for efficiency upto 100% + 10%
bonus for efficiency exceeding 100% efficiency.
 C’s Total wages
= 48 x 20 + ( 30% of 48 x 20)
= 960 + 30% of 960
= 960 + 288
= ` 1248
2.4
Summary
Incentive plans have been introduced over a period of time by owners
and management of industrial concerns to give encouragement to their workers to
increase their efficiencies. When efficiency is increased by a worker he takes
less than the standard time allowed for completing a work or increases output
over expected quantity of output in the same time. In both these situations the
employer is benefitted because of reduction in the per unit cost or because of sale
of additional quantity produced by the efficient workers. Employer, therefore,
agrees to share the additional income with the efficient workers in a certain
proportion. The share given to the worker is the incentive wage amount as the
Advanced Cost Accounting - II
31
Incentive Plans
worker receives the incentive amount in addition to his normal wages. Sharing of
the benefit with the workers is done in different proportions and so there are
different incentive wage plans. Halsey incentive plan, Halsey–Weir incentive plan,
Rowan premium plan, Emerson’s incentive plan, Taylor’s differential wage rate
plan are some of the incentive wage plans which are discussed in this unit.
NOTES
2.5
Key Terms
i)
Incentive Wage Plan : It is a wage plan according to which the employer
agrees to pay an extra amount of wage to those workers who do the work
in less than the standard time allowed or who produce additional units as
compared to the number of units expected to be produced by them. This
extra wage amount is in addition to the basic time rate wages or basic
piece-rate wages payable to the worker.
ii)
Halsey Incentive Plan : It is an incentive plan according to which a worker
is paid basic wages for the actual time worked at the wage rate applicable
to him and additional wages for half of the time saved by him at his wage
rate.
1
2
(Standard Hours - Actual Hours) x Hourly Rate
 Total Earnings = Actual Hours x Hourly Rate +
iii)
Halsey Weir Incentive Plan : This Plan is similar to Halsey Incentive
Plan with the difference that the worker receives 30% of wages for time
saved as incentive amount instead of 50% amount received as incentive
amount under Halsey Incentive Plan.
Total Earning = T x R = 30% (S - T) x R
Where T =
iv)
Time worked by worker
R=
Rate of Time Wage
S =
Standard Time Allowed to worker
Rowan Incentive Plan :
Total Earnings = T x R = (S - T) x T x R
S
In this Incentive Plan the incentive amount is calculated by multiplying the
amount of wage for the time worked by the worker by the proportion of
time saved to standard time.
v)
Taylor’s Differential Wage Rate Plan :
Under this plan two separate wage rates are used for inefficient worker
and efficient worker. Low wage rate is applicable to the workers whose
efficiency is less than 100% and the worker rate of wage is 80% of the
normal rate. High wage rate is applicable to workers who have 100% or
32
Advanced Cost Accounting - II
more efficiency. The high wage rate is 120% of the normal wage rate.
vi)
Incentive Plans
Emerson’s Incentive Plan :
Efficiency upto 66.67% - Only guarnteed time rate wages but no bonus.
Efficiency at or above 66.67% upto 100% - Bonus is paid at 20%
Efficiency above 100% - Bonus of 20% for efficiency upto 100% plus 1%
bonus for every 1% increase in efficiency above 100% efficiency.
2.6
NOTES
Questions and Exercises
A)
Theory Questions
1.
What do you understand by ‘incentive wage plans’ ? Explain necessity
and importance of incentive wage plans ?
2.
Which are the incentive wage plans under time-rate method os remuneration?
Explain how sharing of benefit is done with the workers under these
incentive wage plan ?
3.
Compare ‘Halsey Incentive Plan’ with ‘Rowan incentive Plan’ in detail.
4.
Explain how total earnings of a worker are calculated under the following
incentive wage plans :a.
Halsey Incentive Plan,
b. Rowan Incentive Plan, and
c. Emerson’s Efficiency Bonus Plan.
5.
How wages of a worker are calculated under Taylor’s Differential Piece
Rate method of remuneration ?
6.
“Taylor’s Differential Piece Rate Plan penalises inefficient worker and
rewards more efficient worker”. Explain.
B)
Exercises
1.
Calculate the total earnings and the effective rate of earnings of a worker,
Sensible, under Halsey Premium Plan 50% of time saved and Rowan Premium
Plan separately with the help of following information.
Time Allowed
-
90 Hours
Time Taken
-
72 Hours
Rate of Wages
-
` 25 per hours
Dearness Allowance
-
` 1.25 per hour
Advanced Cost Accounting - II
33
Incentive Plans
NOTES
2.
During one week the workman Trustworthy manufactured 200 articles. He
receives wages for guaranteed 44 hours week @ `1.50 per hour. The estimated
time to produce one article is 15 minute and under incentive scheme the time
allowed is increased by 20% . Calculate his Gross Wages under each of the
following methods of remuneration :
(i)
Time rate
(ii)
Piece Work with Guaranteed Weekly Wages
(iii)
Rowan Premium Bonus
(iv)
Halsey Premium Bonus, 50% to workman.
3.
The Standard Time fixed for a job is 40 hours and the wage rate is `40 per
hour. The worker is to get his normal rate for hours worked and half the normal
rate for hours saved. Material required for the job costs `800 and the work
overheads are charged on the basis of `60 per labour hour. Calculate the total
wages and effective rate of earnings per hour if the job is completed in
(A)
32 hours, and
(B)
24 hours
Also calculate the Job Cost in both the cases.
4.
With the help of the following information ascertain the wages payable to
M and N under Taylor’s Differential Piece Rate System.
Standard Time
10 units per hour
Normal wage rate
` 1 per hour
Differentials to be applied :
80% of Piece-rate when below standard
120% of Piece- rate when above standard
In a day of 8 hours M produced 60 units and N 100 units.
5.
From the following particulars you are required to calculate the weekly
earnings of a worker under :
i)
Straight Piece Rate
ii)
Taylor’s Differential Piece Rate
iii)
Halsey Premium Scheme (50% sharing ) and
iv)
Rowan Premium Scheme
Weekly Working Hours
Hourly Wage Rate
34
Advanced Cost Accounting - II
Normal Time Taken per Unit
48
`10
20 minutes
Normal Output per Week
120 units
Actual Output for the week
150 units
Incentive Plans
Taylor’s Differential Piece rate :80% of piece rate when output is below normal
120% of piece rate when output is at or above normal.
NOTES
6.
Honda Motor Cycles Ltd. Gurgaon has given you with the weekly report
of the two workers viz. Herdy and Sturdy. They get guaranteed wages of `10
per hour. Their payments are made on weekly basis consisting 48 hours .
Worker
Standard Time
House Worked
Per Unit
Units of
Output Made
Hardy
Half an Hour
48
110
Sturdy
Half an Hour
48
80
Calculate the amount payable under :
i)
Time Rate System
ii)
Piece Rate system
iii)
Piece Rate with Guaranteed Weekly Wages
iv)
Taylor’s Differential Piece Rate Plan
v)
Halsey Premium Plan
vi)
Rowan Premium Plan.
7.
Daily wage are rate guaranteed for a worker is ` 2 and the standard output
fixed for a week is 1,000 articles, representing 100% efficiency. The guaranteed
wage rate is paid without bonus to those workers who show efficiency upto 70%
of the standard. Beyond this, bonus is payable on graded scale in the fixed ratio to
the increased output as under :
Efficiency
Bonus
71% to 90%
10%
91% to 100%
20%
Further increase of 1% in the bonus is given for every 1 % increase in the
efficiency. Calculate the total earning of the following workers who have worked
for a week of 7 days.
Worker
Output ( Articles)
Virendra
500
Jitendra
950
Mahendra
1,000
Rajendra
1,200
Advanced Cost Accounting - II
35
Incentive Plans
C)
Multiple Choice Questions
1.
Halsey Premium Plan was introduced in ----------- in 1891.
(a) France
(b) U.K.
NOTES
(c) America
(d) England
2.
Under Halsey Plan the incentive is not strong enough to include ------workers to work hard.
(a) normal
(b) general
(c) efficient
(d) unskilled
3.
Under ----------- plan past performance is taken as the guidance for
determining the standard time for each job.
(a) Rowan premium
(b) Halsey premium
(c) Tailor premium
(d) incentive premium
4.
Under ---------- plan a less efficient and more efficient may get the same
amount of bonus.
(a) Halsey premium
(b) Rowan premium
(c) bonus
(d) Tailor premium
Ans. : (1 - c), (2 - c), (3 - a), (4 - b).
2.7
Further Reading
i) ‘Cost Accounting’ - Jawahar Lal
ii) ‘Advanced Cost Accounting’ - Nigam and Sharma
iii) ‘Cost Accounting - Principles and Practice - N. K. Prasad
36
Advanced Cost Accounting - II
Unit 3
Preparation of Wage-sheets and
Pay–rolls
Preparation of Wage sheets
and Pay-rolls
Structure
NOTES
3.0
Introduction
3.1
Unit Objectives
3.2
Wage-sheets and pay-rolls - meaning
3.3
Necessity and importance
3.4
Preparation of wage-sheets and pay-rolls
3.5
Types of frauds and their prevention
3.6
Control on labour cost
3.7
Summary
3.8
Key Terms
3.9
Questions
3.10 Further Reading
3.0
Introduction
In Unit 1 and 2 different aspects of labour costs have been described in
detail. In this Unit information about accounting of labour cost is provided. Though
total amount of wages payable to each worker and other employees is calculated,
it must be recorded in wage sheets and Pay Rolls and other allowances payable
to them, gross amount payable to each employee, deduction of various amounts
and net amount payable must be recorded in proper way. Preparation of wagesheets and pay-rolls is not dependent upon wish of the owner/employer but it is
an obligatory work to be done by the concern as per the provisions made in the
Payment of Wages Act and Minimum Wages Act. Such records provide evidence
about the remuneration paid to the employees. Whether the various calculations
regarding remuneration payable to employees have been correctly made and
disbursement of net amount payable to them has been properly done is verified by
the internal and external auditors and also by the Government officials appointed
for that work. Information about preparation of wage-sheets and pay-rolls and
disbursement of wage amount is provided in this unit.
Advanced Cost Accounting - II
37
Preparation of Wage sheets
and Pay-rolls
3.1
Unit Objectives
After studying the information given in this unit, you should be able to
NOTES
•
Understand ruling of wage-sheets and pay-rolls;
•
Know how information is recorded in the columns;
•
Understand types of frauds that can be committed in the work of preparation
of records and disbursement of wages; and
•
Understand care to be taken to prevent the frauds.
3.2
Wage-sheets and Pay-rolls - Meaning
Wage-sheets and pay-rolls are the documents which are prepared to record
names of workers and employees, duration for which wages and remuneration is
payable to them, amount of basic wages for that period and amounts of allowances
of various types, amount of incentive or bonus payable to the employee, gross
amount of wages of remuneration, amount of deductions made from total earnings,
net amount payable to employee and signature of the employee for checking the
correctness of calculations shown against his name and for receipt of the net
amount of remuneration. Wage-sheets are generally prepared for a week or a
depending upon the practice followed in each concern. Wage-sheets are in the
form of loose sheets while pay-rolls for other employees are in the form of a
register or a bound volume.
3.3
Necessity and Importance
Wage-sheets and pay-rolls are required to be prepared as they provide
information in written form about employees to whom remuneration has been
paid, calculations related to basic remuneration and others allowances to which
they are entitled, deductions made from gross remuneration amount and net amount
of remuneration which has been paid to them. These records enable the workers
to check correctness of the amount being paid to them as remuneration for the
work performed by them. They also provide evidence, as required by the provisions
of the Payment of Wages Act and the Minimum Wages Act, about fulfillment of
these provisions by the employer. These records are therefore, preserved for a
long period of time.
38
Advanced Cost Accounting - II
The wage-sheets and pay-rolls are necessary to be prepared for recording
information in the financial accounts of the concern. The Accounts Department
comes to know the total amount required for payment of net remuneration if such
payment is to be made in cash to the employees. Similarly information also becomes
available regarding deduction made from the remuneration of the employees for
employee’s contribution to the provident funds, insurance premiums, income-tax,
repayment of loans taken by the employees from the banks or other financial
institutions, etc. and on the basis of this information arrangement can be made for
sending the deducted amounts to the appropriate authorities.
Information available from the wage- sheets is also necessary for costing
purposes. Costing Department uses it for calculation of direct wages, indirect
wages and indirect expenses i.e. overheads etc. Calculation of the labour cost
becomes possible by using the information recorded in the wage-sheets and payrolls. For comparing labour cost over a certain period and for estimating labour
cost for the future period, the information from wage-sheets and pay-rolls proves
necessary.
3.4
Preparation of Wage sheets
and Pay-rolls
NOTES
Preparation of Wage-sheets and Pay-rolls
The work of preparation of wage sheets and pay rolls and the actual payment
or disbursement of wages is generally entrusted to a separate department which
is called ‘payroll department’. The employees working in this department have to
collect the basic documents such as clock-cards, daily or weekly time sheets, job
cards or other similar documents which are used for time keeping and time booking
of the workers. The department prepares a list of all the workers by classifying
the workers department wise and recording name, token/ticket number of the
employee, basic wage rate (on time basis or on piece-rate basis) of the worker.
On the basis of the recording shown in the time keeping and time booking
documents received by it, the time worked by the employee is calculated and
recorded against the name of the employee. Hours of normal working and overtime
working are shown against the name of employee and the rates at which wages
are calculated for normal hours and overtime hours, if mentioned. If the worker
is entitled to get any bonus or incentive payment it is also shown in the appropriate
column. Amounts to be paid for allowances such as dearness allowance, travelling
allowance, house rent allowance, etc. and the amounts payable for them are also
recorded and the total of all these amounts is shown as the gross wages amount.
Deductions made from the amount of gross wages of the worker are shown
under section of ‘deductions’ having columns for each item of deduction and total
amount of deduction. Items of deduction are worker’s contribution to his Provident
Fund, Employee’s State Insurance (E.S.I.), Income tax, recovery of advance or
loan from the worker, fines to be paid by the worker, etc. Net wages payable to
the worker is calculated by deducting total amount of deductions from the gross
wages amount of the worker and the net wages amount is shown in ‘net wages’
column. If the wages are to be paid in cash, there is a last column in the wage
sheet / payroll for obtaining signature of the worker as a proof of payment of
wages made to him.
A specimen of wages sheet / pay roll is given below :-
Advanced Cost Accounting - II
39
e dar G
et a R
. o N ne ko T
e ma N
. o N. r S
Checked by ------------------------
Prepared by ------------------------
l at o T
Hours worked
e ma N
Particular of Workers
Other
Allowances
Earnings
s uno B
Department --------------------------
em
it r e v O
Gross
Wages
Wage Sheet / Payroll
. I. S. E
. F. P
em
it r e v O
Advanced Cost Accounting - II
xa T e moc nI
40
. A. D
Total
Net Signature of
Deduction Wages Workers
Payments made by ---------------
Others
Deductions
For the period -----------------
NOTES
f o yr e voce R
s ec na vd A/ s na o L
--------------------------------- Company Ltd.
Preparation of Wage sheets
and Pay-rolls
l a mr o N
3.5
Types of Frauds and Their Prevention
Preparation of Wage sheets
and Pay-rolls
Persons who prepare the wage sheets / payrolls and who make the payment
of net wages to the workers have opportunities to commit frauds. These frauds
can be of following types :
1.
Inclusion of non-existing workers (also known as ‘dummy’ or ‘ghost’
workers) in the wage sheets or pay rolls and arranging to obtain the net
wages amount of such workers. The amount is shared by persons who are
partners in such fraudulent activities.
2.
Showing absent workers as present for work and claiming wage amounts
for no work done and deceiving the employer.
3.
Claiming wages at a higher rate than the actual rate applicable to some
workers. The difference due to calculation of wages at higher rate is either
totally pocketed by the person who has committed the fraud or it is shared
with the workers whose wage rate is fraudulently increased.
4.
Making changes in the figure of ‘hours worked’ and increasing total number
of hours worked, thereby receiving wages for hours not worked.
5.
Showing bonus amount as payable to workers when actually no bonus is
payable to them.
6.
Paying less cash than the amount of net wages due to workers and obtaining
their signatures for the net wages received by bringing pressure on the
workers.
NOTES
To prevent such fraudulent activities in preparation of wage sheets and
actual disbursement of wages to the workers the management should not allot the
work of preparation, checking and cash payment for net wages to the same persons.
When X has prepared the wage sheet, Y should be asked to check the information
shown in the wage sheets and Z should be given the responsibility of paying cash
to the workers. Each person should be asked to sign for the work done by him.
Internal checks are thus created in this entire work and unless all of them agree
to commit fraud it cannot be committed. Supervisors or foreman should be asked
to certify the hours of work recorded by the workers working under them. This
will prevent the tendency among the workers to show more hours as worked
than the actual hours worked by them and also absent workers cannot be shown
as present for the work. The costing department should be instructed to prepare
and submit to the management reports about labour cost for a specific period and
if the labour cost shows wide variation the reasons due to which the variation has
taken place should be enquired into.
While doing the disbursement of the wages payable to the workers, the
person making the payment should do so only after proper identification of each
and every worker. If disbursement is done in each department the foreman in the
department can identify the workers working under him and the possibility of
paying wages to a wrong person can avoided. Wages of a worker should not be
Advanced Cost Accounting - II
41
Preparation of Wage sheets
and Pay-rolls
given to another person unless the has been duly authorized to collect wage
amount by the absentee worker.
3.6 Control on Labour Cost
NOTES
Check Your Progress
i)
What is the meaning of
Wage-sheets and Payrolls ? Why they are
Prepared ?
ii) What is Responsible for
preparation of wagesheets and Pay-rolls ?
What information is
record in them ?
iii) How frauds can be
committed
in
preparation of wagesheets and pay rolls ?
iv) What care should be
taken to prevent frauds
in wage-sheets and payrolls ?
v ) In order to control
labour cost, to which
factors you will give
attention ?
42
Advanced Cost Accounting - II
Labour cost includes remuneration paid to direct and indirect workers, cost
incurred for providing fringe benefits, cost incurred for providing various welfare
facilities to the workers and cost incurred on departments such as personnel
department, time- keeping and time- booking departments and amount spent for
training the workers and for maintainiing various records and reports related to
the labour activities. Since labour cost forms a large portion of the total cost of
production, it is necessary to keep proper control on the labour cost. The objective
of exercising control on the labour cost is to reduce the labour cost per unit of
goods produced and not reducing the wage rate per hour. While controlling the
labour cost, it should be remembered that labour is human factor having mind,
body and emotions and feelings. Labour reacts to the type of treatment given by
the management. It is also a perishable factor since labour not used for some time
is last for that time and it cannot be stored like material and labour unutilised for
some period results in idle time and cost of idle time increases the labour cost.
For exercising effective control on labour cost attention should be given
to the following points :1.
There should be proper production planning and on the basis of it the number
of labourers and the type of labourers should be correctly decided.
2.
According to the nature of work expected to be performed by the workers,
selection of the properly qualified and skilled workers should be done.
3.
Selected workers should be given necessary training which will enable them
to do the work efficiently and without any wastage of time and other
resources.
4.
Standard time should be set for each type of work on the basis of workstudy, time- study and motion study. At periodic intervals, the actual labour
time and cost should be compared with the standard time and standard
labour cost and variance reports should be prepared and sent to the
management. The management can find out the causes of the variance and
can take appropriate action for controlling the labour cost.
5.
Fixation of the wage-rates should be done in a proper way so that the
workers will feel that they are paid just wages according to the work
performed by them. Use of incentive schemes should also be done so that
the workers will take interest in increasing their productivity. The wagerates should be so fixed that efficient workers will be attracted to the
organization and due to more volume of work done by them the per unit
labour cost can be reduced.
6.
Proper records should be maintained of the attendance time (time keeping)
and of the actual time used for production (time booking) which will enable
the management to avoid payment of wages to absent workers, reduce the
idle time and minimize the amount of overtime work. All this will help in
controlling the labour cost.
7.
3.7
Frauds committed in preparation of wage sheets and pay rolls and in actual
disbursement of wages should be eliminated by making provisions for strict
insepection of work related to prepration of wage-sheets and payment of
wages.
Preparation of Wage sheets
and Pay-rolls
NOTES
Summary
Wage-sheets and pay-rolls are the records prepared by the Pay-roll
Department or Accounts Department showing remuneration payable to
employees who performed the work in a certain period of time such as a week or
a month. Remuneration paid in the form of wages to direct and indirect workers
are generally recorded in the ‘wage-sheets’ while remuneration paid to other
employees as salaries is recorded in the ‘pay-rolls’. Prepration and preservation
of wage-sheets and pay-rolls is a legal responsibility of the employer. Wage-sheets
have a number of columns in which information is recorded about basic wage,
other allowances payable to the worker, incentive wage amount or bonus payable
to the worker, gross amount payable to him, various deductions made from the
gross amount of the worker, total amount of deduction, net amount payable to him
and signature of the worker for receipt of the net amount.
Information recorded in the wage-sheet and pay roll is checked by the
employee so he knows how calculations are made and net amount of remuneration
is arrived at. Such information is used for doing financial accounting and it can be
used by the Costing Departments for calculations of labour cost and for comparison
of labour cost over a period to find out whether it has gone up or it has been
reduced. Estimation of labour cost in the future also becomes possible by using
information provided be wage-sheets and pay-rolls.
By recording false information in the wage-sheets and pay-rolls ghost
employees may be created and in the name of the ghost employees remuneration
can be claimed and such amount can be pocketed. Also more amount of
remuneration than what is actually due to the worker may be recorded in the
wage-sheets or pay-rolls and this extra amount is shared by the employees involved
in the fraud. To prevent such frauds, the work of prepration of the wage-sheets
checking the correctness of the calculations recorded in the wage-sheets and the
work of disbursement of wages should be entrusted to different persons from the
pay-roll or Accounts Department and actual cash equal to net earnings should be
to the worker after due identification of the worker by his supervision or foreman.
Efforts should be made for controlling labour cost right from the steps of
deciding exact number of workers required, selection of right type of workers,
providing them proper training, making arrangements for time keeping and time
booking, selecting a proper method of remuneration and incentive wage plan to
Advanced Cost Accounting - II
43
Preparation of Wage sheets
and Pay-rolls
NOTES
give encouragement to the workers to increase their efficiency and productivity
and providing amenities to them, making arrangement to supervise their work and
by reducing idle time and the rate of labour turnover and labour absenteeism.
3.8
Key Terms
i)
Wage-Sheet : Wage-sheet is a document prepared to record names of
workers, details of period for which wages and allowances, incentive wages
and bonus payble to the worker, details of deducations made from this gross
wage amount, net wage amount payble and signature of the worker of
correctness and reciept of the net wage amount.
ii)
Pay Roll : It is a register in which details of remuneration payble and paid
are recorded for each employee other than the factory workers.
3.9
Questions
(a)
Theory Questions
1.
What is a ‘wage-sheet’? Why it is necessary ? What is the importance of
wage-sheets and pay-rolls ?
2.
Give a specimen of ‘wage-sheet’ and explain nature of information recorded
in a wage-sheet.
3.
Who prepares wage-sheet and pay-rolls ? What is the procedure followed
while preparing wage-sheets and pay-rolls ?
4.
How are wage-sheets and pay-rolls prepared ? What precautions should
be taken to prevent frauds in this work ?
5.
Explain the procedure followed in preparation of wage-sheets and actual
payment of wages to workers.
6.
Which type of frauds may be committed while preparing wage-sheets and
actual disbursement of wages to workers ? How such frauds can be
prevented ?
(b)
Multiple Choice Questions
(1)
Inclusion of non-existing workers in the wage sheet is an example of -----(a) good practices
(b) fair wage system
(c) fraud
(d) allocation of work
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Advanced Cost Accounting - II
(2)
Pay-roll provide ---------- as required by provisions of the Payment of Wages
Act.
Preparation of Wage sheets
and Pay-rolls
(a) oral information
(b) evidence
(c) people source
NOTES
(d) payment of dividend
(3)
Information in wage-sheet is preserved for a --------- period of time.
(a) long
(b) short
(c) no
(d) very short
(4)
The wage-sheet and pay-rolls are necessary to be prepared for recording
information in the ----------- accounts of the concern.
(a) cost
(b) management
(c) financial
(d) control
Ans. : (1 - c), (2 - b), (3 - a), (4 - c).
3.10 Further Reading
1.
‘Cost and Management Accounting’ - M.N. Arora - Published by Himalaya
Publishing house
2.
‘Theory and practice of Cost Accounting’ - M.L.Agarwal - Published by
Sahitya Bhawan, Agra
3.
‘Cost Accounting’ – Jawahar Lal - Published by Tata Mc Graw – Hill
Publishing Co. Ltd.
4.
‘Advanced Cost Accounting – Nigam and Sharma - Published by Himalaya
Publishing House.
Advanced Cost Accounting - II
45
TOPIC 2
Expenses
UNIT 4
Meaning and Definition
Unit 4
Expenses : Meaning and Definition
Meaning & Definition
Structure
4.0
Introduction
4.1
Unit Objectives
4.2
Expenses - meaning and definition
4.3
Types of Expenses
NOTES
4.3.1 Direct expenses
4.3.2 Indirect expenses
4.4
Summary
4.5
Key Terms
4.6
Questions and Exercises
4.7
Further Reading
4.0
Introduction
In previous units, while giving information about elements of cost it was
mentioned that there are three element of cost, viz. material cost, labour cost
and expenses. We have studied information in detail about material cost and
labour cost upto now. In this Unit, we will consider information about the third
element cost i.e expenses. Like the first two elements of cost the third elements
of cost is also divided into two parts - direct and indirect. Both these parts form
a significant proportion in the total cost of the product manufactured, a job
completed, an operation carried out, a process completed and a service rendered.
So careful study of expenses with a view to reduce the cost and offer our
product or service at a competitive price has become necessary. In this Unit,
we shall study only direct expenses.
4.1
Unit Objectives
After studying the information given in this unit, you should be able to :
•
Understand meaning of expenses;
•
Know definition of expenses;
•
Know items included under the heading of direct expenses, and
•
Know treatment given to direct expenses in costing.
Advanced Cost Accounting - II
47
Meaning & Definition
NOTES
4.2
Meaning and Definition
Expenses form the third element of cost. Expense is the cost incurred other
than material cost and labour cost. It is incurred for obtaining and using services
required for running the business activity. For example, to carry on manufacturing
activity a sheltered and protected premise is needed and the owner who provides
such premise expects payments in cash from the business concern for a certain
period and at the agreed rate. This amount paid or agreed to be paid is known as
‘rent’ and it is an item of expense. There are many such expenses as carriage or
transport charges, insurance premium, electricity charges etc. and they are required
to be incurred for obtaining services used for carrying on the business activity
smoothly.
Definition of expenses :
The term ‘expense’ is defined by I.C.M.A. as “The cost of services provided
to an undertaking and the notional cost of the use of owned assets”.
When a business concern contructs a building to be used for office work it
creates an asset. The office building provides service for a certain period and
therefore the business concerns provides depreciation on the office building. The
amount of depreciation provided on office building (which is an owned assets) is
an expense. Expenses are, therefore, described as expired assets. The capacity
to provide service in the future is reduced because the life of building is reduced
due to its use and in this sense the amount of depreciation on office building is the
expired asset and is termed as an expense.
4.3
Types of Expenses
Just as the elements of material cost an labour cost are divided into direct
and indirect parts, the third element of expenses is alos divided into two parts –
direct expenses and indirect expenses. These two types of expenses are decided
by considering whether they are exclusively incureed for a product, job, process
or an operation or they have been incurred as common expenses for different
products, jobs, processes or operations. If it is easy and convenient to establish
direct relationship between amount of expense and output or job completed or a
particular process or specific operation, such expense is termed as direct expense
and when it cannot be easily and conveninently established. It is regarded as an
indirect expense type.
4.3.1 Direct Expenses
Direct expenses which are also known as ‘chargeable expenses’ are those
expenses which are directly indentified with a particular product, job, process or
operation. These expenses are specially incurred for a certain product or job or
process or operation. The relationship between the expense and the product, job,
operation or process can be directly and easily established and so these expenses
48
Advanced Cost Accounting - II
Meaning & Definition
are those items of expenses (other than direct material and direct labour) which
can be allocated to a certain product or a particular job or process or an operation;
e.g. hire charges of a machine or special tools which are to be used for only a
particular job can be fully allocated to that particular job and so such expenses
becomes a direct expenses. Other items of direct expenses are as under :i)
Cost of patents rights for a specific product.
ii)
Cost of patterns, drawings or designs specifically prepared for a specific
job and which cannot be used for any other job;
iii)
Charges paid to an advertising agency for advertising a specific product.
iv)
Freight or carriage expenses for materials purchased for a particular job or
contract;
v)
Research or experimental expenses related to a particular work-order;
vi)
Cost of operating a machine used on a particular job or a particular contract;
vii)
Royalties paid or payable to the owners of mines or authors of literary
work;
viii)
Travelling expenses incurred for securing a particular contract.
NOTES
Direct Expenses are added to direct materials cost and direct labour cost to
find out the prime cost.
4.3.2 Indirect expenses
Expenses which are not direct expenses are known as indirect expenses.
These are the costs incurred for use of services necessary to carry on the activity
of production, office and administration and selling and distribution of goods
produced or services to be provided to customers. Indirect expenses may be
those for which actual cash payment is required to be made or they may be
national type of expenses i.e. services available form owned assets and cash
payments is not required to be made. The indirect expenses may be incurred in
the factory, in the office and in the sales department; e.g. rent paid for factory
building, hire charges paid or payable for factory machinery, factory lighting charges,
papers and other items of stationary purchased for use in the factory are indirect
expenses incurred for factory work. Similarly office insurance premium, office
rent, office stationery expenses, depreciation and maintenance expenses of office
furniture are indirect expenses incurred for office work and advertising expenses,
travelling expenses of salesmen, stationery expenses incurred for selling and
distribution department, rent of sales department, fuel expenses of delivery vans
are examples of indirect expenses incurred for sales activity.
Amount of indirect material cost, indirect labour cost and indirect expenses
incurred for factory are added together to determine the total amount of factory
or production overheads and when this total amount of factory or production
overheads and when this total amount is added to the prime cost, the amount of
factory/works cost becomes available. To the factory cost when the amount of
Check Your Progress
i)
Give
definition
of
‘expenses’. Explains its
meaning.
ii) Distinguish between ‘direct
expenses’ and ‘indirect
expenses’.
iii) State the examples of
‘direct expenses’.
iv) How direct expenses are
treated in costing ?
v ) Which items are included
in indirect expenses ?
Advanced Cost Accounting - II
49
Meaning & Definition
office and administrative overheads (calculated by adding indirect material cost,
indirect labour cost and indirect expenses incurred of office) is added the cost of
production is determined. When total amount of indirect material cost, indirect
labour cost and indirect expenses incurred for selling and distribution activity is
added to cost of production, the cost of sales/total cost is found out.
NOTES
4.4 Summary
Expenses is the third element of cost. A business concern is required to
provide certain services for running the business smoothly. Owner or management
of the concern has to pay cash to those who provide these services to the business
concern. Except payment made for material and labour, all others payments made
for material and labour, all other payments are regarded as expenses. When
relationship between an expense and output, Job order, process or an operation
can be easily and directly established, such expense is called ‘direct expense’. A
direct expense is exclusively incurred for a particular product, job, process, order
or operation. Total amount of direct expenses is added to direct material cost
and direct wages in order to calculate ‘prime cost’. When a relationship between
an expense incurred cannot be directly and easily established with a particular
product, job, process, order or operation that expense is called as ‘indirect expense’.
An indirect expense is, therefore, incurred as a common expense for more than
one product, or job, process, order or operation. Amount of an indirect expense is
therefore divided or distributed among all the products, jobs, processes, orders or
operations which have received benefit from the indirect expenses.
4.5
i)
Expenses : It is the third element of costs. Expenses is the expenditure
incurred or notional expenditure other than materials cost and labour cost,
for carrying on the business activity.
ii)
Direct Expenses : Expenses which can be directly and easily related to a
product, service, job, process, contract or an operation are termed as direct
expenses.
iii)
Indirect Expenses : Expenses which cannot be easily and conveniently
related to a product, service, job, process, contract or an operation and
which are commonly incurred for two or more items are called as indirect
expenses.
4.5
50
Advanced Cost Accounting - II
Key Terms
Questions
(a)
Theory Questions
1.
Define the term ‘expense’. Why expenses are incurred ? What is
difference between direct expense and indirect expense ?
2.
Expain direct expenses and indirect expenses by giving examples of both
these types.
(b)
Multiple Choice Questions
1)
Direct Expenses which are also known as ----------- expenses.
Meaning & Definition
NOTES
(a) chargeable
(b) daily
(c) fixed
(d) secondary
2)
“Cost of patents rights for a specific product” is a --------- expenses.
(a) indirect
(b) direct
(c) unknown
(d) recurring
3)
“Travelling expenses of salesmen” is a ---------- expenses.
(a) fixed
(b) current
(c) indirect
(d) prime
4)
The cost of services provided to an undertaking and the national cost of the
use of owned assets is known as ---------(a) income
(b) expenses
(c) depreciation
(d) sales
Ans. : (1 - a), (2 - b), (3 - c), (4 - b).
4.6
Further Reading
i) ‘Cost Accounting’ - Jawahar Lal
ii) ‘Cost Accounting’ - Principles and Practice’ - N. K. Prasad.
iii) ‘Cost Accounting B. K. Bhar
iv) ‘Advanced Cost Accounting’ - Nigam and Sharma
Advanced Cost Accounting - II
51
Topic 3
Overheads
Unit 5
Classification Overheads
Unit 6
Collection and Codification
Unit 7
Allocation, Distribution and
Primary Distribution
Unit 8
Secondary Distribution of
Overheads
Unit 9
Absorption of Overheads,
Absorption of Factory Overheads
Unit 10
Absorption of Office and
Administration and Selling and
Distribution Overheads
Unit 11
Under and Over Absorption of
Overheads
Unit 12
Some Special Items of Overheads
Unit 5
Classification of Overheads
Classification of Overheads
Structure
5.0
Introduction
5.1
Unit Objectives
5.2
Meaning and definition of overheads
5.3
Classification of overheads – meaning and necessity
5.4
Methods of classification of overheads
5.4.1
Classification according to functions
5.4.2
Classification according to elements
5.4.3
Classification according to behavior or variablility
5.5
Summary
5.6
Key Terms
5.7
Questions
5.8
Further Reading
5.0
NOTES
Introduction
While providing the information about cost sheets in Unit 3, it was mentioned
that the total of direct materials cost, direct labour cost and direct expenses is
called as the Prime Cost and all indirect costs (made up of indirect materials cost,
indirect labour cost and indirect expenses) are added to the Prime cost in order to
find out the Factory cost, the Cost of Production and the Total Cost. In this Unit
we will consider information related to the indirect costs which are also known as
‘overheads’. Meaning and definitions of the term overheads and classification of
overheads by different methods is the information provided in this unit.
5.1
Unit Objectives
After studying the information given in this Unit you should be able to
understand :
•
Meaning of overheads;
•
How overheads are defined by different authorities;
•
Meaning and necessity of classification of overheads; and
•
Different methods used for classification of overheads.
Advanced Cost Accounting - II
53
Classification of Overheads
NOTES
5.2
Meaning and Definition of Overheads
The cost of materials, labour and expenses which cannot be directly and
easily related to a particular product or a particular job or a specific order or
a particular process or operation are the indirect costs or overheads. Indirect cost
are not exclusively and wholly incurred for a particular product or a particular job
or a particular order or a particular process or a particular operation but they are
incurred as common costs for two or more types of products or two or more
jobs, processes, orders or operations. Since the benefit of the indirect costs is
received by all of them, the amount of indirect costs is also required to be shared
by all of them and it cannot be charged fully only to one of them; e.g. when a
supervisor is supervising the work of A worker and B worker who are performing
two different jobs, the supervisor’s remuneration cannot be charged only to A’s
job or only to B’s job but it must be treated as indirect wages common to both the
jobs and will have to be divided between the two jobs by using some basis; so
supervisor’s wages become an item of overhead.
The CIMA of U.K. has defined overhead as “the aggregate of indirect
materials cost, indirect wages and indirect expenses.”
Wheldon has defined overhead as “ the cost of indirect materials, indirect
labour and such other expenses, including services, as cannot conveniently be
charged direct to specific cost units. Alternatively, overheads are all expenses
other than direct expenses.”
Bolcker and Weltmer in their book Cost Accounting have stated that
‘overheads costs are operating costs of a business enterprise which cannot be
traced directly to a particular unit of output.’
‘Burden’, ‘supplementary costs’, ‘indirect expense’, ‘manufacturing
expense’ are other terms used inplace of ‘overheads’. Howerver, the term
overheads is a better term as compared to other terms because the other terms
suggest that these costs are unnecessary costs or extra costs or costs which
come into existence due to inefficiency in the working of an enterprise. Similarly
use of the term ‘manufacturing expenses’ implies that these expenses are incurred
by only manufacturing concerns but overheads are incurred by manufacturing as
well as non- manufacturing business concerns.
In the present times the amount of overheads is almost equal to and in some
excess even more than the amount of the prime cost and so it has become
necessary for the management to pay proper attention to the overheads and try to
control the amount of overheads as much as possible.
54
Advanced Cost Accounting - II
5.3
Classification of Overheads - Meaning and
Necessity
Classification of overhead means grouping of overheads on the basis of a
selected factor according to the purpose to be achieved, e.g. if the management
wants to know which items of overheads can be controlled by it, overheads will
have to be classified on the basis of their behavior. If the management wants to
know costs incurred at different stages after calculation of the prime cost, the
overheads should be classified on the basis of functions, such as factory overheads,
office and administration overheads and selling and distribution overheads.
Classification of Overheads
NOTES
It is necessary to classify overheads because then only the information
related to overheads becomes relevant and understandable. If amounts of all
overheads are put before management, it will merely create chaos. The cost
accountant has to take into consideration the purpose of the management and
what the management wants to find out from the overheads and then accordingly
he should do the classification of overheads. Comparison of overhead amounts
over a period will also become possible only when they are put into various groups
in a systematic manner.
5.4
Methods of Classification of Overheads
Classification of overheads means grouping of overheads on the basis of
a selected factor according to the purpose to be achieved. The classification of
overheads is done according to the following methods :1.
Classification of overheads on the basis of functions,
2.
Classification of overheads on the basis of elements, and
3.
Classification of overheads on the basis of behaviour.
5.4.1 Classification according to functions :
In a manufacturing concern generally the functions performed are production
or manufacturing, administration and selling and distribution. Accordingly the
overheads are classified into following three categories :i)
Production or Manufacturing overheads.
ii)
Office and administration overheads and
iii)
Selling and distribution overheads.
i) Production or manufacturing overheads
These overheads are also known as ‘factory overheads’ are ‘work
overheads’. These overheads are incurred for carrying on the function of production
of goods and they are incurred within the premises of factory which is also known
as the ‘work’. Production overheads include indirect materials cost, indirect wages
Advanced Cost Accounting - II
55
Classification of Overheads
NOTES
and indirect expenses which are necessary for the production work and which
cannot be directly related to a particular unit of product. Production overheads
includes all costs from the stage of procurement of materials till the completion of
the finished product. Items of overheads / production overheads include the
following :Indirect materials such as lubricating materials, oils, welding materials, saop
and detergents used for washing and cleaning of the factory premises, paints for
colouring the factory building, small items of materials such as screws, nuts and
bolts, washers, etc.
Wages and salaries of factory security personnel, remuneration of foreman,
supervisors, staff of stores department, persons involved in the work of setting or
adjusting and repairing of plant, tools etc., salary of factory clerks, time-keepers,
inspection staff, etc.
Indirect expenses such as factory rent, factory rates and taxes, factory
insurance, factory light expenses, depreciation of factory building, depreciation of
plant and machinery, repairs and maintenance of machinery, tools , factory building,
cleaning charges of factory premises, motive power used for running plant and
machinery, factory canteen expenses, hire charges for machinery, factory telephone
expenses, etc.
ii) Office and administration overheads
Every business enterprise needs an office for the work of preparation and
implementation of policies and for maintaining various records related to the policies
framed, decisions taken and instructions given including the records of accounting
and financial matters. To perform the office and administration function the various
indirect costs which are incurred are included under the heading of office and
administration overheads include the indirect costs as mentioned below :Office salaries
Office rent or notional office rent if the office building is owned by the
enterprise.
Printing and stationary expenses
Office telephone expenses, postage expenses
Legal expenses
Depreciation of office building and office equipment
Depreciation and repairs and maintenance expenses of office furniture.
Accounting and audit expenses.
Office electricity and air conditioning expenses
General administration expenses
56
Advanced Cost Accounting - II
Bank charges.
iii) Selling and distribution overheads
For earning profit and becoming successful it is not sufficient for a business
enterprise to merely produce the goods properly; it earns profit only when it is
able to sell the products produced by it. For selling the goods it has to create
demand for the products and must become successful in fulfilling the demand.
This function of the business enterprise is known as the selling and distribution
function and all indirect costs incurred for performing this function are known as
selling and distribution overheads. Selling overheads are the overheads incurred
for giving information to the prospective customers about the products offered to
them and to induce them to place orders for the products. While distribution
overheads are overheads incurred for distribution of products and for giving delivery
of the products to the customers who have placed orders for them. A large
number of overheads are included under this heading, a few of them are mentioned
below :
Classification of Overheads
NOTES
Salaries and commission of salesman, travelling.
Salesman, sales manager and technical representatives.
Travelling expenses of salesman.
Advertising expenses- radio, t.v. and press advertising, hand bills,
hoardings etc.
Catalogues, price-lists, etc.
Show-room expenses.
Window-display expenses.
Rent, rates and taxes of sales office.
Cost of free samples.
Telephone and stationary expenses of sales department.
Market research expenses.
Carriage outward, running and maintenance expenses of delivery vans
and other vehicles used for transportation of finished products.
Packing charges and cost of packing materials.
Warehouse expenses incurred for storage of finished goods.
Loading and unloading expenses for finished goods.
Insurance expenses for goods-in-transit.
Wastage of finished goods.
Classification of overheads on the basis of functions helps in preparation of
cost sheet. After calculating the prime cost overheads are added as shown
below :
Advanced Cost Accounting - II
57
Classification of Overheads
Prime Cost
Add : Production Overheads
Factory Cost
Add : Office and administration overheads
NOTES
Cost of Production / General cost
Add : Selling and distribution overheads
Total cost / cost of sales
Add : Profit or deduct loss
Sales
5.4.2 Classification according to elements
According to the method of classification of overheads on the basis of
elements, overheads are divided in the following groups :i)
Indirect materials,
ii)
Indirect labour, and
iii)
Indirect expenses.
Thus nature of overhead and source of overhead is taken into consideration
while classifying the overheads. In the definition of overheads it is stated that
overheads are the aggregate of all indirect materials costs, indirect labour costs
and indirect expenses and the same basis of classification is used in this method.
Indirect materials may be used in any department and for any purpose or any
products but taking into consideration its nature and because it cannot be directly
related to a specific production unit, it is included in the group of indirect materials
cost. Same is true about indirect labour cost and indirect expenses. Items of
overheads included in each group are mentioned below:
i) Indirect Materials :
Consumable stores, lubricants, fuel and oils, small items of materials such
as screws, bolts, washers, stationery items, packing materials, cotton waste, small
tools, sundry materials.
ii) Indirect Labour :
58
Salary of security personnel, time- keepers, sweepers, stores personnel,
inspectors, quality control personnel, office clerks, supervisors and foreman, repairs
and maintenance staff, telephone operator, wages of coolies employed for carrying
and loading and unloading materials and finished products, electricians, employer’s
contribution to provident fund of employees, bonus given to workers and other
employees, subsidy given to employee’s canteen, holiday pay and leave pay of
workers and employees, salary and allowances of management persons, salary of
Advanced Cost Accounting - II
drivers of delivery vans, salary of salesman and other persons working in the
sales department and also of packers counters and other persons working in
distribution department etc.
Classification of Overheads
iii) Indirect Expenses :
Expenses which cannot be allocated but which have to be apportioned to
and absorbed by the cost units or cost centres are the indirect expenses and they
are included in the group of indirect expenses. They may be incurred in the
factory, office or sales department but being of the nature of indirect expenses
they are placed in the group of indirect expenses. Examples of indirect expenses
can be mentioned as under :-
NOTES
Rent, rates, taxes and insurance of factory building, office building, stores
and sales department
Electricity expenses
Water charges
Printing and stationery expenses
Depreciation of buildings, furniture, machinery etc.
Repairs and maintenance expenses
Telephone expenses
Carriage and transport expenses
Subsidy given to canteen run for the employees training expenses
Expenses incurred for cleaning of the premises
Postage expenses
Administration and management expenses
Selling and distribution expenses
Accounting and audit expenses.
5.4.3 Classification according to behaviour or variability
Under this method of classification behavior or variability of overheads
according to changes in the volume of output is considered and accordingly
overheads are classified as under :i)
Fixed overheads,
ii)
Variable overheads, and
iii)
Semi-variable / semi-fixed overheads.
i) Fixed overheads :
These overheads remain fixed or unchanged in the total amount and do not
Advanced Cost Accounting - II
59
Classification of Overheads
NOTES
increase or decrease in total even if volume of output is increased or decreased.
The amount of fixed overhead per unit of output however, changes or varies with
the change in the volume of output. When volume of output is increased the
amount of fixed overhead per unit of output decreases (because the fixed overhead
amount is divided over a larger quantity of output) and when the volume of output
is decreased, the amount of fixed overhead per unit of output increases (because
the same amount of fixed overhead is now divided over a smaller quantity of
output. Fixed overheads are not dependent upon the quantity produced but they
are dependent upon the period and so they are also called as periodic overhead.
Items of fixed overheads include overheads like rent of building, salary of
office, stores and sales department employees, depreciation on assets (when it is
charged on per annum basis), insurance charges of building , plant and machinery,
salary of factory foreman, salary of production, office and sales department (when
paid on the time basis), depreciation on delivery vans when it is provided on per
annum basis, salary of training staff etc.
ii) Variable Overheads :
Variable overheads are those overheads which vary directly with the volume
of output. When volume of output is increased the variable overheads increase
proportionately and when volume of output is decreased the variable overheads
decrease proportionately. This increase or decrease in the variable overhead is in
the total amount of overhead and the amount of overhead per unit remains constant,
e.g. indirect material which is a variable overhead is `15000 for 5000 units. If
production is increased to 7000 units the amount of indirect material will become
` 21000 and if output is reduced to 4000 units the amount indirect material will
become ` 12000. This is because the indirect material cost per unit of output is
`3. The amount of a variable overhead thus can be calculated by multiplying the
per unit amount of the overhead by the number of units to be produced. Examples
of variable overhead are given below :
Indirect material, fuel and power, commission of salesman, indirect labour,
stores expenses, cost of packing material, variable expenses of delivery vans,
repair cost of machinery and small tools etc.
iii) Semi-Variable / Semi-fixed Overheads :
These overheads are partly fixed and partly variable and so they increase
or decrease with changes in the volume of output but the change is disproportionate.
Certain amount of such overhead is fixed and so it remains same even if there is
fluctuation in the volume of output while the variable portion of such overhead
varies proportionately with the change in the volume of output. The total amount
of such overhead ( fixed amount + variable amount) therefore, shows a change
but such change in the total amount of the overhead is disproportionate. In case of
telephone bill, the amount of rent charged per month is fixed and the other part
varies proportionately according to the number of calls made by the user. So
telephone bill which is an item of overhead is an example of semi-variable overhead.
Other examples of semi-variable overheads are as under :-
60
Advanced Cost Accounting - II
Classification of Overheads
Factory supervisor’s salary
Depreciation
Repairs and maintenance of machinery, furniture and other equipment used
for production and office function.
Stores expenses
NOTES
Some items of semi-variable overheads remain constant upto a particular
volume of outpur and then they increase and increased amount of overhead again
remains constant upto a certain volume of output, They, in other words, show
increasing trend in a step-ladder way. When they are plotted on a graph paper
they appear as under :-
Overhead in `
Y
O
Units of output
X
Segregation of the semi-variable overhead amount in fixed overhead and
variable overhead is possible by using ‘High and Low Points Method’ and ‘Equation
Method’ under high and low points method the difference between high volume
quantity and low volume quantity is calculated. The difference between the semivariable overhead costs at high volume of output and low level of output is also
calculated. The difference in the amount of overhead indicates the amount of
variable overhead for the quantity of difference in the volume of output and from
this the variable overhead per unit can be found out. When the volume of output at
either low level of output or high level of output is multiplied by the variable overhead
per unit, the total amount of variable overhead can be found out. From the total
amount of semi-variable overhead at the high or low level of output, the
corresponding amount of the variable overhead is subtracted, the the balance
remaining is the amount of fixed overhead.
ILLUSTRATION
The following figures have been obtained from the costing records of a
manufacturing firm :Month
Output In Units
Semi- Variable Overhead
(`)
April
200
2000
May
300
2600
June
500
3800
July
600
4400
August
800
5600
September
1000
6800
Advanced Cost Accounting - II
61
Classification of Overheads
Using High and Low Points method segregate the amount of semi- variable
overhead into fixed and variable overhead for the six months.
SOLUTION
Highest Volume
1000 Units
Semi-variable overhead `6800
Lowest Volume
200 Units
Semi-Variable overhead `2000
800 Units
`4800
NOTES
Difference
It means variable overheads of 800 units amount to ` 4800
` 4800
Per unit variable overhead =
800 units
= `6
 At the lowest volume of 200 units variable overheads amount to

(200 units x `6) = `1200
Amount of semi-variable overhead for 200 units is `2000. If from this
amount of `2000 the variable overhead amount of `1200 is deducted the balance
of `800 is the amount of fixed overhead.
At the highest volume of 1000 units the semi-variable overhead amount to
` 6800. Out of this if variable overhead amount for 1000 units at `6 per unit is
deducted the balance remaining will be `6800 - (1000 units x `6) = `800 which
is the amount of fixed overhead for 1000 units.
The segregation of semi-variable overhead amounts for the given period of
6 months will be as under :Month
Volume of
Semi-variable
Variable
Fixed
Output in Units
Overhead (`)
overhead at
Overhead
`6 per unit
(`)
April
200
2000
1200
800
May
300
2600
1800
800
June
500
3800
3000
800
July
600
4400
3600
800
August
800
5600
4800
800
September
1000
6800
6000
800
For segregation of semi-variable overhead into fixed overhead and variable
overhead ‘equation method’ can also be used. Under this method two simultaneous
equations are formed by using the information of volume of output and the amount
of semi-variable overhead for two consecutive periods and by solving the equations
amount of variable overhead per unit of output is found out and by using this the
amount of fixed overhead for a period is calculated.
The equation is Y = mx + c
62
Advanced Cost Accounting - II
Where,
Y = Total amount of semi-variable overhead;
Classification of Overheads
m = variable overhead per unit of output;
x = volume of output and
c = amount of fixed overhead
Using the information for August and September given in the above
illustration, we can form the two equations as under :6800 = m x 1000 + c
(1)
5600 = m x 800 + c
(2)
NOTES
Substracting equation (2) from equation (1) we get the following ;1200 = m x 200

m
= `6
The amount of variable overhead is `6 per unit, putting this value in equation
(1) we get 6800 = 6 x 1000 + c

C = 6800 – 6000
= ` 800
The fixed overhead amount included in the semi variable overhead is `800.
The segregation of semi-variable overhead amount in the fixed overhead
and variable overhead is important for the management because by using this
information it can prepare flexiable budgets for different volumes of output and
can also decide the selling price per unit of the output level planned by it, which
will provide a desired amount of profit to the business enterprise.
5.5
Summary
Indirect materials cost, indirect labour costs and indirect expenses form the
overheads. The costs which are added to the prime cost are the indirect costs or
overheads. Overheads are the common cost incurred for two or more products,
jobs orders, processes or operations carried out by an industrial or a business
concern. Classification of overheads means grouping of overheads on a basis of a
selected factor according to the purpose to be achieved, e.g. to find out overheads
incurred in the factory during a certain period, all indirect materials costs, all indirect
labour costs and all indirect expenses incurred for the factory during the decided
period will be placed in one group and such group will be called ‘factory overheads’.
Overheads can be classified by different methods according to the
information to be obtained. The methods of classification of overheads are i)
functional classification, ii) elementwise classification, and iii) Classification on
the basis of behavior or variability. Under functional classification there are three
groups in which all overheads are divided. These three groups are :
i)
manufacturing or factory or production overheads,
Check Your Progress
i)
Explain the meaning of
‘Overheads’ and define
‘Overheads’.
ii) What you understand by
the term ‘classification
of overheads’ ? Why
such
classification
becomes necessary ?
iii) Which methods
available
classification
overheads ?
are
for
of
iv) Mention the groups in
which overheads are
classified under each of
the following methods of
classification
of
overheads :a) Classification on the
basis of functions
b) Classification on the
basis of elements
c) Classification on the
basis of behavior or
Variability.
Advanced Cost Accounting - II
63
Classification of Overheads
ii)
office and administration overheads, and
iii)
selling and distribution overheads.
Under elementwise classification all overheads are divided in following three
groups :-
NOTES
i)
Indirect Materials,
ii)
Indirect Labour, and
iii)
Indirect Expenses.
When overheads are classified on the basis of behavior or variability, all
overheads are grouped under following categories :-
5.6
i)
Fixed Variable,
ii)
Variable Overheads,
iii)
Semi – fixed or Semi-Variable overheads.
Key Terms
i)
Overheads : Overheads is the aggregate of indirect materials cost, indirect
wages and indirect expenses.
ii)
Classification Overheads : Classification of Overheads means grouping
of overheads on the basis of a selected factor.
5.7
Questions
(a) Theory Questions
64
Advanced Cost Accounting - II
1.
Define the term ‘Overheads’. Explain naure and importance of overheads.
2.
What do you understand by ‘classificatoin of overheads ‘? Why classification
of overheads is necessary ?
3.
State methods of classification of overheads. Briefly explain the groups of
overheads under each method of classification of overheads.
4.
Explain by giving examples the functional method of classification of
overheads.
5.
How classification of overheads is done on the basis of elements of cost ?
6.
Explain by giving examples how overheads are classified on the basis of
behavior or variability ?
7.
“In case of fixed overheads, the incidence per unit varies as per changes in
the volume of output, whereas the incidence per unit remains fixed even
though the volume of output is changed:” Explain.
Classification of Overheads
(b)
Multiple Choice Questions
1)
‘Overheads’ are also known as ---------- costs.
(a) ‘Supplementary’
(b) ‘direct’
NOTES
(c) ‘prime’
(d) ‘fixed’
2)
All ------------- are the costs but all costs may not be overheads.
(a) expenses
(b) incomes
(c) gains
(d) overheads
3)
Match the pairs.
Group I
(a) Production Overheads
Group II
i) Total cost
(b) Office & Administrative Overheads ii) Final keeper’s salary
(c) Selling & Distribution Expenses
iii) ‘Advertising’ expenses
(d) Indirect Labour
iv) Printing and stationary
expenses
v) ‘Factory Overheads’
Ans. (a) = (v); (b) = (iv); (c) = (iii); (d) = (ii).
4)
“Wages of coolies emplyed for carrying and loading and unloading material
of finished products” is ----------- expenses.
(a) direct labour
(b) indirect labour
(c) indirect materials
(d) indirect expenses
Ans. :
(1 - a), (2 - d), (4 - b).
5.8
Further Reading
i)
‘Advanced Cost Accounting’ - Nigam and Sharma
ii)
‘Cost Accounting’ - B. K. Bhar
iii)
‘Cost Accounting’ - Jawahar Lal
Advanced Cost Accounting - II
65
Unit 6
Collection and Codification
Collection & Codification
Structure
6.0
Introduction
6.1
Unit Objectives
6.2
Collection - meaning and sources
6.3
Codification of overheads
6.3.1
Meaning and necessity
6.3.2
Methods of codification of overheads
6.4
Summary
6.5
Key Terms
6.6
Questions
6.7
Further Reading
6.0
NOTES
Introduction
In the previous Unit 5, we have studied methods which can be used for
classification of overheads. But mere classification of overheads by using a method
of classification of overheads is not sufficient in itself. It is the objective of
calculating the amount of overheads incurred for each item of overheads so that
it can be included in the total cost of a product, job, process, order or operation.
Information about each item of overhead incurred is required to be found out from
the records and documents where the recording is made about that item of overhead.
In other words information about overhead incurred by the concern is required to
be collected from different sources where recording for overheads is done. This
is the first step in accounting and inclusion of overheads in the total cost of the
product, job, process, operation. In this unit collection and codification of overheads
are the two points about which information is provided.
6.1
Unit Objectives
After studying the information provided in this Unit you should be able to
know :
•
Why collection of overhead is necessary,
•
The sources from which information about overhead is collect,
•
Meaning of codification of overheads, and
•
Methods used for codification of overheads.
Advanced Cost Accounting - II
67
Collection & Codification
NOTES
6.2
Collection of Overheads – Meaning and
Sources
This is the first step in the accounting and distribution of overheads. After
the overheads are classified, for each item of overhead included in the group as
per the classification the amount incurred is required to be found out. For this
purpose information about the amount incurred for each item of overhead is found
out by using the sources and this activity is called collection of overheads. The
sources from which overheads can be collected are as under :i)
Purchase Journal and Invoices,
ii)
Stores Requisitions,
iii)
Wages Analysis Sheets,
iv)
Cash Book,
v)
Journal, and
vi)
Different Registers and Reports.
Let us briefly consider the items of overheads about which information
becomes available from the above mentioned sources.
i) Purchase Journal and Invoices
Purchase Journal provides information about items of indirect materials
purchased from the suppliers. From the invoices information about indirect expenses
cab be obtained.
ii) Store Requisitions
Store requisitions provide information about indirect materials for which
requisitions have been received from different department. Depending upon the
nature of the indirect materials requisitioned and the purpose for which it is to be
used the amount of the indirect material can be included under a specific overhead
and it can be recorded as incurred by the particular department. e.g. welding rods
requisitioned by the maintenance department is an item of overhead to be charged
to the repairs and maintenance department under the heading of indirect materials.
iii) Wages Analysis Sheets
They provide information about items of indirect labour overheads such as
overtime, incentive payment, night-shift allowance etc.
iv) Cash Book
68
Advanced Cost Accounting - II
Cash book records all cash transactions including cash payments made on
account of various indirect expenses. Thus amounts paid in cash for rent,
commission, advertising expenses, insurance, travelling expenses, printing expenses
and indirect materials purchased on cash basis etc. can be found out from the
recording made in the cash book. Care should be taken to see that these items of
overheads are not recorded in the sources mentioned above.
Collection & Codification
v) Journal
Information about notional expenses, adjustments, outstanding expenses,
depreciation provided on building, plant and machinery, furniture, office and other
equipment, wastage of materials and finished products, etc. can be obtained from
the Journal and collected under the appropriate heading of overheads.
NOTES
vi) Different Registers and Reports
Information about overheads such as depreciation can be collected from
the Plant and Machinery Register, Building Register and other registers. Similarly
information about waste, scrap and spoilage of materials and finished product, idle
labour time, idle machine capacity can be obtained from the reports prepared to
give information to the management persons.
6.3
Codification of Overheads
6.3.1 Meaning and Necessity
There are various items of overheads in a business enterprise and the similar
items of overheads are put under a group of overheads; e.g. indirect labour cost
incurred in the factory includes wages of factory gate-keepers, wages of sweepers
working in the factory, wages of electricians employed in the factory premises,
wages of persons doing the work of carrying and loading and unloading materials,
equipments and machinery etc. wages of persons doing coloring of the factory
building and many more of such items of indirect wages incurred in the working
of the factory. There are similarly indirect labour costs related to office work and
selling and distribution work. Costs incurred for each item of overhead is required
to be correctly collected and accounted for in the recording of overheads. Therefore,
instead of writing the name of overheads items and the heading of the overhead
group under which it is to be included, codification of all items of overheads is
done. Since each item or overhead is allotted a specific code the information of
costs incurred for various items of overheads do not get mixed up. Codification of
overheads also helps in remembering the items of overheads by their codes and
since codes are short the time required to write the names of overheads is reduced.
Codification also enables maintaining secrecy of overhead information as the codes
are known by only the persons doing the work of collecting and recording the
information about the overheads, other employees and outsiders cannot understand
anything about the information even if the coded information falls in their hands.
6.3.2
Methods of codification of overheads
For codification of overheads different methods are available and costing
department of a business enterprise can use any of them as per its requirements.
Following methods of codification are generally used :
Advanced Cost Accounting - II
69
Collection & Codification
a) Numerical codes
b) Alphabetical codes
c) Combination of numerical and alphabetical codes
NOTES
a) Numerical codes
In this method numbers are allotted to each item of overhead. In the simplest
form each item of overhead is given one number; e.g. 01 number means factory
manager’s salary, 02 means factory rent, 07 means oil and fuel, 215 means office
stationary. Another form of numerical codes is ‘number block’ under this method
a certain number blocks are used for similar items of overheads to be grouped
under one heading. The block numbers are allotted by taking into consideration
the present number of items of overheads and provision for future additional items
of overheads to be included under that heading, e.g. number 1 to 50 are block
numbers provided for items of overheads to be included under the heading of
factory indirect materials. So number 1 is allotted as a code number for fuel and
oil used in the factory, number 2 is for small tools used in the factory, etc. Out of
these 50 numbers at present only 32 numbers may have been allotted and 33 to 50
numbers may have been provided for future additional items of indirect materials
to be used in the factory.
If an enterprise follows mechanised accounting it has to make use of nine
digits codes for the items of overheads. The first two digits show whether the
item of overhead is fixed or variable. The next three digits indicate the head of
expense. The next two digits stands for analysis of the expenses for further subdivision and the last two digits show the cost centre which has incurred the expense,
e.g. code number 201250608 indicates ‘Fixed salary of Accounts department
incurred by the office’. In this code first two digits stands for fixed expense (20),
next three digit (125) indicate that it is ‘salary’ head of expense, next two digits
(06) show the analysis of expenses that it is the salary expense of ‘Accounts
department’ and the last two digits (08) show that the cost centre which has
incurred this overhead expense is ‘office’.
This nine digits numerical method used for overhead expenses is a better
method because of the following advantages provided by it :
70
Advanced Cost Accounting - II
1.
It provides complete details about the overhead expense since it indicates
that nature ( fixed or variable) of overhead expense, the head under which
the overhead expense is to be grouped, the analysis of the overhead expense
and the cost centre which has incurred that overhead expenses.
2.
Since there is no limit to the numbers, it can be used for any number of
overhead expenses.
3.
Mechanised accounting becomes possible with use of nine digits numerical
method and speed of doing accounting work is increased considerably.
Under numerical codes method there is one more way of using codes. This
is use of ‘Decimal Codes’. When decimal codes are used the whole number is
used for the heading of overhead expense and the decimal numbers indicate the
Collection & Codification
sub-groups. For example the whole number one may be used for Factory Overheads
and the decimal numbers after it may be used for the groups and sub-groups
under factory overheads. A few examples of decimal codes are given below:1.1
Means factory overheads indirect materials
1.1.1 Means brushes which is an item of indirect materials used in the factory.
NOTES
1.2.3 Means wages of supervisors which is an item of indirect labour grouped
under the factory overheads.
3.1.5 In which number 3 indicates selling overheads, decimal number 1 indicates
salary and 5 indicates Travelling Salesman.
3.4.1 Indicates window display expenses incurred for Advertising and grouped
under the heading Selling Overheads ( 3 means selling overheads, 4 means
Advertising and 1 means Window display expenses.)
This method of codification of overheads also provides required details about
the overheads expenses and since there is no limit to numbers it can accommodate
any number of items of overheads.
b) Alphabetical Method of Codification of overheads
Under this method of codification capital letters are used to denote the
heading under which the overhead expense it to be grouped and the small letters
are used to indicate name of the overheads expense. For Example :BL means Building Expenses
PM means Plant and Machinery Expenses
IM means Indirect Material Expenses
BL (a) Factory Building Expenses
Check Your Progress
BL (b) Office Building Expenses
i)
BL (c) Stores Building Expenses
Which sources are used for
collecting
overheads
information ?
BL (a) lh means Lighting and Heating expenses of Factory Building
ii) What is the meaning of
codification of overheads ?
IM (c) pk means packing Material Expense which is Indirect Material
Expense incurred in Stores Building.
iii) Mention the advantages
which become available due
to
codification
of
overheads.
c) Combination of Numerical and Alphabetical Codes
In this method Alphabets and numbers are used in combination for forming
a code for the overhead. Alphabets may indicate the heading of overheads expense
while the number written after alphabet indicates the sub-group of the overhead
expense. For example :
iv) Which methods can be used
for
codification
of
overheads ? Giving a few
examples,
show
how
codification of overheads is
done under the methods of
codification of overheads.
DP indicates Depreciation Expense of overhead
DP1 is a code for Depreciation Expense of Factory Plant
Advanced Cost Accounting - II
71
Collection & Codification
DP2 is a code for Depreciation Expense of Office Furniture
PT1 is a code for Printing Expenses of Office
PT3 is a code for Printing Expenses of Sales Office.
NOTES
6.4
Summary
In order to charge the overheads to products, jobs, orders, processes or
operation, it is necessary to find out the total amount of each item to overheads.
For this amount of overheads incurred and recorded for each item of overhead
is required to be found out and recorded under the name of that overhead. This
work of finding out and recording the amounts related to each overhead item is
known as ‘collection of overheads’. Without completing the work of collection of
overheads the work of accounting of overheads and charging of overheads cannot
begin and so collection of overheads is the first step in accounting for overheads.
Overheads are incurred at different sections, departments etc. and so
information about the overheads is recorded by concerned persons in different
registers, statements, reports, vouchers etc. and from these the amount of
overheads is required to be found and brought together. The sources from which
overheads information can be obtained are purchase journals and invoices, store
requisitions, wage analysis sheets, cash book, journals and different registers and
reports.
Codification of overheads means assigning and using a separate symbol
for each item of overheads. Instead of writing the name of the overheads account
the symbol may be a number, an alphabet or combination of both. Codification
saves time of persons since time spent in writing full name of overhead account is
more than writing the code of the overhead account, brings accuracy in collecting
the amount of overheads since use of codes results in recording information about
a particular overhead account to that account only and codification of overheads
also provides secrecy to information as persons who know the codes of overheads
accounts can only understand to which overhead account the information is related.
6.5
72
Advanced Cost Accounting - II
Key Terms
i)
Codification of Overheads : Codification of overheads is the work of
assigning a certain code to each item of overheads so that the code assigned
can be used inplace of the name of the overhead.
ii)
Numerical Code : Assigning a number to each item of overhead.
iii)
Alphabetical Code : Assigning a letter to each item of overhead. (Capital
and small letters can be assigned to each item of overhead and sub-item of
overhead.)
iv)
Combination of Numarical and Alphabetical codes : Combination of a
number and a letter is assigned as a code for each item of overheads.
6.7
Questions
Collection & Codification
(a) Theory Questions
1.
What do you mean by ‘collection of overheads’ ? Why collection of
overheads is necessary ?
2.
What is ‘collection of overheads’? What are the sources from which
information about overheads is collected ?
3.
Explain the concept of codification of overheads and describe the advantages
available from such codification
4.
Describe the methods of codification of overheads and explain how
codification is done under these methods.
NOTES
(b) Multiple Choice Questions
1)
Wages of persons doing colouring of the factory building are ------ wages.
(a) direct
(b) indirect
(c) primary
(d) fixed
2)
‘Codification’ enables maintaining ---------- of overhead information.
(a) books
(b) secrecy
(c) accounting
(d) presentation
3)
In ‘numerical codes’ method ---------- are allotted for each item of overheads.
(a) alphabets
(b) numbers
(c) pictures
(d) signs
4)
Codification of overheads means assigning and using a separate ----------for each item of overhead.
(a) symbol
(b) name
(c) number
Advanced Cost Accounting - II
73
Collection & Codification
(d) account
Ans. : (1 - b), (2 - b), (3 - b), (4 - a).
NOTES
74
Advanced Cost Accounting - II
6.8
Further Reading
i)
‘Cost Accounting’ - Jawahar Lal
ii)
‘Advanced Cost Accounting’ Nigam and Sharma
iii)
‘Cost Accounting’ - B. K. Bhar.
Unit 7
Allocation, Distribution and Primary
Distribution
Allocation, Distribution &
Primary Distribution
Structure
NOTES
7.0
Introduction
7.1
Unit Objectives
7.2
Stages in absorption of overheads
7.3
Allocation of overheads
7.4
Distribution of overheads
7.5
Primary distribution of overheads
7.6
Summary
7.7
Key Terms
7.8
Questions and Exercises
7.9
Further Reading
7.0
Introduction
In Unit 5 and 6 information about definition of overheads, classification of
overheads and collection and codification of overheads has been provided. The
amount of overheads is required to be charged to the output, jobs, processes,
orders, operations etc. for which the overheads are incurred. By charging the
overheads to the products , jobs etc. the total cost of the output or jobs performed
can be calculated. This is necessary for fixing the selling price of the products and
for quotating the job-price to earn the desired amount of profit. If the selling price
is already fixed, sales effected and total cost of products sold are compared to
decide profit earned or loss suffered during the specific period. However, before
charging the overheads some steps like departmentalisation of overheads, allocation
of overheads and secondary distribution of overheads have to be completed. In
this Unit information is provided about allocation of overheads and primary
distribution of overheads. The subsequent units will provide information about the
remaining steps.
7.1
Unit Objectives
After completing study of information given in this Unit, you should be able
to understand :Advanced Cost Accounting - II
75
Allocation, Distribution &
Primary Distribution
•
Meaning of allocation of overheads,
•
Meaning of distribution of overheads, and
•
How primary distribution of overheads is done by selecting appropriate
bases for different items of overheads.
NOTES
7.2
Stages in Absorption of Overheads
When the work of collection and codification of overheads is complete the
various overhead expenses are required to be recovered by including them in the
product costs to decide the total cost of a product unit and by deciding the selling
price per unit of the product. However this work is not simple. For doing this work
first step to be completed is deciding the number of production departments and
service departments. Then the various overheads are to be charged to these
production and service departments. This is done by allocation and apportionment
of overheads incurred for the concerned departments. The overheads of each
production and service department become available in the manner. This is known
as ‘departmentalisation of overheads’ or ‘primary distribution of overheads’. As
the service departments do not produce any product but render the service to the
production as well as other service departments, the overheads of service
departments are ultimately charged only to the production department. This
distribution of overheads of service departments among the production department
is known as ‘secondary distribution of overheads’. The total overheads of production
department are recovered from the output of the production department. This is
called ‘absorption of overheads’. The detailed information about these stages is to
be studied now.
7.3
Allocation of Overheads
Allocation means charging the entire amount of an overhead expenses to a
particular department for which it has been incurred. Allocation of overheads
becomes possible when an overhead expenses is directly related to a specific
department. It cannot be directly related to a specific job, process or production
unit but it can be directly related to a particular production or service department.
Allocation is defined as ‘the allotment of whole items of cost to cost centres or
cost units’. The full amount of an overhead expense can be easily identified as
incurred for a particular cost centre or a production or a service department; e.g.
Indirect materials issued for repairs and maintenance work of Production
Department A is an overhead expense related only to Production Department A
and so the full cost of such indirect materials issued should be allocated to that
production department. Similarly wages of a foreman of a particular production
department should be wholly allocated to that particular production department.
Light expenses of the canteen premises are incurred for the canteen which is a
service department and so they should be allocated only to the canteen.
76
Advanced Cost Accounting - II
Allocation, Distribution &
Primary Distribution
Overtime costs of each department can be ascertained and so the actual
amount of overtime cost of each department can be allocated to the particular
department.
7.4
Distribution of Overheads
NOTES
Distribution of overheads is also known as the apportionment of overheads.
There are a number of overheads expenses which are incurred as common costs
for two or more departments - production and service. As the overhead costs are
incurred for more than one department, they become the common costs for them
and so allocation of such overheads is not possible. These common overheads are
required to be divided or distributed among the departments which have received
the benefit due to such overhead expenses. This distribution is to be done on a
rational basis so that each beneficiery department is charged with a proper share
of such overheads.
I.C.M.A. defines apportionment as “the allotment of proportions of items
of cost centres or cost units”.
The apportionment of overhead cost becomes necessary when more than
one department receives the benefit from incurring the overhead cost. The
departments which have received the benefit may be production departments as
well as service departments. A production department is a department which is
engaged in the activity of production. It does the work of mixing of materials,
heating of materials, cutting and grinding of material to give it a particular shape,
or assembling the parts to create a finished product. A service department does
not produce any product by itself but it gives service to the production departments
to do the production work. Stores department, repairs and maintenance department,
personnel department, canteen, tools department, time-keeping department are
some examples of the service departments.
Check Your Progress
i)
What
is
meant
by
‘allocation of overheads’ ?
ii) What is distribution or
apportionment
of
overheads ?
iii) How ‘primary distribution
of overheads’ is done ?
iv) Suggest the basis to be used
for primary distribution of
following
items
of
overheads :a) Lighting Expenses
b) Canteen Expenses
c) Depreciation on
machinery
d) Rent of factory building
e) Salary of factory manager
7.5
Primary Distribution of Overhead
When an overhead cost is to be apportioned to production and service
departments it is known as ‘primary distribution’ of overhead. For deciding how
much proportionate amount of an overhead cost should be charged to each
beneficiary department an equitable and proper base should be used. Bases used
for the primary distribution of overheads are given below :Overheads Costs
Bases of Apportioment
1.1 Rent and other building expenses
Floor area of the departments in the
2 Lighting and heating
f) Power charges
g) Time office expenses
h ) Stores department
expenses
i) Repairs and Maintenance
expenses
j) Welfare expenses
k ) Fire insurance of building
l) Personnel department
expenses
building
3 Rent, rates and taxes of building
4 Fire Insurance of building
Advanced Cost Accounting - II
77
Allocation, Distribution &
Primary Distribution
2.1 Personnel office expenses
2 Welfare expenses
Number of employees working in
each department.
3 Canteen expenses
NOTES
4 Fringe benefits
5 Time-office expenses
6 General administration cost
7 Supervision expenses
8 Employees state Insurance
Direct wages amounts.
contribution by employer
3.1 Depreciation on plant and
Capital value of assets
machinery
2 Fire Insurance
4.1 Compensation to workers
2 Holiday Pay
Direct wages amount of employees
in each department
3 ESI contribution
4 Contribution to pension fund
5. Fuel and Power Cost
Horse power, kilo watt hours (kwh),
Horse power hours, technical
estimates
6. Repairs and maintenance cost
Number of hours spent for repairs
and maintenance work
7.1 Stores department expenses
2 Materials issue expenses
8.1 General management expenses
2 General Manager’s Salary
78
Advanced Cost Accounting - II
Value of materials supplied
Number of materials issue
requisitions handled Quantity or
weight of materials issued to
the departments.
Technical estimates
Time devoted to each department
estimated on survey basis
Allocation, Distribution &
Primary Distribution
Illustrations of Primary Distribution of Overheads :
ILLUSTRATION 1
Following figures have been extracted from the books of Model
Manufacturing Company for month of July 2013:`
Indirect Materials
Production Department A
950
Production Department B
1,200
Production Department C
200
Service Department X
NOTES
1,500
Service Department Y
400
`
Indirect Wages
Production Department A
900
Production Department B
1,100
Production Department C
300
Service Department X
1,000
Service Department Y
650
Power
6,000
Light Charges
2,120
Rent and Rates
2,800
Insurance on Assets
1,000
Meal charges
3,000
Depreciation on assets @ 6% p.a.
From the following additional information provided to you prepare a statement
showing Primary Distribution of Overheads :
Item
Production Departments
Service Departments
A
B
C
X
Y
4000
4000
3000
2000
1000
Number of employees
18
24
6
8
4
No. of light points
15
15
12
8
3
Kilo Watt Hours
400
440
160
150
50
1,00,000
1,20,000
80,000
60,000
40,000
Area (sq.ft)
Capital value of Assets ( `)
Advanced Cost Accounting - II
79
Allocation, Distribution &
Primary Distribution
SOLUTION
Statement showing Primary Distribution of Overheads
Item of Overhead
Basis
NOTES
Total
Production Dept. Service Dept.
A
B
C
X
Y
`
`
`
`
`
`
Indirect Materials
Allocation
4,250
950
1,200
200
1,500
400
Indirect Wages
Allocation
3,950
900
1,100
300
1,000
650
Power
Kilowatt Hrs
6,000
2,000
2,200
800
750
250
Light Charges
No.of Light
2,120
600
600
480
320
120
Rent and Rates
Points Area
2,800
800
800
600
400
200
1,000
250
300
200
150
100
3,000
900
1,200
300
400
200
2,000
500
600
400
300
200
(sq.ft)
Insurance on
Capital value
Asset
of assets
Meal Charges
Number of
Employees
Depreciations
@6%p.a.on
on Assets
Capital Value
of Assets
Total
25,120 6,900
8,000 3,280 4,820
2,120
ILLUSTRATION 2
Apollo Engineers Ltd. Aurangabad, provides the following particulars
regarding a Repairs and Maintenance Service Dept., for the month ended 31st
March, 2010
Particulars
Standard labour hours required
Actual labour hours worked
Productions Depts.
Service Depts.
X
Y
A
B
1,000
500
400
600
800
400
300
500
The total expenses of Repairs and Maintenance Dept. for the period
amounted to `50,000 out of which `40,000 was spent as marginal expenses.
You required to allocate the expenses of Repairs and Maintenance Dept. to the
Production Depts. and Service Depts.
80
Advanced Cost Accounting - II
Allocation, Distribution &
Primary Distribution
SOLUTION
In the Books of Apollo Engineers Ltd. Aurangabad
Statement showing Allocations of Repairs and Maintenance Depts.
Cost to the Production Depts. and Service Depts.
for the month ended 31-3-2010
Particulars
Basis of Apportionment
Ratio
Total
Production Depts. Service Depts.
‘X’
‘Y’
‘A’
‘B’
`
`
`
`
`
Marginal i.e.
Actual Labour Hours Worked
8:4:3:5
40,000
16,000
8,000
6,000
10,000
Standard Labour Hours
10 : 5 : 4 : 6
10,000
4,000
2,000
1,600
2,400
50,000
20,000
10,000
7,600
12,400
Variable Expenses
Fixed Expenses
Required
(+)
Total
ILLUSTRATION 3
The following are the figures obtained from the records of Bharat Petro
Chemicals Ltd., Baramati for the month of March, 2010
Departments
Indirect Material
Indirect Labour
`
`
‘A’
7,300
4,700
‘B’
4,850
2,650
‘C’
2,400
3,800
‘X’
8,300
4,250
‘Y’
4,150
2,600
Production Depts.
Service Depts.
`
Additional Information :
Lighting, Heating and Power
20,000
Rent, Rates and Taxes
8,000
Staff Welfare Charges
10,000
Depreciation on Machinery
30,000
Particulars
Production Depts.
Service Depts.
‘A’
‘B’
‘C’
‘X’
‘Y’
Area occupied
sq.ft.
3,000
2,000
1,000
1,500
500
Kilo watt-hours
kWH
6,000
5,000
4,500
2,500
2,000
No.
80
100
60
130
30
`
1,00,000
50,000
78,000
62,000
10,000
Number of Employees
Value of Machinery
Advanced Cost Accounting - II
81
Allocation, Distribution &
Primary Distribution
You are required to apportion the costs to various department by considering
the most suitable basis.
SOLUTION
In the books of Bharat Petro Chemicals Ltd. Baramati
Statements showing Apportionment of costs to Various Depts.
For the Month Ended 31st March, 2010
Particulars
Basis of Apportionment
Ratio
Total
Production Depts.
Service Depts.
A
B
C
X
Y
`
`
`
`
`
`
Indirect Material
Actual
-
27,000
7,300
4,850
2,400
8,300
4,150
Indirect Labour
Actual
-
18,000
4,700
2,650
3,800
4,250
2,600
Lighting, Heating and Power
Kilo-watt hours
12:10:9:5:4
20,000
6,000
5,000
4,500
2,500
2,000
Rent, Rates & Taxes
Area occupied sq.ft.
6:4:2:3:1
8,000
3,000
2,000
1,000
1,500
500
Staff Welfare Charges
Number of employees
8:10:6:13:3
10,000
2,000
2,500
1,500
3,250
750
Depreciation on Machinery
Value of Machinery
50:25:39:31:5
30,000
10,000
5,000
7,800
6,200
1,000
(+)
 Total
1,13,000 33,000 22,000 21,000 26,000 11,000
ILLUSTRATION 4
Cadbury India Ltd. Chandannagar, has two production cost centres ‘A’ and
‘B’ and two services cost centres ‘X’ and ‘Y’. The following is the summary of
overhead costs for the month of March 2010.
`
Salary to works Manager
6,000
Light and Power
36,000
Repairs to Plant
10,000
Rent of Factory Buildings
8,000
Meals to Working Staff
12,000
Depreciation on Machinery
25,000
Provident Fund Contribution
15,000
Additional Information :Particulars
Production Depts.
Service Depts.
‘A’
‘B’
‘X’
‘Y’
12
18
3
3
Sq. Mtr.
1,000
2,000
500
500
`
45,000
90,000
45,000
45,000
Direct Wages
`
5,000
6,000
2,000
2,000
Horse Power
HP
5
4
-
3
Number of Workers
Area Sq. meter
Value of Plant and
No.
Machinery
82
Advanced Cost Accounting - II
Allocation, Distribution &
Primary Distribution
You are required to distribute the overhead costs to the Production and
Service Depts. on the most equitable basis.
SOLUTION
In the books of Cadbury India Ltd., Chandannagar
Statement showing distribution of Overhead Costs of the Production and Service Depts.
For the month ended 31st March , 2010
Particulars
Basis of Apportionment
Ratio
Total
Production Depts.Service Depts.
A
B
X
Y
`
`
`
`
`
Salary to Worker Manager
Number of workers
4:6:1:1
6,000
2,000
3,000
500
500
Light and Power
Horse Power
5:4:-:3
36,000
15,000
12,000
-
9,000
Repairs to Plant
Value of Plant and Machinery
1:2:1:1
10,000
2,000
4,000
2,000
2,000
Rent of Factory Buildings
Area Sq. Meter
2:4:1:1
8,000
2,000
4,000
1,000
1,000
Meals to Working Staff
Number of Workers
4:6:1:1
12,000
4,000
6,000
1,000
1,000
Depreciation on Machinery
Value of Plant and Machinery
1:2:1:1
25,000
5,000
10,000
5,000
5,000
5:6:2:2
15,000
5,000
6,000
2,000
2,000
Provident Fund Contribution Direct Wages
(+)
Total
1,12,000
35,000 45,000 11,500 20,500
ILLUSTRATION 5
Dabur Chems Ltd. Dombivali, has four departments, three producing
departments viz. I,II and III and one service departments viz. IV. The actual costs
for the month of March 2010, were as follows :
•
Indirect Expenses :
`
Producing Departments
•
I
825
II
100
III
955
Service Department :
IV
620
Additional Expenses
Repairs
1,500
Depreciation
1,000
Rent, rates and Taxes
5,000
Lighting
500
Insurance of Buildings
1,000
Supervision charges
4,000
Employee’s State Insurance-contribution by the Employer
Motive Power
500
2,000
Advanced Cost Accounting - II
83
Allocation, Distribution &
Primary Distribution
Other Information :
Particulars
Production Depts.
I
Area Sq. Ft.
NOTES
Number of Workers
II
Service Depts.
III
IV
Sq.ft.
100
150
90
160
No.
15
10
9
16
Direct Wages
`
5,000
8,000
5,000
2,000
Value of Plant and Machinery
`
25,000
10,000
8,000
7,000
Number of Light Points
No.
10
5
6
4
Kilo-watt Hours
kwh
2,000
5,000
6,000
7,000
You are required to apportion the overhead costs to the various producing
and service department on suitable basis.
SOLUTION
In the books of Dabur Chems. Ltd., Dombivali
Statement showing apportionment of overhead cost to the Producing and Service Depts.
For the Month Ended 31st March, 2010
Particulars
Basis of Apportionment
Ratio
Total
Production Depts. Service Depts.
I
II
III
IV
`
`
`
`
`
-
2,500
825
100
955
620
Indirect Expenses
Actual
Repairs
Value of Plant and Machinery
25:10:8:7
1,500
750
300
240
210
Depreciation
Value of Plant and Machinery
25:10:8:7
1,000
500
200
160
140
Rent, Rates and Taxes
Area Sq. ft.
10:15:9:16
5,000
1,000
1,500
900
1,600
Lighting
Number of Light Points
10:5:6:4
500
200
100
120
80
Insurance of Buildings
Area Sq. Ft.
10:15:9:16
1,000
200
300
180
320
Supervision Charges
Number of Workers
15:10:9:16
4,000
1,200
800
720
1,280
Employees State Insurance
contribution by Employer
Direct Wages
5:8:5:2
500
125
200
125
50
Motive Power
Kilo-watt hours
2:5:6:7
(+)
2,000
200
500
600
700
18,000
5,000
4,000
Total
7.6
84
Advanced Cost Accounting - II
4,000 5,000
Summary
For the purpose of charging overheads to the products or jobs, it is necessary
to record them department wise. There are two types of departments in a
manufacturing concern - production departments and service departments.
Production departments are those departments which do the work of production.
Departments which do the work of cutting, mixing, heating, molding, assembling
of components or parts, finishing the product are the production departments.
Service departments provide services to the production and service departments.
Stores departments does the work of receiving, storing, preserving and issuing of
materials and it gives service to production departments as well as to service
departments like repairs and maintenance department, office and sales department.
When a particular overhead is wholly incurred for a production or a service
department it can be exclusively charged to that production or service department
and distribution or apportionment of the amount of that overhead does not become
necessary. Charging of the whole amount of an item of overhead to a single
department or a single cost-centre is known as ‘allocation of overhead’.
Allocation, Distribution &
Primary Distribution
NOTES
When the amount of an item of overhead is incurred as common for two or
more departments or cost centers it has to be divided among those departments or
cost centers . Such division is called distribution or apportionment of overheads.
When the amount of an item of overhead is to be apportioned, a proper basis is to
be selected for doing the apportionment. Overheads such as canteen expenses,
personnel office expenses, welfare expenses are apportioned to production and
service departments on the basis of number of employees working in each of
these departments. Distribution of overheads among production and service
departments is called ‘primary distribution of overheads’. When all items of
overheads are distributed among production and service departments, total amount
of all overheads allocated and apportioned to each department is calculated and
thus overhead amount charged to the department is decided. After calculating
the total amount of overheads for each production and service department, the
work of primary distribution of overheads becomes complete.
7.7
Key Terms
i)
Allocation of Overheads : Charging whole amount of overhead to one
production department or one service department for which that overhead
in incurred.
ii)
Apportionment of Overheads : Distribution or division of an overhead
amount between two or more production departments and/or service
departments which have received benefit of that overhead expense, by
using the most suitable basis.
7.8
Questions and Exercises
(a)
Theory Questions
1.
Explain the terms ‘overheads allocation’ and ‘overhead apportionment’ by
giving suitable examples.
2.
What is departmentalisation of overheads ? How it helps the work of
absorption of overheads ?
3.
What is ‘Primary distribution of overheads’? Give any ten items of
Advanced Cost Accounting - II
85
Allocation, Distribution &
Primary Distribution
overheads and point out which basis will be proper for apportionment of
each one of them.
4.
NOTES
What basis would you recommend for the departmental apportionment in
respect of the following ? Justify the basis you recommend.
a.
Factory rent
b. Material issuing expenses
c. General lighting expenses
d. Canteen expenses
e. Building insurance premium
f. Depreciation on machinery
(b)
Multiple choice questions
1)
Allocation means ------------- the entire amount of an overhead expenses
to a particular department for which it has been incurred.
(a) charging
(b) changing
(c) excluding
(d) deducting
2)
Distribution of overheads is also known as the --------- of overheads.
(a) classification
(b) codification
(c) apportionment
(d) generalisation
3)
Apportionment means the allotment of proportions of items of cost to cost
----------(a) centre
(b) classification
(c) specification
(d) allocation
4)
Match the pairs
Group I (Overhead Costs)
Group II (Bases of Appointment)
(a) Rent, Rates & Taxes of Building i) General management Expenses
86
Advanced Cost Accounting - II
(b) Welfare expenses
ii) Direct wages amount of
employees in each
(c) Fire Insurance
iii) Capital value of Assets
(d) Holiday pay
iv) No of employees working in each
department.
Allocation, Distribution &
Primary Distribution
v) ----- of the departments in the
building.
Ans. : (1 - a), (2 - c), (3 - a).
NOTES
(c)
Exercises
1.
A manufacturing company has two production departments X and Y and
three service departments, Time keeping, Stores and Maintenance. The
departmental summary showed the following expenses for December, 2014 :`
Production departments :X
16,000
Y
10,000
`
26,000
Service Departments :Time – Keeping
4,000
Stores
5,000
Maintenance
3,000
12,000
38,000
The Other Information is :Particulars
Production Departments
Service
Departments
X
Y
Timekeeping
Stores
Maintenance
No. of employees
40
30
20
16
10
No. of stores requisitions
24
20
—
—
6
2400
1600
—
—
—
Machine hours
Prepare a statement showing departmental allocation of expenses.
2.
S. R. Ltd. has provided following information to you :-
Items
Production Department
P1
P2
P3
Service Departments
Total
Office Stores Workshop
Direct wages `
20000
25000
30000
-
-
-
75000
Direct material `
30000
35000
45000
-
-
-
11000
Indirect Materials `
2000
3000
3000
1000
2000
2000
13000
Indirect wages `
3000
3000
4000
10000 10000
5000
35000
Area in Sq. meters
200
250
300
150
250
1250
Book value of Machinery ` 30000
35000
25000
-
- 15000 105000
H. P. Machines
Machine hours worked
100
15
20
25
-
-
5
65
10000
20000
15000
-
-
5000
50000
Advanced Cost Accounting - II
87
Allocation, Distribution &
Primary Distribution
Total general expenses :i)
NOTES
` 12,500
Rent
ii) Insurance
` 1050
iii) Depreciation
15% of value of machinery
iv) Power
` 3,800
v)
` 1,250
Light
You are required to prepare on Overhead Analysis Sheet for the departments
showing clearly the basis of apportionment, where necessary.
3. The Alfa Co. Ltd. is divided into four departments A, B, C are the production
departments and D is the service department. The actual costs incurred by the
company for June 2014 are as follows :`
Rent
1000
Repairs and plant
600
Depreciation of plant
450
Light
100
Supervision
1,500
Fire-Insurance - Stock
500
Power
900
Employee’s state Insurance contribution
150
Following information is available related to four departments :Departments
Area in Sq.feet
A
B
C
1500
1100
900
500
20
15
10
5
No.of employees
D
Total Wages
`
6000
4000
3000
2000
Value of Plant
`
24000
18000
12000
6000
Value of Stock
`
15000
9000
6000
-
Apportion the costs to the various departments by preparing overhead
Distribution statement clearly stating the basis used of apportionment of expenses
wherever necessary.
4)
Escorts Machineries Pvt. Ltd. Ernakulam, has five operating departments
viz. A, B, C, D and E. The actual costs incurred for March, 2010 were as under :
•
88
Advanced Cost Accounting - II
Indirect Material Labour :
`
Dept. ‘A’
980
Dept. ‘B’
540
Dept. ‘C’
770
Dept. ‘D’
730
Dept. ‘E’
580
•
Allocation, Distribution &
Primary Distribution
The Other costs were as follows :
Insurance of Plant
10,500
Taxes on Buildings and Premises
12,500
Depreciation
7,000
Supervisor’s Salary
28,000
Insurance of Stock
6,400
Employer’s liability for employees insurance
3,000
Electric Lighting
9,000
NOTES
The following data is also available in respect of five departments.
Particulars
Operating Depts.
‘A’
Area
‘B’
‘C’
‘D’
‘E’
Sq.ft
140
120
110
90
40
Number of Workers
No.
25
20
10
10
5
Prime Cost Wages
`
1,00,000
80,000
50,000
50,000
20,000
Value of Plant
`
2,00,000
1,80,000 1,60,000 1,00,000
60,000
Value of Stock
`
1,50,000
1,00,000
50,000
20,000
—
You are required to prepare Statement showing Primary Distribution of of
Overhead costs for the month ended 31st March, 2010.
7.9
Further Reading
i)
‘Advanced Cost Accounting’ - Nigam and Sharma
ii)
‘Cost Accounting - Principles and Practice’ - N. K. Prasad
iii)
‘Theory and Practice of cost Accounting’ - M. L. Agrawal
iv)
‘Cost Accounting’ - Jawahar Lal
Advanced Cost Accounting - II
89
Unit 8
Secondary Distribution of Overheads
Secondary Distribution of
Overheads
Structure
8.0
Introduction
8.1
Unit Objectives
8.2
Secondary distribution of overheads
NOTES
8.2.1 Non-reciprocal basis of apportionment
8.2.2 Reciprocal basis of apportionment
8.3
Methods used for secondary distribution of overheads
8.3.1 Simultaneous Equation Method
8.3.2 Repeated Distribution Method
8.3.3 Trial and Error Method
8.4
Summary
8.5
Key Terms
8.6
Questions and Exercises
8.7
Further Reading
8.0
Introduction
In Unit 7, information has been provided about Primary Distribution of
overheads according to which total overheads of each production department and
each service department are calculated. Since service departments do not produce
any goods, the overheads of service departments are required to be distributed
among production departments. Some service departments render service to
only production departments but some service departments render service to
production departments and other service departments also. Different methods
are, therefore, required to be followed to do distribution of overheads of the
service departments. Information about these methods is provided in this units.
8.1
Unit Objectives
After studying the information provided in this Unit, you should be able to
understand :-
•
meaning and necessity of secondary distribution of overheads,
•
different methods which are used for doing non-reciprocal and reciprocal
Advanced Cost Accounting - II
91
Secondary Distribution of
Overheads
basis for apportionment of overheads, and
•
NOTES
8.2
how secondary distribution of overheads is done under different methods.
Secondary Distribution of Overheads
When allocation and apportionment of overheads to production and service
departments is completed and total amount of overheads of each production
departments and service departments are calculated, the work of primary distribution
of overhead costs becomes complete. The next step is the ‘Secondary distribution
of overheads’. Service departments such as stores department, personnel
department, repairs and maintenance department, welfare department provide
service to production departments and also to other service departments. Service
departments do not carry on any production activity and hence it becomes
necessary to charge or distribute overheads of service departments to production
departments so that they can be recovered or charged to the product units of the
production departments. This distribution of service departments to production
departments is called ‘secondary distribution of overheads’.
Secondary distribution of overheads can be done in the following ways:i)
Apportionment of service department’s overheads to production
departments only.
ii)
Apportionment of service department’s overheads to production as well as
other service departments.
Under the (i) way mentioned above it is assumed that each service
department renders service only to production departments but does not render
service to other service departments. Therefore, when secondary distribution is
done of the overheads of a service department the distribution of overheads of
that service department is over and no further overheads will be charged /
apportioned to that service department. In this way overheads of each service
department will be apportioned to only production departments on some equitable
bases and when the apportionment of the overheads of the last service department
is completed, only production departments will show the overheads..
Under the (ii) way mentioned, above, there are following two ways in
which the apportionment of overheads of service departments can be done
a)
Non- reciprocal basis of apportionment, and
b)
Reciprocal basis of apportionment.
8.2.1 Non - reciprocal basis of apportionment
92
Advanced Cost Accounting - II
While doing apportionment of service department’s overhead it is assumed
that the first service department renders service to the production departments
and other service departments but does not receive any service from the remaining
service departments. While apportioning the overheads of the second service
department its own amount of overheads plus the share of overheads charged to
it from the overheads of the first service departments will be apportioned to the
production departments and the remaining service departments when the overheads
of the last service department are to be apportioned, they will be apportioned only
to the production departments as all other service departments are already closed.
8.2.2 Reciprocal basis of apportionment
Secondary Distribution of
Overheads
NOTES
When there are two or more service departments in the organisation and
each service department renders service to production departments as well as
other service departments, ‘reciprocal basis of apportionment’ basis is used for
apportionment of the overheads. For example if there are three service departments
X, Y and Z and four production departments A, B, C, and D apportionment of X
department’s overhead amount will be apportioned to A, B, C, D, Y and Z
departments; Y service department’s own overheads and proportionate share of
overheads of X service department charged to Y service department will be
apportioned to A, B, C, D and service departments X and Z. Apportionment of
overheads of z service department will be done to A,.B,C,D and service
departments X and Y. Due to this X service department shows amount apportioned
to it by Y and Z service departments and this total amount will again be apportioned
to A, B, C, and D production departments and Y and Z service departments. In
this way the process of apportioning of service departments overhead continues
till the amount of service department’s overheads becomes very small and this
amount is apportioned only to the production departments will show the amount of
overheads and this amount will be charged to the outputs of the production
departments on a suitable basis.
8.3 Methods Used for Secondary Distribution
Secondary distribution of overheads can be done by using any one of the
following methods :i)
Simultaneous Equation Method,
ii)
Repeated Distribution Method, and
iii)
Trial and Error Method.
8.3.1 Simultaneous Equation Method
In this method algebric equations are formed to find out the total overheads
of the two service departments. The total overheads of the two service
departments are denoted by two letters, say X and Y and the value of X and Y is
shown as the overhead amount of each service department as per the primary
distribution of overheads plus the percentage overheads of the other service
department received from that service department; e.g. as per the primary
distribution overheads of service departments A is ` 4800 and of service
department B is ` 3000. A service department renders 20% service to service
Advanced Cost Accounting - II
93
Secondary Distribution of
Overheads
department B. Assuming that X denotes the total overheads of service departments
A and Y denotes the total overheads of service departments B, the two simultaneous
equation will be as under :X = ` 4800 + 10% Y
NOTES
Y = ` 3000 + 20% X
By solving the two equations value of X and Y can be calculated and these
amounts will be distributed among the production departments only in the
percentages in which the service departments render service to the production
departments. Total overheads of each production departments will be its own
overhead amount as per the primary distribution of overheads plus the amounts
charged to it form each service department.
ILLUSTRATION
B Ltd. a manufacturing concern, has three production department A, B and
C and two service departments P and Q. The primary distribution of overheads
shows the following amounts of overheads for these departments :`
Department
A
6300
B
7400
C
2800
P
4500
Q
2000
A Survey conducted to decide the service rendered by the service
departments shows the following result :-
Service Departments P
Service Departments Q
A
40%
30%
B
30%
30%
C
20%
20%
P
20%
Q
10%
Find out the total overheads of the production departments using Simultaneous
Equation Method.
SOLUTION
Let X be the total overheads of Service Department P and Y be the total
overheads of Service Departments Q.
Or
94
Advanced Cost Accounting - II
X
=
4500 + 2 Y
(1)
Y
=
2000 + X
(2)
10 X
=
45000 + 2 Y
10 Y
=
20000 + X

10X - 2Y = 45000
(3)
-X + 10 Y = 20000
(4)
Secondary Distribution of
Overheads
By multiplying equation (3) by 5 and adding it to equation (4) we get,
50X - 10Y
= 225000
-X + 10Y
= 20000
49X
NOTES
= 245000
245000
X =
49
= 5000
Substituting value of X in equation (4) we get the value of Y as
-X + 10Y
 -5000 + 10 Y
=
20000
=
20000

10 Y
=
20000+5000

Y
=
2500
Secondary Distribution Of Overheads
Item
Overheads as per
Total
Production Departments
A
B
C
`
`
`
`
16500
6300
7400
2800
4500
2000
1500
1000
2000
750
750
500
23000
9050
9650
4300
Primary Distribution
Service Departments p
(90% of ` 5000)
Service Departments Q
( 80% of ` 2500 )
Total
8.3.2 Repeated Distribution Method
In repeated Distribution Method of secondary overhead distribution the
overhead amounts as per the primary distribution are recorded in the columns
prepared for the production departments and service departments. The next step
is to apportion the overhead amount of the first service department in the
percentages in which it provides service to the production departments and other
service department. The next step is to apportion the total overhead amount (second
service department’s overhead amount as per the primary distribution plus the
amount charged to it while apportioning overheads of the first service department)
of the second service department to production departments and first service
Advanced Cost Accounting - II
95
Secondary Distribution of
Overheads
NOTES
department in the percentages in which the second service department renders
service to them. This will close the second service departments but now the
first service department shows some amount of overhead charged to it while
apportioning the overheads of the second service department so this overhead
amount of first service department will be apportioned to the production and the
second service department. This process will be repeated till the amount of
overheads of a service department is fully exhausted or it has become so small
that further apportionment is not worthwhile. The overheads of the remaining
service department will be distributed only among the production departments.
The amounts appearing in the columns of production departments are added and
the total amount of overheads of each production department becomes available.
As the overheads of the service departments are apportioned again and
again this method is known as ‘repeated distribution method’ or ‘continuous
distribution method’ when there are more than two service departments a
manufacturing concern, it is not possible to use the simultaneous equation method
cannot be used and the use of the repeated distribution method becomes
necessary.
Following illustration should help in understanding the use of the repeated
distribution method.
ILLUSTRATION
A manufacturing company has three production departments P, Q and R
and two service departments A and B. After primary distribution, overheads of
these departments show the following position.
Production Departments
Service Departments
P
` 7000
A
` 4000
Q
` 7500
B
` 3000
R
` 6000
Service provided by the Service Departments to production and service
departments is as under :P
Q
R
A
B
Service Department A
30%
25%
25%
-
20%
Service Department B
40%
30%
20%
10%
-
You are required to prepare Secondary Distribution using Repeated
Distribution Method.
96
Advanced Cost Accounting - II
Secondary Distribution of
Overheads
SOLUTION
Statement showing Secondary Distribution of Overheads
Particulars
Overhead as per
Production Department
Service Department
P
Q
R
A
B
`
`
`
`
`
7000
7500
6000
4000
3000
1200
1000
1000
-4000
800
-
3800
NOTES
Primary Distribution
Apportionment of A Dept
Apportionment of B Dept
1520
1140
760
380
-3800
Apportionment of A Dept
114
95
95
-380
76
Apportionment of B Dept
30.40
22.80
15.20
7.60
Apportionment of A Dept
2.28
1.90
1.52
-7.60
Apportionment of B Dept
0.60
0.46
0.46
-
-76
1.52
-1.52
(Only to Production
Departments)
Total Overheads
9867.28
9760.16 7872.18
Note
Addition of the total overheads of production departments P, Q and R shows
that ` 27,499.62 is the total amount of overhead distributed among them. The
total amount of overheads of the production and service departments as per
primary distribution is ` 27,500. The difference of `0.38 is caused because the
repeated distribution is stopped after apportionment of `1.52. If the repeated
distribution is continued for 1 or 2 more steps, the difference of ` 0.38 will be
reduced to zero or a very negligible amount.
8.3.3 Trial and Error Method
Under this method, the apportionment of overheads of service departments
are distributed only between or among the service departments . The apportionment
is done according to the percentage in which the service department renders
service to the other service department. Then in the next step the second service
department’s overheads (overheads as per primary distribution plus the amount
of overheads of first service department apportioned to it) are apportioned to the
first service department according to the percentage of service rendered to first
service department. This procedure is continued till the amount of overhead to be
apportioned becomes zero or negligible. By adding the amounts shown in the
service department column, the total overheads of the service department become
available. The apportionment of the total overheads of the service department is
done in the same manner as in the simultaneous equation method to the production
departments. For each production department the total overhead amount is
calculate by adding to the overhead amount as per primary distribution of overheads
Check Your Progress
i)
What you understand from
‘secondary distribution of
overheads’ ?
ii) How
overheads
are
distributed under ‘nonreciprocal distribution of
overheads ?
iii) What
is
meant
‘reciprocal
basis
apportionment
overheads’ ?
by
of
of
iv) Explain following methods
of secondary distribution of
overheads :a) Simultaneous Equation
Method
b) Repeated Distribution
Method
c) Trial and Error Method.
Advanced Cost Accounting - II
97
Secondary Distribution of
Overheads
the amounts charged from the service departments .
The following illustration should help in understanding the procedure used
in the Trial and Error Method.
ILLUSTRATION
NOTES
In a manufacturing concern X, Y and Z are three production departments
and A and B are the service departments. After the primary distribution the
overheads shown by the five departments are as under :Department
`
Department
`
X
8,500
A
1,200
Y
6,250
B
2,000
Z
5,800
The overheads of the service departments are to be apportioned in the
following percentages :X
Y
Z
A
B
Service Department A
25%
30%
25%
-
20%
Service Department B
30%
20%
25%
25%
-
Using Trial and Error Method find out the total overheads of Service
Departments A and Service Departments B. Also prepare a statement showing
the total overheads of each of the production departments.
SOLUTION
Particulars
Overheads as per the
Service Dept A
Service Dept B
`
`
1200
2000
—
240
Primary Distribution
Apportionment of overheads
of Service Dept. A to B
2240
(20% of `1200)
Apportionment of overheads
560
-
—
112
28
—
of Service Dept. B to A
(25% of ` 2240)
Apportionment of overheads
of Service Dept. A to B
(20% of ` 560)
Apportionment of overheads
of Service Dept. B to A
(25% of ` 112)
98
Advanced Cost Accounting - II
Apportionment of overheads
—
5.60
of Service Dept. A to B
Secondary Distribution of
Overheads
(20% of ` 28)
Apportionment of overheads
1.40
—
of Service Dept. B to A
NOTES
(25% of ` 5.60)
Apportionment of overheads
—
0.28
of Service Dept. A to B
(20% of ` 1.40)
Apportionment of overheads
0.07
—
of Service Dept. B to A
(25% of ` 0.28)
Total Overheads of Service Depts.
1789.47
2357.88
Statement Showing Secondary Distribution Of Overheads
Item
Total
Production Departments
X
Y
Z
`
`
`
`
20550
8500
6250
5800
Overheads as per
Primary Distribution
Apportionment of
Overheads of Service
Department A
(80% of ` 1789.47)
1431.57
447.37
536.84
447.36
1768.40
707.36
471.57
589.47
23749.97
9654.73
7258.41
6836.83
Apportionment of
Overheads of Service
Department B
(75% of ` 2357.88)
Total
Note
(A difference of ` 0.03 is seen in the total amount of overheads of the five
departments as per the primary distribution of overheads (` 23750) and the total
overheads of the three production departments after the secondary distribution.
This difference is due to rounding up of the amounts and is a negligible amount.)
Using the information given in the above illustration if secondary distribution
is done according to the simultaneous equation method it will appear as under :
Advanced Cost Accounting - II
99
Secondary Distribution of
Overheads
SOLUTION
Let P be the total overheads of Service Department A and Q be the total
overheads of Service Department B.
NOTES

P = 1200 + 25 % of Q
 P = 1200 + .25Q
(1)

Q = 2000 + 20% of P
 Q = 2000 + .2P
(2)
Multiplying equation (1) by four and adding equation (2) to it , we get

4P = 4800 + Q
4P - Q = 4800
- 2P + Q = 2000

3.8P
= 6800

P
= 6800 ÷ 3.8
=
1789.47
Substituting the value of P in equation (1) we get,

1789.47- .25 Q
=
1200
- .25 Q
=
1200-1789.47
-.25 Q
=
-589.47
Q
=
2357.88

Thus, the total overheads of Service Department A are `1789.47 and total
overheads of service department B are 2357.88
These amounts are same as the amounts calculated by using Trial and
Error Method, Secondary Distribution of overheads statements will be prepared
in the same way as shown in the Trial and Error Method.
ILLUSTRATIONS
ILLUSTRATION 1
Ford Tools Ltd., Faizpur, has three production departments and six service
departments. The overhead expenses for the departments as per Primary
Distribution were as follows :
Production Depts.
`
•
‘A’
50,450
•
‘B’
20,800
•
‘C’
30,750
Service Depts.
100
Advanced Cost Accounting - II
•
Stores
5,000
•
Accounts
4,000
•
Power House
3,000
•
Canteen
3,000
•
Time-keeping
5,000
•
Time-Room
8,000
Total
1,30,000
The following additional information were made available from the costing,
records as regards the production departments.
Particulars
Secondary Distribution of
Overheads
Production Depts.
‘A’
‘B’
‘C’
Number of Workers
No.
80
100
20
H.P. of Machines
HP
500
800
700
Value of Stores Requisition
`
6,000
2,000
2,000
Services Rendered
%
25
50
25
NOTES
You are required to prepare a statement showing distribution of service
departments costs to production departments for the month ended 31st March,
2010.
SOLUTION
In the Books of Ford Tools Ltd., Faizpur
Statement showing Secondary Distribution of Service Depts. costs to the Production Depts.
for the month ended 31st March, 2010
Particulars
Basis of Re-apportionment
Ratio
Total
`
Overhead Expenses
as per Primary
Distribution Summary
Service Depts. :
Stores Depts.
Accounts Dept.
Power House Dept.
Canteen Dept.
Time-keeping Dept.
Tool Room Dept.
Value of Stores requestioned
Number of workers
H.P. of machines
Number of workers
Number of workers
Services rendered
Total
3:1:1
4:5:1
5:8:7
4:5:1
4:5:1
1:2:1
(+)
Production Depts.
‘A’
‘B’
`
`
‘C’
`
1,02,000
50,450
20,800
30,750
5,000
4,000
3,000
3,000
5,000
8,000
3,000
1,600
750
1,200
2,000
2,000
1,000
2,000
1,200
1,500
2,500
4,000
1,000
400
1,050
300
500
2,000
1,30,000
61,000
33,000
36,000
ILLUSTRATION 2
Orient Paper Co. Ltd., Osmanabad, has three Production departments and
two service departments. Their primary distribution summary discloses the results
which are as follows :
Production Departments
`
•
‘A’
7,810
•
‘B’
12,543
•
‘C’
4,547
Service Departments
•
‘X’
4,000
•
‘Y’
2,600
Advanced Cost Accounting - II
101
Secondary Distribution of
Overheads
The expenses of Service Depts. are charged on a percentage basis as
follows :
Particulars
‘A’
‘B’
‘C’
‘X’
‘Y’
Service Dept. X
30%
40%
20%
-
10%
Service Dept. Y
10%
20%
50%
20%
-
NOTES
You are required to prepare Secondary Distribution Statement as per
Repeated Distribution Method for the period ended 31st March, 2010.
SOLUTION
In the books of Orient Paper Co. Ltd., Osmanabad
Statement showing Secondary Distribution as per Repeated Distribution Method
For the period ended 31st March, 2010
Particulars
Ratio
Total
Production Depts.
Service Depts.
‘A’
`
‘B’
`
‘C’
`
‘X’
`
7,810
1,200
12,543
1,600
4,547
800
`
`
Cost as per Primary
Distribution Summary
Service Dept. ‘X’
3:4:2:1
31,500
Service Dept. ‘Y’
1:2:5:2
300
600
1,500
Service Dept. ‘X’
3:4:2:1
180
240
120
Service Dept. ‘Y’
1:2:5:2
6
12
30
Service Dept. ‘X’
3:4:2:1
(+)
4
5
9,500
15,000
 Total
31,500
‘Y’
3
4,000
(-) 4,000
NIL
600
600
(-) 600
NIL
12
12
(-) 12
2,600
400
3,000
(-) 3,000
NIL
60
60
(-) 60
NIL
-
7,000
NIL
NIL
ILLUSTRATION 3
The following information relates to the Production Departments A, B and
C and the Service Departments X and Y for the month ended 31st March, 2010.
Total
`
Service Depts.
‘A’
‘B’
‘C’
‘X’
‘Y’
`
`
`
`
`
Heating and Lighting
3,600
500
500
500
700
1,400
Audit Fees
2,000
500
800
300
200
200
10,000 15,000
10,000
3,000
2,000
Depreciation
Time-Keeping Charges
Rates and Taxes
102 Advanced Cost Accounting - II
Production Depts.
Total
40,000
4,000
800
1,600
600
600
400
10,000
2,000
4,000
1,500
1,500
1,000
59,600
13,800 21,900 12,900 6,000 5,000
Secondary Distribution of
Overheads
Expenses of Service Depts. are to be apportioned as follows :
Particulars
‘A’
‘B’
‘C’
‘X’
‘Y’
Service Dept. X
30%
40%
20%
-
10%
Service Dept. Y
10%
20%
50%
20%
-
Estimated Working Hours are as follows :
NOTES
•
Dept. A
:
8,257 hours
•
Dept. B
:
8,633 hours
•
Dept. C
:
5,729 hours
You are required to work out the production hour rate of recovery of
overheads in departments A, B and C under Repeated Distribution Method of
Mathur Plant Ltd., Mumbai.
SOLUTION
In the books of Mathur Plant Ltd., Mumbai
Statements showing Secondary Distribution of Service Depts. Costs to Production Depts. as per
Repeated Distibution Method for the period ended 31st March, 2010
Particulars
Ratio
Total
Production Depts.
`
59,600
-
Service Depts.
A
`
13,800
B
`
21,900
C
`
12,900
X
`
6,000
Y
`
5,000
600
5,600
(-) 5,600
NIL
112
112
(-) 112
NIL
NIL
Overhead Expenses as per Primary
Distribution Summary
Service Dept. ‘X’
3:4:2:1
1,800
2,400
1,200
Service Dept. ‘Y’
1:2:5:2
560
1,120
2,800
Service Dept. ‘X’
3:4:2:1
336
448
224
Service Dept. ‘Y’
1:2:5:2
11
22
57
Service Dept. ‘X’
3:4:2:1
(+)
7
9
6
(-) 6,000
NIL
1,120
1,120
(-) 1,120
NIL
22
22
(-) 22
16,514
25,899
17,187
NIL
 Total
59,600
Working Notes :
1)
Calculation of Overhead rate of recovery in Production Depts. taking
estimated working hours as a base.
=
Total Production Overheads
Estimated Working Hours
A
=
` 16,514
B
=
` 25,899
C
=
` 17,187
Hrs. 8,257
Hrs. 8,633
Hrs. 5,729
= `2
= `3
= `3
Advanced Cost Accounting - II
103
Secondary Distribution of
Overheads
ILLUSTRATION 4
Lupin Engineering Co. Ltd., Lohgaon, has three Production Depts. X, Y
and Z and two Service Depts. A and B. The expenses incurred by them during the
month of March, 2010, were as follows :
NOTES
`
Rent and Taxes
5,000
Canteen Expenses
1,300
Motive Power
4,000
Depreciation on Machines
5,000
Electric Lighting
2,000
Indirect Materials
1,500
Additional information provided for the month of March, 2010.
Particulars
Production Depts.
Service Depts.
X
Y
Z
A
B
Machine values
` 15,000
30,000
22,500
-
7,500
Direct Materials
`
5,000
6,000
4,000
-
-
Direct Wages
`
4,000
5,000
3,000
-
-
Electricity
KWH
5
10
10
6
9
Area occupied
sq. ft.
1,100
1,300
1,200
500
900
Light Point Numbers
No.
8
12
10
4
6
Employee Numbers
No.
50
10
40
10
20
Expenses of Service Depts. are to be apportioned as per Repeated
Distribution Method as follows :
Particulars
X
Y
Z
A
B
Dept. A
20%
40%
30%
-
10%
Dept. B
30%
20%
30%
20%
-
Prepare a statement showing Primary Distribution of overhead expenses
on most equitable basis. Also prepare a statement showing Secondary distribution
of service dept. costs to production dept.
104 Advanced Cost Accounting - II
SOLUTION
In the books of Lupin Engineering Co. Ltd., Lohgaon
Statement showing Primary Distribution of Overhead Expenses
for the month ended 31st March, 2010
Particulars
Basis of Apportionment
Ratio
Total
Production Depts.
Service Depts.
X
Y
Z
A
B
`
`
`
`
`
`
Rent and Taxes
Area occupied sq.ft.
11:13:12:5:9
5,000
1,100
1,300
1,200
500
900
Canteen Expenses
Employee Numbers
5:1:4:1:2
1,300
500
100
400
100
200
Motive Power
Electricity K.W.H.
5:10:10:6:9
4,000
500
1,000
1,000
600
900
Depreciation on Machines
Machines Values
2:4:3:-:1
5,000
1,000
2,000
1,500
-
500
Electric Lighting
Light Point Numbers
4:6:5:2:3
2,000
400
600
500
200
300
Indirect Materials
Direct Materials
5:6:4:-:-
1,500
500
600
400
-
-
18,800
4,000
5,600
5,000
(+)
 Total
1,400 2,800
Statements showing Secondary Distribution of Service Depts. Costs to Production Depts. as per
Repeated Distibution Method for the month ended 31st March, 2010
Particulars
Ratio
`
18,800
Production Depts.
Service Depts.
‘X’
`
4,000
‘Y’
`
5,600
‘Z’
`
5,000
‘A’
`
1,400
‘B’
`
2,800
140
2,940
(-) 2,940
NIL
59
59
(-) 59
NIL
NIL
Overhead Expenses as per Primary
Distribution Summary
Service Dept. ‘A’
2:4:3:1
280
560
420
Service Dept. ‘B’
3:2:3:2
882
588
882
Service Dept. ‘A’
2:4:3:1
118
235
176
Service Dept. ‘B’
3:2:3:2
18
11
18
Service Dept. ‘A’
2:4:3:1
(+)
2
6
4
(-) 1,400
NIL
588
588
(-) 588
NIL
12
12
(-) 12
5,300
7,000
6,500
NIL
 Total
-
Total
18,800
Advanced Cost Accounting - II
105
Secondary Distribution of
Overheads
ILLUSTRATION 5
Nahar Plastics Ltd., Navapur, has three Production Depts. and two Service
Depts. The overhead expenses for March, 2010, are as follows :
Particulars
NOTES
Production Depts.
‘A’
‘B’
‘C’
‘D’
‘E’
`
`
`
`
`
Indirect Materials
Indirect Labour
Service Depts.
800
2,000
900
400
200
1,500
1,600
1,300
350
1,900
` 10,000
Rent and Taxes
Electricity Charges
` 7,100
Plant Depreciation
` 6,000
Supervisor’s Salary
` 3,200
The other details are as follows
Particulars
Area occupied
‘A’
‘B’
‘C’
‘D’
‘E’
Sq. Mtrs.
800
1,000
900
700
600
Light Points
No.
15
35
8
7
6
Employee Numbers
No.
5
15
6
4
2
`
30,000
15,000
5,000
4,000
6,000
Hrs.
1,000
2,000
1,000
-
-
Capital value of Plant
Working Hours
The expenses of Service Dept. ‘D’ and ‘E’ are to be charged as follows :
Particulars
‘A’
‘B’
‘C’
‘D’
‘E’
Dept. ‘D’
20%
50%
20%
-
10%
Dept. ‘E’
10%
30%
40%
20%
-
You are required to find out the overhead rate per hour in Production Depts.
using Repeated Distribution Method.
106 Advanced Cost Accounting - II
SOLUTION
In the books of Nahar Plastics Ltd., Navapur
Statements showing Primary Distribution of Overhead Expenses
for the month ended 31st March, 2010
Particulars
Basis of Apportionment
Ratio
Total
Production Depts.
Service Depts.
‘A’
‘B’
‘C’
‘D’
‘E’
`
`
`
`
`
`
Indirect Materials
Actual
-
4,300
800
2,000
900
400
200
Indirect Labour
Actual
-
6,650
1,500
1,600
1,300
350
1,900
Rent and Taxes
Area occupied Sq. Mtrs.
8:10:9:7:6
10,000
2,000
2,500
2,250
1,750
1,500
Electricity charges
Light points
15:35:8:7:6
7,100
1,500
3,500
800
700
600
Plant Depreciation
Capital Value of Plant
30:15:5:4:6
6,000
3,000
1,500
500
400
600
Supervisor’s Salary
Employee Numbers
5:15:6:4:2
3,200
500
1,500
600
400
200
37,250
9,300
12,600
6,350
4,000
5,000
(+)
 Total
Statements showing Secondary Distribution of Service Depts. Costs to Production Depts. as per
Repeated Distibution Method for the period ended 31st March, 2010
Particulars
Ratio
Total
-
`
37,250
Production Depts.
‘A’
‘B’
‘C’
`
`
`
9,300 12,600
6,350
Overhead Expenses as per Primary
Distribution Summary
Service Dept. D
2:5:2:1
800
2,000
800
Service Dept. E
1:3:4:2
540
1,620
2,160
Service Dept. D
2:5:2:1
216
540
216
Service Dept. E
1:3:4:2
11
32
43
Service Dept. D
2:5:2:1
(+)
5
12
10,872
16,804
 Total
37,250
Service Depts.
‘D’
‘E’
`
`
4,000
5,000
5
(-) 4,000
NIL
1,080
1,080
(-) 1,080
NIL
22
22
(-) 22
400
5,400
(-) 5,400
NIL
108
108
(-) 108
NIL
-
9,574
NIL
NIL
Working Notes :
1) Calculation of Overhead rate per hour in Production Dept. taking hours as a base:
=
Total Production Overheads
Working Hours
‘A’
=
` 10,872
Hrs. 1,000
= ` 10.87
‘B’
=
` 16,804
Hrs. 2,000
= ` 8.40
‘C’
=
` 9,574
Hrs. 1,000
= `9.57
Advanced Cost Accounting - II
107
Secondary Distribution of
Overheads
ILLUSTRATION 6
Sandesh Ltd., Solapur, has three manufacturing departments S1, S2, S3 and
two service departments M1 and M2. The following are the total overhead expenses
as per primary distribution summary for the month ended 31st March, 2010.
NOTES
`
Manufacturing Depts. :
•
S1
2,000
•
S2
1,800
•
S3
1,600
`
Service Depts. :
•
M1
900
•
M2
400
The expenses of service depts. are charged on a percentage basis as
follows :
Particulars
S1
S2
S3
M1
M2
Service Dept. M1
20%
30%
40%
-
10%
Service Dept. M2
40%
20%
20%
20%
-
Prepare a statement showing apportionment of Service Depts. overhead
expenses to Production Depts. by Simultaneous Equation Method.
SOLUTION
Let x be the total overheads of Service Dept. M1 and let y be the total overheads
of Service Dept. M2.
Then,
x
= ` 900 + 20% of y

x
= ` 900 +

5x
y

5
= ` 4,500 + y
... (1)
5x - y = ` 4,500

y
= ` 400 + 10 % of x

y
= ` 400 +
x

10y = ` 4,000 + x
10 y - x
= ` 4,000
Multiplying Eq. No. 2 by 5, we get,
50y - 5x
= ` 20,000
Now, the Equations are,
5x - y =
` 4,500
-5x + 50y = ` 20,000
49y = ` 24,500
108
Advanced Cost Accounting - II
10
... (2)
Secondary Distribution of
Overheads
` 24,500

y =

y =
49
500
Substituting the value of y in Eq. No. 1, we get,
5x - ` 500 =
` 4,500
NOTES

5x =
` 4,500 + ` 500

5x =
` 5,000

x =

x =
` 5,000
5
` 1,000.
In the books of Sandesh Ltd., Solapur
Statement showing Secondary Distribution of Service Depts. Overhead
Expenses to Production Depts. by Simultaneous Equation Method
for the month ended 31st March, 2010
Particulars
Total
Overhead Expenses as per
Primary Distribution Summary
Service Dept. :
Production Depts.
S1
S2
S3
`
`
`
`
5,400
2,000
1,800
1,600
900
200
300
400
400
200
100
100
6,700
2,400
2,200
2,100
M1
90% of ` 1,000
Service Dept. :
(2:3:4)
M2
80% of ` 500
(4:2:2)
(+)
 Total
ILLUSTRATION 7
Vanita Engineering Ltd., Vijapur, has three Production Departments viz.
Assembly, Cutting and Mixing and two Service Departments viz. Transport and
Power. The following are the total overhead expenses as per departmental
distribution summary for the month March, 2010.
A) Production Depts.
`
•
Assembly
2,000
•
Cutting
2,500
•
Mixing
3,000
B) Service Depts.
•
Transport
760
•
Power
700
Advanced Cost Accounting - II
109
Secondary Distribution of
Overheads
The expenses of the Service Depts. are charged out on a percentage basis
as follows :
Particulars
NOTES
Assembly Cutting Mixing
Transport Power
Service Dept. Transport
30%
30%
30%
-
10%
Service Dept. Power
20%
20%
30%
30%
-
Prepare a Statement showing apportionment of Service Dept. expenses to
Production Dept. by Simultaneous Equation Method.
SOLUTION
Let x be the total overheads of Service Dept. Transport and let y be the total
overheads of Service Dept. Power.
Then,
x
= ` 760 + 30% of y

x
= ` 760 +

10x
3y

10
= ` 7,600 + 3y
10x - 3y = ` 7,600
... (1)

y
= ` 700 + 10 % of y

y
= ` 700 +
x

10
10y = ` 7,000 + x
10y - x
= ` 7,000
Multiplying Eq. No. 2 by 10 we get,
100 y - 10x
= ` 70,000
Now, the Equations are,
10x - 3y = ` 7,600
-10x + 100y = ` 70,000
97y = ` 77,600
` 77,600

y
=

y
= ` 800
97
Substituting the value of y in Eq. No. 1, we get,
10x - 3 x `800
= ` 7,600

10x - ` 2,400
= ` 7,600

10x

x
=

x
= ` 1,000
= ` 7,600 + ` 2,400
` 10,000
110
Advanced Cost Accounting - II
10
... (2)
Secondary Distribution of
Overheads
In the books of Vanita Engineering Ltd., Vijapur
Statement showing Secondary Distribution of Service Depts. cost
to Production Depts. by Simultaneous Equation Method
for the month ended 31st March, 2010
Particulars
Total
Production Depts.
Assembly Cutting
`
`
`
Overhead Expenses as per Departmental
Distribution Summary
NOTES
Mixing
`
7,500
2,000
2,500
3,000
(3:3:3)
900
300
300
300
(2:2:3)
560
160
160
240
8,960
2,460
2,960
3,540
Service Dept. : Transport
90% of ` 1,000
Service Dept. : Power
70% of ` 800
(+)
 Total
ILLUSTRATION 8
You are supplied with the following information of Ravalgaon Ltd.,
Ranjangaon, for the year ended 31st March, 2010, from which work out the
production hour rate of recovery of overheads in Depts. ‘A’, ‘B’ & ‘C.
Particulars
Total
Production Depts.
Service Depts.
`
A
`
B
`
C
`
D
`
E
`
12,000
2,400
4,800
2,000
2,000
800
General Overheads
3,600
100
2,100
800
300
300
Indirect Materials
5,900
1,200
2,000
1,000
1,300
400
Machinery Depreciation
5,000
2,500
1,600
200
500
200
Electric Lighting
4,000
800
2,000
500
400
300
7,000 12,500
4,500
4,500
2,000
1,125
-
-
Factory Rent
(+)
 Total
30,500
Estimated Working Hours
17,500
3,000
Expenses of the Service Depts. D and E are to be apportioned as per
Simultaneous Equation Method as under :
Particulars
‘A’
‘B’
‘C’
‘D’
‘E’
Service Dept. ‘D’
30%
40%
20%
-
10%
Service Dept. ‘E’
10%
20%
50%
20%
-
Advanced Cost Accounting - II
111
Secondary Distribution of
Overheads
SOLUTION
Let x be the total overheads of Service Dept. ‘D’ and let y be the total
overheads of Service Dept. ‘E’.
Then,
x
= ` 4,500 + 20% of y

x
= ` 4,500 +

5x
NOTES
y

5
= ` 22,500 + y
5x - y = ` 22,500
... (1)

y
= ` 2,000 + 10 % of x

y
= ` 2,000 +
x

10
10y = ` 20,000 + x
10y - x
= ` 20,000
Multiplying Eq. No. 2 by 5, we get,
50y - 5x
= ` 1,00,000
Now, the Equations are,
5x - y = ` 22,500
-5x + 50y = ` 1,00,000
49y = ` 1,22,500
` 1,22,500

y
=

y
= ` 2,500
49
Substituting the value of y in Eq. No. 1, we get,
5x - ` 2,500
= ` 22,500
5x
= ` 22,500 + ` 2,500

5x
= ` 25,000

x
=

x
= ` 5,000
` 25,000
112
Advanced Cost Accounting - II
5
... (2)
In the books of Ravalgaon Ltd., Ranjangaon
Statement showing Secondary Distribution of Service Depts. cost
to Production Depts. as per Simultaneous Equation Method
Secondary Distribution of
Overheads
for the month ended 31st March, 2010
Particulars
Total
Production Depts.
`
‘A’
`
‘B’
`
‘C’
`
24,000
7,000
12,500
4,500
(3:4:2)
4,500
1,500
2,000
1,000
(1:2:5)
2,000
250
500
1,250
30,500
8,750
15,000
6,750
Overhead Expenses as per Primary
NOTES
Distribution Summary
Service Dept. : ‘D’
90% of ` 5,000
Service Dept. : ‘E’
70% of ` 2,500
(+)
 Total
Working Notes :
1)
Calculation of of Production hour rate of recovery of overheads taking
estimated working hours as a base.
=
Total Production Overheads
Estimated Working Hours
‘A’
‘B’
` 8,750
=
Hrs. 1,750
=`5
‘C’
` 15,000
=
Hrs. 3,000
=`5
` 6,750
=
Hrs. 1,125
= Rs.6
ILLUSTRATION 9
Tata Engineering Co. Ltd., Tatanagar, has three Production Depts. viz. ‘A’,
‘B’ and ‘C’ and two service Depts. viz. ‘P’ and ‘Q’. The following figures are
extracted from their books for the month ended 31st March, 2010.
Indirect Expenses :
Production Depts.
`
•
‘A’
100
•
‘B’
600
•
‘C’
300
Service Depts.
`
•
‘P’
700
•
‘Q’
300
Electric Lighting
2,000
Power
3,000
Plant Depreciation
9,000
Rent and Taxes
5,500
Advanced Cost Accounting - II
113
Secondary Distribution of
Overheads
The other details are as follows :
Particulars
‘A’
‘B’
No.
14
10
4
8
4
KWH
50
30
20
30
20
` 70,000
30,000
Light Points
Electricity
NOTES
Value of Plant
Floor Space
‘C’
‘P’
‘Q’
10,000 30,000 10,000
Sq. ft.
4,000
3,000
1,000
2,000
1,000
Hrs.
2,500
2,250
2,375
-
-
Working Hours
The expenses of the Service Depts. ‘P’ and ‘Q’ are to be alloted as follows :
Particulars
‘A’
‘B’
‘C’
‘P’
‘Q’
Service Dept. ‘P’
30%
20%
40%
-
10%
Service Dept. ‘Q’
20%
30%
30%
20%
-
You are required to distribute the Service Dept. expenses to Production
Dept. under Simultaneous Equation Method. Also calculate hourly rate of each
Production Dept.
SOLUTION
In the books of Tata Engineering Co. Ltd., Taranagar
Statements showing Primary Distribution of Overhead Expenses
for the month ended 31st March, 2010
Particulars
Basis of Apportionment
Ratio
Total
Production Depts. Service Depts.
`
‘A’
`
‘B’
`
‘C’
`
‘P’
`
‘Q’
`
-
2,000
700
600
300
700
300
Indirect Expenses
Actual
Electric Lighting
Light Points
7:5:2:4:2
2,000
700
500
200
400
200
Power
Electricity K.W.H.
5:3:2:3:2
3,000
1,000
600
400
600
400
Plant Depreciation Value of Plant
7:3:1:3:1
9,000
4,200
1,800
600 1,800
600
Rent and Taxes
4:3:1:2:1
5,500
2,000
1,500
500 1,000
500
Floor space Sq. ft.
(+)
 Total
21,500 8,000
5,000 2,000 4,500 2,000
Let x’ be the total overheads of Service Dept. ‘P’ and let y’ be the total
overheads of Service Dept. ‘Q’.
Then,
x
= ` 4,500 + 20% of y

x
= ` 4,500 +

5x
y

114
Advanced Cost Accounting - II
5
= ` 22,500 + y
5x - y = ` 22,500
... (1)

y
= ` 2,000 + 10 % of x

y
= ` 2,000 +
x
10

10y =
10y - x
=
Secondary Distribution of
Overheads
` 20,000 + x
` 20,000
... (2)
Multiplying Eq. No. 2 by 5, we get,
50y - 5x =
` 1,00,000
Now, the Equations are,
NOTES
5x - y =
` 22,500
-5x + 50y =
` 1,00,000
49y =
` 1,22,500
` 1,22,500

y =

y =
49
` 2,500
Substituting the value of y in Eq. No. 1, we get,
5x - ` 2,500
=
` 22,500

5x =
` 22,500 + ` 2,500

5x =
` 25,000

x =

x =
` 25,000
5
` 5,000
In the books of Tata Engineering Co. Ltd., Tatanagar
Statement showing Secondary Distribution of Service Depts. Overhead
Expenses to Production Depts. by Simultaneous Equation Method
for the month ended 31st March, 2010
Particulars
Total
Production Depts.
`
A
`
B
`
15,000
8,000
5,000
2,000
(3 : 2 : 4)
4,500
1,500
1,000
2,000
(2 : 3 : 3)
2,000
500
750
750
21,500
10,000
6,750
4,750
Overhead Expenses as per Primary
Distribution Summary
C
`
Service Dept. : ‘P’
90% of ` 5,000
Service Dept. : ‘Q’
80% of ` 2,500
(+)
 Total
Advanced Cost Accounting - II
115
Secondary Distribution of
Overheads
Working Notes :
1)
Calculation of of hourly rate of Production Department =
Total Production Overheads
Working Hours
NOTES
‘A’
‘B’
` 10,000
=
` 6,750
=
Hrs. 2,500
=
‘C’
`4
=
Hrs. 2,250
`3
` 4,750
=
=
Hrs. 2,375
`2
ILLUSTRATION 10
In Peacock Industries Ltd., Pune, there are three production departments
viz. ‘X’, ‘Y’, ‘Z’ and two Service departments viz. ‘A’ and ‘B’. The primary
distribution summary of March, 2010, gives the following details `
Production Depts.
•
‘X’
23,000
•
‘Y’
6,000
•
‘Z’
6,500
`
Service Depts.
•
‘A’
4,500
•
‘B’
2,000
The Service Dept. expenses are charged out on a percentage basis as follows :
Particulars
‘X’
‘Y’
‘Z’
‘A’
‘B’
Service Dept. ‘A’
40%
30%
20%
-
10%
Service Dept. ‘B’
30%
30%
20%
20%
-
You are required to apportion the cost of Service Depts. to Production
Depts. under Repeated Distribution Method and Simultaneous Equation Method.
116
Advanced Cost Accounting - II
Secondary Distribution of
Overheads
SOLUTION
In the books of Peacock Industries Ltd., Pune
Statements showing Secondary Distribution of Service Depts. Costs to Production Depts.
as per Repeated Distibution Method for the period ended 31st March, 2010
Particulars
Ratio
Total
`
Overhead Expenses as per
-
42,000
Production Depts.
Service Depts.
‘A’
`
‘B’
`
‘C’
`
‘D’
`
‘E’
`
23,000
6,000
6,500
4,500
2,000
(-) 4,500
450
Primary Distribution Summary
Service Dept. ‘A’
4:3:2:1
1,800
1,350
900
Service Dept. ‘B’
3:3:2:2
735
735
490
Service Dept. ‘A’
4:3:2:1
Service Dept. ‘B’
196
3:3:2:2
Service Dept. ‘A’
14
4:3:2:1
147
98
15
10
NIL
2,450
490
(-) 2,450
490
NIL
(-) 490
49
NIL
49
10
(-) 49
10
NIL
5
3
2
(-) 10
-
25,750
8,250
8,000
NIL
NIL
(+)
 Total
42,000
Simultaneous Equation Method :
Let ‘P’ be the total overheads of Service Dept. ‘A’ and let ‘Q’ be the total
overheads of Service Dept. ‘B’.
Then,
P
=
` 4,500 + 20% of Q

P
=
` 4,500 +

5P
=
` 22,500 + Q

5P - Q =

Q
=
` 2,000 + 10 % of P

Q
=
` 2,000 +

10Q
=
` 20,000 + P
10Q - P
=
` 20,000
Q
5
` 22,500
... (1)
P
10
... (2)
Multiplying Eq. No. 2 by 5, we get,
=
` 1,00,000
5P - Q =
` 22,500
-5P + 50Q =
` 1,00,000
50Q - 5P
Now, the Equations are,
49Q
=
` 1,22,500
Advanced Cost Accounting - II
117
Secondary Distribution of
Overheads
` 1,22,500

Q
=

Q
= ` 2,500
49
Substituting the value of Q in Eq. No. 1, we get,
NOTES
5P - ` 2,500
= ` 22,500

5P
= ` 22,500 + ` 2,500

5P
= ` 25,000

P
=

P
= ` 5,000
` 25,000
5
In the books of Peacock Industries Ltd., Pune
Statement showing Secondary Distribution of Service Depts.
Cost to Production Depts. as per Simultaneous Equation Method
for the month ended 31st March, 2010
Particulars
Total
Production Depts.
`
‘X’
`
‘Y’
`
‘Z’
`
35,500
23,000
6,000
6,500
(4:3:2)
4,500
2,000
1,500
1,000
(3:3:2)
2,000
750
750
500
42,000
25,750
8,250
8,000
Overhead Expenses as per Primary
Distribution Summary
Service Dept. : ‘A’
90% of ` 5,000
Service Dept. : ‘B’
80% of ` 2,500
(+)
 Total
ILLUSTRATION 11
Universal Engineering Co. Ltd., Ulhasnagar, has four Production Depts. A1, A2, A3 and A4 and two service Depts. - B1 and B2.
The particulars of expenses of these depts. for the period ended 31-3-2010,
are as follows :
Production Depts.
•
A1
1,000
•
A2
900
•
A3
800
•
A4
700
Service Depts.
118
Advanced Cost Accounting - II
`
`
•
B1
550
•
B2
380
The expenses of Service Depts. are charged out on a percentage basis
given below :
Particulars
A1
A2
A3
A4
B1
B2
Service Dept. B1
10%
30%
20%
20%
-
20%
Service Dept. B2
30%
20%
30%
10%
10%
-
You are required to apportion the Service Depts. expenses to various
Production Depts. under a)
Secondary Distribution of
Overheads
NOTES
Simultaneous Equation Method, and b) Repeated Distribution Method.
SOLUTION
a)
Simultaneous Equation Method :
Let x’ be the total overheads of Service Dept. B1 and let y’ be the total
overheads of Service Dept. B2.
Then,
x =
` 550 + 10% of y

x =
` 550 +

10x =

10x - y =

y =
` 380 + 20 % of x

y =
` 380 +

5y =
y
10
` 5,500 + y
` 5,500
... (1)
x
5y - x
=
5
` 1,900 + x
` 1,900
... (2)
Multiplying Eq. No. 2 by 10, we get,
50y - 10x =
` 19,000
Now, the Equations are,
10x - y =
` 5,500
-10x + 50y =
` 19,000
49y =
` 24,500
` 24,500

y =

y =
49
` 500
Substituting the value of y in Eq. No. 1, we get,
10x - ` 500 =

10x =
` 5,500
` 5,500 + ` 500
Advanced Cost Accounting - II
119
Secondary Distribution of
Overheads
= ` 6,000

10x

x
=

x
= ` 600
` 6,000
10
NOTES
In the books of Universal Engineering Co. Ltd., Ulhasnagar
Statement showing Secondary Distribution of Service Depts. Cost to
Production Depts. under Simultaneous Equation Method
for the period ended 31st March, 2010
Particulars
Total
Production Depts.
A1
A2
A3
A4
`
`
`
`
`
3,400
1,000
900
800
700
(1:3:2:2)
480
60
180
120
120
(3:2:3:1)
450
150
100
150
50
4,330
1,210
1,180
1,070
870
Overhead Expenses as per Primary
Distribution Summary
Service Dept. : B1
80% of ` 600
Service Dept. : B2
90% of ` 500
(+)

b)
Total
Repeated Distribution Method :
In the books of Universal Engineering Co., Ltd., Ulhasnagar
Statements showing Secondary Distribution of Service Depts. Costs to Production Depts. as per
Repeated Distibution Method for the period ended 31st March, 2010
Particulars
Ratio
`
4,330
Production Depts.
Service Depts.
A1
`
1,000
A2
`
900
A3
`
800
A4
`
700
B1
`
550
B2
`
380
110
490
(-) 490
NIL
10
10
(-) 10
NIL
Overhead Expenses as per Primary
Distribution Summary
Service Dept. B1
1:3:2:2:2
55
165
110
110
Service Dept. B2
3:2:3:1:1
147
98
147
49
Service Dept. B1
1:3:2:2:2
5
14
10
10
Service Dept. B2
3:2:3:1:1
(+)
3
3
3
1
(-) 550
NIL
49
49
(- )49
NIL
-
1,210
1,180
1,070
870
NIL
 Total
120 Advanced Cost Accounting - II
-
Total
4,330
Secondary Distribution of
Overheads
ILLUSTRATION 12
Cadbury Ltd., Chalisgaon, has three Production Depts. viz. ‘P’, ‘Q’ and
‘R’ and two Service Detps. ‘S’ and ‘T’. The Primary distribution summary of
March, 2010, gives the following details.
`
Production Depts.
•
‘P’
` 8,000
•
‘Q’
` 7,000
•
‘R’
` 8,000
NOTES
`
Service Depts.
•
‘S’
` 5,000
•
‘T’
` 2,000
The Service Depts. costs of ‘S’ and ‘T’ Depts. are to be charged on the
basis of the following percentages.
Particulars
‘P’
‘Q’
‘R’
‘S’
‘T’
Service Dept. ‘S’
20%
40%
30%
-
10%
Service Dept. ‘T’
40%
20%
30%
10%
-
You are required to find out the total production overheads under Repeated
Distribution Method and Simultaneous Equation Method.
SOLUTION
In the books of Cadbury Ltd., Chalisgaon
Statements showing Secondary Distribution of Service Detps. Cost to Production Depts.
as per Repeated Distribution Method for the month ended 31st March, 2010
Particulars
Ratio
`
30,000
Production Depts.
‘Q’
`
7,000
‘R’
`
8,000
1,500 (-) 5,000
500
NIL
2,500
1,500
250 (-) 2,500
250
NIL
75
(-) 250
25
NIL
25
9
(-) 25
2:4:3:1
1,000
2,000
Service Dept. ‘T’
4:2:3:1
1,000
2,000
Service Dept. ‘S’
2:4:3:1
50
100
Service Dept. ‘T’
4:2:3:1
(+)
10
6
10,060
9,606
30,000
Service Depts.
‘P’
`
8,000
Overhead Expenses as per
Primary Distribution Summary
Service Dept. ‘S’
 Total
-
Total
10,334
‘S’
`
5,000
NIL
‘T’
`
2,000
NIL
Advanced Cost Accounting - II
121
Secondary Distribution of
Overheads
a)
Simultaneous Equation Method :
Let x be the total overheads of Service Dept. ‘S’ and let y be the total
overheads of Service Dept. ‘T’.
Then,
x
= ` 5,000 + 10% of y

x
= ` 5,000 +

10x
NOTES
y

10
= ` 50,000 + y
10x - y = ` 50,000
... (1)

y
= ` 2,000 + 10 % of x

y
= ` 2,000 +
x

10
10y = ` 2,000 + x
10y - x
= ` 20,000
Multiplying Eq. No. 2 by 10, we get,
100y - 10x
= ` 2,00,000
Now, the Equations are,
10x - y = ` 50,000
-10x + 100y = ` 2,00,000
99y = ` 2,50,000
` 2,50,000

y
=

y
= ` 2,525
99
Substituting the value of y in Eq. No. 1, we get,
10x - ` 2,525
= ` 50,000

10x
= ` 50,000 + ` 2,525

10x
= ` 52,525

x
=

x
= ` 5,252
` 52,525
122 Advanced Cost Accounting - II
10
... (2)
Secondary Distribution of
Overheads
In the books of Cadbury Ltd., Chalisgaon
Statement showing Secondary Distribution of Service Depts. Cost of
Production Depts. as per Simultaneous Equation Method
for the month ended 31st March, 2010
Particulars
Overhead Expenses as per Primary
Distribution Summary
Service Dept. : ‘S’
90% of ` 5,252
Service Dept. : ‘T’
90% of ` 2,525

8.4
Total
Total
Production Depts.
`
23,000
‘P’
`
8,000
‘Q’
`
7,000
‘R’
`
8,000
(2:4:3)
4,727
1,050
2,101
1,576
(4:2:3)
(+)
2,273
1,010
505
758
30,000
10,060
NOTES
9,606 10,334
Summary
Secondary distribution of overheads is the step taken after total amount of
overheads for each production department and each service department is
calculated by completing the step of primary distribution of overhead. Secondary
distribution of overheads becomes necessary because service departments do
not carry on any production activity and do not produce any goods. Service
department overheads are apportioned to production departments and other service
departments. For this, ‘non-reciprocal basis of distribution of overhead’s or
‘reciprocal basis of distributions of overheads’ is used. Under reciprocal basis of
distribution of overheads, three methods, viz. Simultaneous Equation Method,
Repeated Distribution Method and Trial and Error Method, are used for secondary
distribution of overheads. After completing the secondary distribution of overheads
only production departments show the amounts of overheads.
8.5
Key Terms
i)
Secondary Distribution of Overheads : Distribution or apportionment
of overheads of service departments to production departments is called
secondary distribution of overheads.
ii)
Non-Reciprocal Basis of Apportionment : Apportionment of overheads
of service departments done to production and other service departments
by assuming that the service department whose overheads are being
apportioned dose not receive any service from the remaining service
departments.
iii)
Reciprocal Basis of Apportionment : Apportionment of overheads of
service departments is done by assuming that each service department
Advanced Cost Accounting - II
123
Secondary Distribution of
Overheads
provides service to production departments and other service departments
and also receives service from other service departments.
8.6
Questions and Exercises
NOTES
I - Theory Questions
1.
What is meant by ‘Secondary distribution of overheads’? How it differs
from primary distribution of overheads ?
2.
What is the difference between ‘non-reciprocal basis of apportionment of
overheads’ and ‘reciprocal basis of apportionment of overheads’ ?
3.
Explain the methods which can be used for secondary distribution of
overheads.
4.
Explain ‘simultaneous equation method’ of secondary distribution of
overheads.
5.
What is the procedure followed while using ‘repeated distribution method’
of secondary distribution of overheads ?
6.
Describe ‘trial and error method’ of secondary distribution of overheads.
II - Multiple Choice Questions
1.
Distribution of overheads of service departments to production department
is called ----------- of overheads.
(a) Primary distribution
(b) Secondary distribution
(c) Allocation
(d) Classification
2.
In ----------- method algebraic equation are formed to find out the total
overheads of the two service departments.
(a) Simultaneous equation
(b) Repeated distribution
(c) Trial & Error
(d) apportioning of service
3.
Under ------------- method, the apportionment of overheads of service
departments are distributed only between or among the service department.
(a) Trial & Error
124 Advanced Cost Accounting - II
Secondary Distribution of
Overheads
(b) Repeated distribution
(c) Simultaneous equation
(d) apportioning of services
4.
In ------------- method the overhead amount as per primary distribution are
recorded in the columns prepared for the production & service departments.
NOTES
(a) Trial & Error
(b) Repeated Distribution
(c) Operating of services
(d) Simultaneous equation.
Ans. : (1 - b), (2 - a), (3 - a), (4 - d).
III - Exercises
1.
Following cost information relating to Ambassador Ltd. Ahmednagar, for
the month March, 2010 is available.
Particulars
Production Departments
‘A’
‘B’
‘C’
Service Departments
Office
Stores Workshop
Direct Wages
`
20,000
25,000
30,000
-
-
-
Direct Material
`
30,000
35,000
45,000
-
-
-
Indirect Material
`
2,000
3,000
3,000
1,000
2,000
2,000
Indirect Wages
`
3,000
3,000
4,000 10,000
10,000
5,000
200
250
300
150
100
250
30,000
25,000
25,000
-
-
15,000
Total H.P. of Machine
15
20
25
-
-
5
Machine Hrs. Worked
10,000
20,000
15,000
-
-
5,000
Area in Sq. Mtrs.
Book value of
Machinery
`
Other items are as follows :
General Expenses
Rent
Depreciation
` 12,500
` 1,050
15% of Value of Machine
Power
` 3,800
Light
` 1,250
You are requested to prepare an overhead analysis sheet for the
departments showing the apportionment of total cost of service departments to
production depatments on an appropriate basis.
2.
Surabhi Ltd., Surat, is divided into two production departments ‘A’ and ‘B’
and two service departments ‘X’ and ‘Y’. The following is the summary of
overhead costs for a particular period.
Advanced Cost Accounting - II
125
Secondary Distribution of
Overheads
`
Works Manager’s Salary
4,000
Power
NOTES
21,000
Contribution to Provident Fund
9,000
Plant Maintenance
4,000
Depreciation on Plant and Machinery
20,000
Rent paid
6,000
Canteen Expenses
12,000
Following information is also available from the various departments.
Particulars
‘A’
Number of employees
‘B’
‘X’
‘Y’
No.
16
8
4
4
Sq. mtrs.
2,000
3,000
500
500
Value of plant
`
75,000
1,00,000
25,000
-
Wages paid
`
40,000
20,000
10,000
5,000
HP
3
3
1
-
Area in Sq. meters
H.P. Ratio
Apportion to cost to the various departments on the most suitable basis.
3.
In Modern Enterprises, Mumbai, there are three production departments
‘A’, ‘B’, ‘C’ and one service department.
The following figures are available for one month of 25 working days of 8
hours each day. All departments work all these days with full attendance.
Particulars
Service Depts.
‘S’
Production Depts.
‘A’
‘B’
‘C’
Power and Lighting
`
240
200
300
360
Supervisor’s Salary
` 2,000
-
-
-
-
Rent
` 500
-
-
-
-
Welfare Expenses
` 600
-
-
-
-
Other Expenses
`
200
200
400
400
Supervisor’s Salary
%
20%
30%
30%
20%
Number of Workers
No.
10
30
40
20
Sq. mtrs.
500
600
800
600
50%
30%
20%
Floor area in Sq. mtrs.
Service rendered by Service Dept. to
Production Dept.
%
Calculate overhead recovery rate of the departments ‘A’, ‘B’, and ‘C’.
126 Advanced Cost Accounting - II
4.
Nano Enterprises Ltd., Nashik, has three Production departments ‘A’, ‘B’,
‘C’ and two Service departments ‘D’ and ‘E’.
Secondary Distribution of
Overheads
The following figures are extracted from their records.
`
Rent and Rates
5,000
General Lighting
600
Indirect Wages
1,500
Power
1,500
Depreciation of Machinery
10,000
Sundries
10,000
NOTES
The following further details are available :
Particulars
Total
‘A’
‘B’
‘C’
‘D’
‘E’
10,000
2,000
2,500
3,000
2,000
500
60
10
15
20
10
5
`
10,000
3,000
2,000
3,000
1,500
500
HP
150
60
30
50
10
-
`
2,50,000
60,000
80,000 1,00,000
5,000
5,000
-
6,226
4,028
4,066
-
-
Floor Space
Sq.Ft.
Light Points
No.
Direct Wages
H.P. of Machines
Value of Machinery
Working Hours
Hrs.
The expenses of ‘D’ and ‘E’ are allocated as follows :
Particulars
‘A’
‘B’
‘C’
‘D’
‘E’
Dept. ‘D’
20%
30%
40%
-
10%
Dept. ‘E’
40%
20%
30%
10%
-
Calculate the Overhead Recovery Rate for each of these departments.
Sundry expenses are to be allocated on the basis of direct wages. What is the
total cost of article if material cost is ` 30 and it passes through Dept. ‘A’, ‘B’ and
‘C’ for 4 ,5 and 8 hours respectively.
5.
The primary distribution of expenses disclosed the following details in respect
of Production departments P1, P2 and P3 and Service department S1 and S2.
Departments
P1
P2
P3
S1
S2
6,300
7,400
2,800
4,500
2,000
P1
P2
P3
S1
S2
S1
40%
30%
20%
-
10%
S2
30%
30%
20%
20%
-
Overheads
`
The services given by S1 and S2 are as below :
Departments
Find out the overheads chargeable to Production departments by using
Simultaneous Equation Method.
6.
Baramati Ltd., Baramati, there are two Service departments ‘P’ and ‘Q’
and three Production departments ‘A’, ‘B’ and ‘C’. In April 2010, the departmental
as expenses were :
Advanced Cost Accounting - II
127
Secondary Distribution of
Overheads
Departments
‘A’
`
75,000
‘B’
‘C’
‘P’
60,000 50,000
‘Q’
12,000 10,000
The service department expenses are allotted on a percentage basis as
follows :
NOTES
Service Depts.
Production Depts.
Service Depts.
‘A’
‘B’
‘C’
‘P’
‘Q’
P
%
30
40
15
-
15
Q
%
40
30
25
5
-
Prepare a statement showing the distribution of the two Service departments
expenses to the three production departments by Simultaneous Equation Method,
and Repeated Distribution Method.
7.
Work out overhead recovery rate under Repeated Distribution Method and
Simultaneous Equation Method.
Primary Overheads are as follows.
Production Depts.
Service Depts.
`
•
‘A’
-
7,810
•
‘B’
-
12,540
•
‘C’
-
4,550
•
‘D’
-
3,000
`
Transport ‘P’
-
4,000
Power ‘Q’
-
2,700
Expenses of Service Depts. are apportioned as under ‘A’
‘B’
‘C’
‘D’
‘P’
‘Q’
P
10%
30%
20%
20%
-
20%
Q
30%
20%
30%
10%
10%
-
Estimated Labour Hours are : ‘A’ - 900, ‘B’ - 2,700, ‘C’ - 1,500.
8.7
128 Advanced Cost Accounting - II
Further Reading
i)
‘Advanced Cost Accounting’ - Nigam and Sharma
ii)
‘Cost Accounting - Principles and Practice’ - N. K. Prasad
iii)
‘Cost Accounting’ - Jawahar Lal
iv)
‘Theory and Practice of Cost Accounting’ - M. L. Agrawal
v)
‘Cost Accounting’ - B. K. Bhar
Unit 9
Absorption of Overheads, Absorption
of Factory Overheads
Absorption of overheads,
Absorption of Factory Overheads
Structure
NOTES
9.0
Introduction
9.1
Unit Objectives
9.2
Absorption of overheads
9.2.1
Actual Overhead Rate
9.2.2
Pre-determined Overhead Rate
9.3
Methods of absorption of overheads
9.4
Methods of absorption of factory overheads
9.4.1
Percentage of direct materials cost
9.4.2
Percentage of direct wages
9.4.3
Percentage of prime cost
9.4.4
Direct labour hour rate
9.4.5
Machine hour rate
9.4.6
Rate per unit of production
9.5
Summary
9.6
Key Terms
9.7
Questions and Exercises
9.8
Further Reading
9.0
Introduction
In Unit 8, it is explained that after doing secondary distribution of overheads
only production departments show the amounts of overheads. The amount of
overhead shown by each production department is to be charged to the output or
jobs completed and this process of charging overheads to output or jobs is called
‘absorption of overheads’. Overheads recorded as factory overheads, office and
administration overheads and selling and distribution overheads are absorbed
separately and different methods are used for such absorption. In this Unit
information is provided explaining meaning of overheads absorption and methods
used for absorption of factory overheads.
Advanced Cost Accounting - II
129
Absorption of overheads,
Absorption of Factory Overheads
9.1
Unit Objectives
After studying the information provided in this Unit you should be able to:
NOTES
•
understand meaning of absorption of overheads,
•
understand difference between actual overhead rate and pre-determined
overhead rate, and
•
know the different methods used for absorption of factory overheads and
how to use these methods.
9.2
Absorption of Overheads
This is the objective for which the primary and secondary distribution is
done. Overheads represent costs incurred for the cost centre or departments and
so the overheads incurred are required to be included in the costs of the products
so that total cost of a unit produced can be calculated and by adding the expected
amount of profit, the selling price of the unit of the product can be fixed. Absorption
of overheads thus means inclusion or recovery of the overheads costs by charging
them to the products or jobs or processes for which they are incurred. For absorption
of overheads the amount of overheads as per secondary distribution are required
to be charged to the units of the product or products and for this purpose overhead
absorption rate is to be calculated by dividing the amount of overheads by a basis
selected which may be number of units, materials, prime cost, labour hours, direct
labour cost or machine hours. Therefore, the formula for overhead absorption
rate can be stated as :
Total Amount of Overheads
Overhead Absorption Rate =
Basis Selected
Once the overhead absorption rate is calculated, it is used to charge overhead
amount to unit of a product or a job completed or a process carried out.
9.2.1 Actual Overhead Rate
130 Advanced Cost Accounting - II
When an overhead absorption rate is calculated by using the actual amount
of overheads and the actual quantity or value of the basis (such as number of
units produced, the value of materials consumed, actual labour hours, actual machine
hours, worked, etc.) the overhead absorption rate so obtained is called ‘an actual
overhead rate’. When actual overhead rates are used, the full amount of overheads
incurred can be charged/recovered from the output. However, actual overhead
rate can be calculated only at the end of the accounting period since the actual
amount of overheads as well as the actual quantity or value of the basis to be
used becomes available only after the books are closed at the end of the year.
Production activity and sales activity are carried out continuously in any business
unit and for selling the products manufactured, the selling price must be decided
for the products or jobs immediately. This cannot be done if actual rate of overhead
is to be used. So instead of the actual rate of overheads, estimated or pre-determined
overhead rates are required to be used.
Absorption of overheads,
Absorption of Factory Overheads
9.2.2 Pre-determined Overhead Rate
For calculating the pre-determined overhead rate, the overhead amount
as well as the quantity or value in the basis used are required to be estimated
before the activity is started. Pre-determined overhead rate is a rate decided in
advance before the commencement of the period in which it is to be used. An
estimate of the overheads likely to be incurred in the next period and on estimate
of the basis quantity or value for the next period is required to be made. By
dividing the estimated amount of overheads amount by the estimated basis for
the next period, the pre-determined overhead absorption rate is calculated and
overheads are absorbed in the next period. e.g. for the next year overheads amount
is estimated as `48,000 and for the next year the output is estimated as 8,000
units. The pre-determined overhead absorption rate will be -
NOTES
`48000
= ` 6 per unit of output.
8000 units
By using the pre-determined overhead rate calculation of the total cost and
fixation of the selling price per unit of output becomes possible in advance. However,
the estimation of overhead amounts and estimation of the basis to be used must
be done properly. Error in estimation of either of the two things leads to underabsorption or over- absorption of overheads.
9.3
Methods of absorption of overheads
Generally the overheads are grouped under three categories – Factory
overheads, Office and Administration overheads and Selling and Distribution
Overheads. As the nature of these three categories of overheads is different the
same methods cannot be used for absorption of these overheads. Therefore, the
methods of absorption of overheads are considered under the following ways :1.
Methods of absorption of factory overheads,
2.
Methods of absorption of office and administration overheads, and
3.
Methods of absorption of selling and distribution overheads.
9.4
Check Your Progress
i)
What is the meaning of
‘absorption
of
overheads’ ?
ii) Compare
‘Actual
Overhead Rate’ and
‘Pre-Determined
Overhead Rate’ stating
advantages
and
disadvantages of each.
Methods of absorption of factory overheads
Factory overheads incurred for manufacturing of the products or completion
of jobs depend upon different factors such as direct materials cost, direct wages,
labour hours and machine hours and so while calculating the factory overhead
absorption rate which factor influences the amount of factory overheads is required
to be taken into consideration. There are following six methods out of which a
Advanced Cost Accounting - II
131
Absorption of overheads,
Absorption of Factory Overheads
NOTES
manufacturing concern is required to select the method most suitable for it :1.
Percentage of direct materials cost
2.
Percentage of direct wages
3.
Percentage of prime cost
4.
Direct labour hour rate
5.
Machine hour rate
6.
Rate per unit of production
9.4.1 Percentage of direct materials cost
In this method of absorption of factory overheads the cost of direct materials
consumed in the factory and the amount of factory overheads incurred are
considered and their percentage is calculated and used as a rate for absorption of
the factory overheads.
Factory Overheads
x 100
Factory Overheads Rate =
Direct Material Cost
Thus, if the amount of factory overheads is `60,000 and the cost of direct
materials consumed is `2,00,000 the overhead rate is
60,000
x 100 = 30%
2,00,000
If a job completed in the factory has consumed direct materials of `4000,
it will be charged with factory overheads of `1,200, being 30% of the direct
material cost of the job.
Advantages :
The advantages of this method of overhead absorption are as under :
i)
The method is simple and easy to follow. The amount of direct materials
cost of a product or a job are easily available and so calculation of the
factory overhead absorption rate and its application to the products produced
or jobs completed in the factory can be done without any difficulty.
ii)
This method can be suitably used in those concerns which use the same
direct materials for carrying on their production activity. When materials
prices are relatively stable use of this method gives satisfactory results.
Disadvantages :
i)
132 Advanced Cost Accounting - II
This method assumes that the factory overheads are dependent upon the
direct material cost. However, most of the factory overheads are dependent
upon other factors such as machine hours or labour hours. Use of this
method of absorption of factory overheads in such circumstances does not
give proper results.
ii)
Direct materials used for two types of products or two different jobs may
not be same. One product may require high quality costly material while the
other product may need average or low quality material whose cost is low.
Under this method, the first product will be charged with more amount of
factory overheads as compared to the second product. Actually the second
product may be responsible for incurring more amount of the factory
overheads.
iii)
When the prices of direct materials fluctuate over a period, the amount
of factory overheads absorbed will also be different. The factory overheads
incurred, however, may remains same in the two periods because they are
dependent upon time factor and not on the cost of direct materials.
iv)
In this method for charging factory overheads attention is given only to the
cost of direct materials consumed. Factory overheads, however, depend
upon whether the work of production is done by using machine power or it
is done manually and also whether it is done by skilled or unskilled workers.
Absorption of overheads,
Absorption of Factory Overheads
NOTES
9.4.2 Percentage of direct wages
In this method for calculating the overhead rate the amount of direct wages
of the factory and the amount of factory overheads incurred in the same period
are taken into consideration. The overhead rate is calculated as under :Factory overheads
x 100
Factory overhead rate =
Direct wages
Assuming that the factory overheads of a manufacturing company for a
certain period amount to `1,25,000 and direct wages paid for the same period
amount to `5,00,000, the factory overhead rate will be as under :
Factory Overheads
x 100
Factory Overhead Rate =
Direct Wages
1,25,000
x 100
=
5,00,000
=
25%
If for manufacturing one unit of a product direct wages paid are `180, then
the factory overheads to be charged to that unit of the product will be :
` 180 x 25% = ` 45
Advanced Cost Accounting - II
133
Absorption of overheads,
Absorption of Factory Overheads
Advantages :
Absorption of factory overheads as a percentage of direct wages gives
the following advantages :i)
In most of the concerns the direct wages are paid on the basis of the time.
Factory overheads amount for a number of items of overheads also
depend upon the period. So absorption of factory overheads by using direct
wages as a basis appears logical.
ii)
Direct wages rates are fixed for a period of 2 to 3 years by a contract
between the management and the trade union. So the wage rates do not
fluctuate as the material prices fluctuate. Therefore the overhead rate
calculated on the basis of direct wages remains stable over a period and the
factory overheads absorbed by using this rate can give correct amount to
be charged for factory overheads.
iii)
When the category of workers employed to carry on particular production
activity remains same for different jobs or when single type of product is
being produced by a concern, the overheads charged by using this method
prove more appropriate.
iv)
This method is easy to understand and follow. Since record of direct wages
paid is maintained by every concern information about direct wages is easily
available for calculation of factory overhead rate and additional records are
not required to be prepared.
NOTES
Disadvantages :
This method of absorption of factory overheads suffers from the following
disadvantages :-
134 Advanced Cost Accounting - II
i)
It is assumed in this method that factory overheads depend on the direct
wages amount. Some items of factory overheads, no doubt, arise due to the
workers employed in the factory. But there are many items of factory
overheads like rent of factory building, insurance of factory building,
depreciation of plant and machinery, repairs and maintenance expenses of
machinery etc. Which do not depend upon the amount of direct wages paid
and so the basis of direct wages used for absorption of factory overheads
does not seem to be correct.
ii)
When workers are paid direct wages by using piece-rate method of
remuneration, time spent by the workers for the work is not considered. In
such circumstances used of this method may not give proper results.
iii)
No attention is given to the skill of workers in this method. Skilled workers
do the work in less time and may give rise to a smaller amount of factory
overheads but because of the high rate at which the skilled workers are
paid their wages the amount of direct wages is more and on percentage
basis the amount of overheads charged to their work also becomes more.
In case of unskilled workers because of the lower rate of wage applicable
to them, the direct wages amount is less and as a percentage of this amount
the factory overheads absorbed by their work also becomes less when
actually the unskilled workers may give rise to more amount of factory
overheads.
iv)
This method becomes unsuitable in those concerns where production is
carried out by using automatic or semi-automatic machines. In such concerns
the factory overheads will be caused by use of machines and so charging
factory overheads on the basis of direct wages may not be proper.
Absorption of overheads,
Absorption of Factory Overheads
NOTES
9.4.3 Percentage of prime cost
In this method the rate of factory overhead is calculated by finding out the
amount of factory overheads and the amount of the prime cost i.e. the total of
direct materials cost, the direct wages and the direct expenses. The rate for
absorption of factory overheads is calculated as under :Factory Overheads
x 100
Factory Overhead Rate =
Prime Cost
Assuming that the factory overheads are `60,000 and the prime cost is
`3,00,000. The factory overhead rate will be
60,000
x 100 = 20%
3,00,000
If prime cost of a job is ` 4,800, the factory overheads to be charged to the
job will be `960 calculated as 20% of `4,800.
Advantages :
The only advantage of using this method is it is simple to understand and
used for absorption of the factory overheads for the products manufactured and
jobs completed. No additional records or registers are required to be maintained
since the normal recordings provide the information about the prime cost.
Disadvantages :
Use of this method is criticised because of the following disadvantages of
this method :
i)
Factory overheads do not depend upon the amount of the prime cost and
so absorption of factory overheads on the basis of the prime cost is not
logical.
ii)
Combining the direct materials cost, direct wages and direct expenses is
done with the hope that the advantages of the first and second method
explained earlier will be available from the used of this third method. But
instead of combining the advantages the disadvantages of first two methods
are likely to be combined in this method.
This method of absorption of factory overhead is used only by a few
manufacturing concerns.
Advanced Cost Accounting - II
135
Absorption of overheads,
Absorption of Factory Overheads
9.4.4 Direct labour hour rate
In this method the factory overhead rate is calculated by dividing the amount
of factory overheads incurred by the concern in a certain period by the number of
direct labour hours for which the work was done in the same period.
NOTES
Factory overheads
Factory overhead rate =
Total direct labour hours worked
If the amount of factory overheads incurred in the period of 6 months ending
on 30th September is `85,000 and the number of direct labour hours worked in the
same period are 17,000, the factory overhead absorption rate will be `5 per direct
labour hour. For producing one unit of the product if 4 direct labour hours have
been spent, the unit of the product will be charged with factory overheads of
4 hours x ` 5 = `20.
Advantages :
Direct labour hours method provides following advantages :i)
Majority items of the factory overheads depend upon the time factor and
so absorption of factory overheads on the basis of direct labour hours
spent for production of products or completion of the job results in charging
proper amount of overheads.
ii)
In those concerns where direct labour is the major factor in the manufacturing
process, charging factory overheads by using direct labour hours method
is most appropriate.
iii)
This method can be used in all manufacturing concerns irrespective of
whether wages are paid on time rates basis or piece- rate basis because
the basis used is direct labour hours and not direct wages.
iv)
As factory overheads are charged on the basis of direct labour hours
other factors like grade of pay, skilled or unskilled workers do not become
relevant.
Disadvantages :
136 Advanced Cost Accounting - II
i)
In this method only direct labour hours is the factor which is considered for
absorption of factory overheads. There are other factors like insurance,
depreciation of factory building, cost of repairs and maintenance of
machinery, power charges etc. Which do not depend upon direct labour
hours worked and so charging of the factory overheads only on the basis
of direct labour hours does not seem proper.
ii)
For using this method the arrangement made for recording total direct labour
hours worked and the direct labour hours spent for a certain production or
for completion of the various jobs must be perfect. Time-booking cards
are required to be prepared and accurate timing must be recorded in them.
This increase the clerical work and any inefficiency in this work will result
in wrong amounts of factory overheads being charged to products
manufactured and jobs performed.
iii)
In some concerns use of machines for production work is done to a greater
extent than the use of the direct labour. This method is unsuitable in such
concerns because a large portion of the factory overheads is incurred due
to the operating of the machines.
Absorption of overheads,
Absorption of Factory Overheads
NOTES
Following illustrations which includes primary and secondary distribution of
factory overheads, calculations of direct labour hours for production departments
and calculation of factory overhead absorption rate based upon the direct labour
hours should help in understanding direct labour hours rate of absorption of factory
overheads.
ILLUSTRATION
A Ltd., a manufacturing company has three production departments X, Y
and Z and one service departments S. In July, 2013 the company worked for 25
days at 8 hours per day with full attendance of the workers each day.
The information related to the factory overheads and other necessary data
is provided for July, 2013 as under :Particular
Total
Service Dept.
Production Department
`
S
`
X
`
Y
`
Z
`
15000
1000
6000
5000
3000
Indirect Materials
8000
1200
2800
2600
1400
Indirect Wages
7100
1100
2500
1500
2000
General Lighting Charges
7000
5
12
10
8
12
24
30
14
150
400
450
200
Power Charges
Rent
Expenses of worker’s canteen
Supervisor’s Salary
Welfare Expenses
No. of Light Points
No. of Workers
Floor Area (Sq.ft.)
12000
8000
16000
4000
Service Department S renders 50% service to X Department, 30% service
to Y Department and 20% service to Z Department.
You are required to show Primary and Secondary distribution of the factory
overheads, calculate the total direct labour hours for each production department
and calculate the factory overheads absorption rate for each production department
on the basis of direct labour hours.
Advanced Cost Accounting - II
137
Absorption of overheads,
Absorption of Factory Overheads
SOLUTION
A Ltd.
Statement showing Primary and Secondary Distribution of
Factory Overheads for July, 2013
NOTES
Item
Basis used
Total
Service
Production
Dept.
Departments
S
X
Y
Z
`
`
`
`
Power charges
Allocation
15000
1000
6000
5000
3000
Indirect Materials
Allocation
8000
1200
2800
2600
1400
Indirect wages
Allocation
7100
1100
2500
1500
2000
General lighting charges
No. of light
points
7000
1000
2400
2000
1600
Floor Area
12000
1500
4000
4500
2000
canteen
No. of workers
8000
1200
2400
3000
1400
Supervisor’s Salary
No. of Workers
16000
2400
4800
6000
2800
Welfare Expenses
No. of Workers
4000
600
1200
1500
700
Rent
Exp.of workers
Distribution of
10000
26100 26100 14900
-10000
5000
Service pendered
overheads of Service
(X 50%, Y 30%,
Dept. S among
Z 20%)
Production Departments
Total Overheads
77100
-
3000
2000
31100 29100 16900
Calculation of direct labour hours of the production departments :No. of days x working hours per day x No. of workers
X Department : 25 x 8 x 24
=
4,800
Y Department : 25 x 8 x 30
=
6,000
Z Department : 25 x 8 x 14
=
2,800
Calculation of direct labour hour rate for absorption of the factory
overheads :Amount of Departmental Overheads
Direct Labour Hour Rate
=
No. of direct Labour Hours Worked
` 31,100
For X production Department =
4800 hours
138 Advanced Cost Accounting - II
= ` 6.48
` 29,100
For Y production Department =
Absorption of overheads,
Absorption of Factory Overheads
6,000 hours
= ` 4.85
` 16,900
For Z production Department =
2,800 hours
NOTES
= ` 6.04
9.4.5 Machine hour rate
This method of absorption of factory overheads is used in those
manufacturing concerns where production activity is carried out mostly by using
machines. Machine hour rate is calculated for each type of machine separately
and if a group of similar machines are used in the production process such group
of machines is regarded as one cost centre and for all the machines included in
the cost centre one machine hour rate is calculated and used for absorption of the
factory overheads. When a machine is operated for one hour it is called one
machine hour. In the simple form use of machine hour rate is done by calculating
the amount of the factory overheads and dividing it by the total number of machine
hours calculated by considering the total machines used and the hours for which
they have been used. In such case the machine hour rate is calculated as under:
Amount of factory Overheads
Machine Hour Rate =
No. of Machine Hours
If the amount of factory overheads is `75000 for a month and number of
machine hours in the month is 15,000 the machine hour rate will be `75,000 ÷
15,000 machine hours i.e. `5 per machine hour. If 12 machine hours have been
used for completing a job it will be charged with `60 as the factory overheads
incurred for the job.
In the actual working, there are different production departments and each
department has different types of machines for performing specific type of work.
So it becomes necessary to calculate separate machine hour rate for each type of
machine used in a department. This is done by completing the following steps :1.
The factory overheads are allocated or apportioned to each production
department.
2.
In a production department how many separate types of machines or groups
of similar type of machines exist is ascertained.
3.
The department’s factory overheads are apportioned to the different
machines or groups of similar machines.
4.
Overheads like power charges, depreciation are of specific nature and can
be related to a machine and such overheads should be directly allocated to
the machine.
Advanced Cost Accounting - II
139
Absorption of overheads,
Absorption of Factory Overheads
5.
Other items of overheads related to the machine should be divided under
two headings - fixed overheads and variable overheads. Fixed overheads
are periodic expenses and they do not depend upon whether the machine
is operated or is standing still. These-fixed expenses are also called as
standing charges and include rent, supervisor’s salary, insurance of machine
etc. Variable charges also called running charges are those expenses which
vary according to the use or running of the machine and they include power
charges, depreciation, repairs etc.
6.
The hours for which the machine is likely to be operated during the period
for which the factory overheads are incurred are estimated.
7.
Factory overheads related to the machine are totalled and divided by the
estimated machine hours. The rate so obtained is the machine hour rate. At
this rate the factory overheads are charged to the product or the job for the
number of the machine hours used for the product or the job.
NOTES
While calculating the number of machine hours for a machine the problem
arises about the hours spent for setting-up of the machine i.e. making the machine
ready for starting the machine. If the setting up time is regarded as no-productive
the hours spent for setting-up the machine are not included in the calculation of
the machine hours. However, when the setting-up hours are treated as productive
time such hours are included in the calculation of the machine hours.
Depreciation on the machine is another item about which the treatment
differs. Some cost accountants treat it as an item to be include under the heading
of the ‘standing charges’ while some others include it under the heading of ‘variable
charges’. Decision about depreciation should be taken according to the method
used for depreciation. When depreciation is to be charged at a certain rate on
value of the machine on per annum basis, it should be regarded as a standing
charge and when depreciation is calculated by considering the life of the machine
in terms of the running hours, it should be treated as a variable charge.
Bases used for apportionment of some expenses to machines.
140 Advanced Cost Accounting - II
A]
Standing Charges :
1.
Supervision - Time devoted by supervisor to each machine.
2.
Rent and rates - Floor area occupied by each machine.
3.
Lighting and heating charges - Number of points for the machine or floor
area occupied by each machine.
4.
Insurance- insured value of each machine.
5.
Miscellaneous or other expenses - Equitable distribution among the machines
or any other appropriate base on the basis of information provided.
6.
Lubricating oil and consumable stores - Number of machine hours or capital
values of machines.
Absorption of overheads,
Absorption of Factory Overheads
B]
Variable or Machine Expenses :
1.
Depreciation on machine - Capital value of machine or machine hours.
2.
Repairs and Maintenance - Capital value of machine or machine hours or
total repairs and maintenance expenses estimated for the machine in its
life spread over the working life of the machine in terms of machine hours
or any specific instructions for charging repairs and maintenance expenses.
3.
NOTES
Power charges - On the basis of meter reading or horse power of machines
or consumption of power per machine hours.
ILLUSTRATION
From the following information provided to you, calculate the machine hour rate
Per Annum
`
Rent of the department
6,240
General lighting of the department
2,400
Insurance
360
Cotton waste, Oil, etc. for the machine
600
Salary of the foreman
60,000
The cost of the machine is ` 1,02,000 and its estimated scrap value at the
end of its working life of 10 years is `12,000.
The machine occupies one-fourth space of the department. There are total
10 light points in the department out of which 2 points are provided for the machine.
The foreman devotes one-fourth of his time to the machines
It is estimated from the past experience that :i)
The machine will work for 1800 hours per annum.
ii)
The machine will incur total expenditure of `11,250 in respect of repairs
and maintenance during its life, and
iii)
It consumes 5 units of power per hour and the cost of power per unit is `4.
SOLUTION
Calculation of depreciation on the machine :Cost of the machine - Scarp value
Depreciation per hour
=
Life of machine in working hours
1,02,000 - 12,000
=
10 yrs x 1,800 hours
` 90,000
=
=
1,800 machine hours
`5
Advanced Cost Accounting - II
141
Absorption of overheads,
Absorption of Factory Overheads
Computation of Machine Hour Rate
Particulars
Per Annum
Per Hour
`
`
Standing Charges :
NOTES
1. Rent ( ` 6240 ÷ 4)
1,560
2
2. General Lighting ( ` 2400 x /10)
480
3. Insurance
360
4. Cotton waste, oil etc.
600
5. Salary of foreman ( `60000 ÷ 4 )
15,000
18,000
Standing charges per hour
`18000
1800 hours
10.00
Variable Charges :
1. Depreciation
2. Repairs and maintenance
`11,250
5.00
0.625
3. Power charges (5 units x ` 4)
20.00
Machine Hour Rate
35.625
Comprehensive Machine Hour Rate
When the direct wages of the operator of the machine is also included
while including calculating the machine hour rate, the machine hour rate is known
as the comprehensive or composite machine hour rate. The following illustration
is on calculation of comprehensive machine hour rate :ILLUSTRATION
In a machine shop, the machine hour rate is worked out at the beginning of
a year on the basis of a 13 week period which is equal to three calendar months.
The following estimates are relevent for operating a machine :Total working hours available per work
48 hours
Maintenance time included in the above
2 hours
Setting-up time included in the above
2 hours
Cost details :
Operator’s wages (per month)
`6,500
Supervisor’s Salary (per month)
`15,000
(Common supervisor for 3 machines)
Written down value of the machine
`1,80,000
Depreciation on written down value at 12% p.a.
Repairs and maintenance (per annum)
142 Advanced Cost Accounting - II
` 16,000
`30,000
Consumable stores (per annum)
Absorption of overheads,
Absorption of Factory Overheads
`5,000
Rent, rates and taxes (for the quarter apportioned)
Power consumed is at 15 units per hour at `2 per unit power is used for
productive hours only. Setting up time is part of productive time but no power is
used in the setting-up period.
NOTES
The operator and the supervisor are permanent.
Repairs and maintenance and consumable stores are to be treated as variable
expenses.
Calculate a comprehensive machine hour rate.
SOLUTION
Computation of comprehensive Machine Hour Rate
Particulars
Per quarter
Per hour
`
`
Standing Charges :
Rent, rates and taxes
`15,000 x 3 months
Supervisors salary
3 machines
5,000
15,000
Operator’s wages ( `6,500 x 3 months)
19,500
Total Standing charges per quarter
39,500
Standing charges per hour
`39,500
66.05
598 hours
Variable Charges :
Power
15 units x 44 hours x ` 2
28.70
46 productive hours
Repairs and Maintenance
`16,000
6.69
4 months x 598 hours
Depreciation :
Consumable stores
9.03
30,000
12.54
4 x 598
Comprehensive Machine Hour Rate
123.01
Notes :1.
Calculation of Productive hours of the machines :
Calculation of productive hours is done for a quarter of the year as under:
48 hours per week x 13 week in the quarter
= 624 hours
Less hours spent for maintenance : 2 hours x 13 weeks
= 26 hours
Productive machine hours per quarter
598 hours
Advanced Cost Accounting - II
143
Absorption of overheads,
Absorption of Factory Overheads
[Note : Setting-up time is not deducated because it is mentioned in the
problem that setting-up time should be treated as productive time.]
2.
Calculation of depreciation on the machine :`1,80,000
Written down value of the machine
NOTES
Depreciation rete 12% p.a. on W.D. value
`18,000 x
12
= ` 21,600
100
` 21,600
Depreciation per productive hour =
3.
4 months x 598 hours
=
` 9.03
Power charges are calculated at 15 units per hour for 44 hours at the rate
of `2 per unit because power is not used during the setting-up time of 2
hours per week. The amount so obtained is divided by 46 hours because the
setting-up time of 2 hours is to be included in the productive hours as per
the given instruction.
Advantages of Machine Hour Rate :
i)
When machine hour rate is calculated for absorption of factory overheads,
the various expenses are grouped under the headings of standing charges
and variable charges. This method, therefore, takes into consideration the
nature of overheads and the fact that some overheads are of periodic nature
whereas some other overheads move with the operations and are of variable
nature. The machine hour rate, therefore, enables absorption of the factory
overheads in a proper way.
ii)
This method is most suitable in the concerns where production activity is
mechanised. In these concerns majority of factory overhead items are related
to the use of machines; manual labour is used to a very small extent. Use of
machine hour rate is proper in such situation for absorption of the factory
overheads.
iii)
Machine hour rate is calculated for each type of machine separately and
overheads are absorbed at that rate from the products or jobs which actually
use that machine by calculating overheads for the number of hours for
which the machine was used. Machine hour rates calculated for other types
of machines are not used if these machines have not been used for a
particular product or a job. Thus factory overheads are absorbed in a just
manner.
iv)
Machine hour rate method gives due weightage to he time factor, both in
calculation of machine hour rate and while absorbing the factory overheads
for products or jobs.
Disadvantages :
i)
144 Advanced Cost Accounting - II
For calculation of machine hour rate details records of actual or estimated
amounts of various expenses related to each type of machine become
necessary. This increases the clerical work and clerical expenses. Accurate
record of number of machine hours used for each product and each job
must be kept for calculation of the amount of overheads to be charged to
the production and jobs. This creates difficulty in using the method.
ii)
Absorption of overheads,
Absorption of Factory Overheads
This method is suitable only in those concerns which used machines in the
manufacturing processes. In the concerns where a few machines are used
and mainly production is done with the help of manual labour, this method
cannot be used.
NOTES
9.4.6 Rate per unit of production
This is the simplest method of absorption of factory overheads. In this method
the overheads of a department are calculated or estimated. The units produced or
estimated to be produced by that department are decided and by using the following
formula the rate per unit for absorption of factory overhead is calculated :Factory overheads
Rate of overhead per unit
=
Units produced
If the concern is producing a single type of product of uniform size and
quality, the overhead absorption rate can be calculated for the entire factory instead
of calculating it for each department separately. This is done as under :
Total factory overheads
Factory overheads absorption rate =
Total units produced
Assuming that a single and uniform product is produced by a concern and
the factory overheads amount to `45,000 and the estimated units of production
are 5,000, the factory overheads absorption rate will be `45,000 ÷ 5,000 units =
`9 per unit and at this rate for the actual units produced the factory overheads
will be charged. Thus for an order received by the concern to supply 200 units of
the product, factory overheads will be charged as 200 units x `9 per units =
`1,800.
If more than one type of products are produced by a concern, this method
can by used by allotting points to a unit of each type of product on the basis of the
production activities involved, the time required for producing one unit of each
type of product and the weight, size and quality of each type of product. Following
example will show how this method can be used in such situation :X Ltd. produces two types of products P and Q. On the basis of their
nature, time required for production and other factors one unit of P product is
allotted 4 points and one unit of Q product is allotted 6 points. The factory overheads
are estimated as `
for a period of 3 months and estimated production in this
period is 1,000 units of P product and 1,500 units of Q product. Calculate the rate
per unit for absorption of the factory overheads.
Check Your Progress
i)
Which methods can be
used for absorption of
factory overheads ?
ii) Show
how
factory
overheads
absorption
rate is calculated under the
following methods :a) Percentage of direct
materials cost,
b) Percentage of direct
wages,
c) Percentage of prime
cost,
d) Direct labour hour
rate,
e)
and
Machine hour rate,
f) Rate per
production.
unit
of
iii) Show the format used for
computation of Machine
Hour Rate.
Advanced Cost Accounting - II
145
Absorption of overheads,
Absorption of Factory Overheads
SOLUTION
P Product : 1,000 units x 4 points = 4,000 points
Q Product : 1,500 units x 6 points = 9,000 points
NOTES
 Total points = 4,000 + 9,000
= 13,000 points
Total Factory Overheads
Rate per point =
Total Points
` 52,000
=
13,000
=
`4
Factory overhead absorption rate per unit of P product = 4 points x `4 = `16
Factory overhead absorption rate per unit of Q product = 6 points x `4 = `24
Rate per unit of production is very simple and easy to follow. As records of
production are maintained by every manufacturing concerns no additional records
are required to be prepared and so there is no additional to the clerical work and
no increase in the clerical cost.
This method of absorption of factory overheads is suitable for mining
concerns, brick laying concerns and foundries where one type of output is produced
by the concerns.
ADDITIONAL ILLUSTRATIONS
ILLUSTRATION 1
Kalyani Steel Ltd., Kalyan has three Production Departments and four
Service Departments. The departmental overhead summary for the month of
March, 2010, discloses the following results :
`
A)
B)
146 Advanced Cost Accounting - II
Production Depts. :
•
Cutting
7,000
•
Milling
8,000
•
Grinding
10,000
Service Depts. :
•
Stores
3,000
•
Repairs
5,000
•
Time-keeping
1,000
•
Staff Welfare
4,000
Absorption of overheads,
Absorption of Factory Overheads
Additional Information :
Particulars
Production Depts.
Cutting
Milling
Grinding
Employee Numbers
No.
40
70
90
Material Requisitions
MR
10
16
14
Direct Labour Hours Worked
Hrs.
975
2,075
3,950
NOTES
You are required to work out the Overhead Absorption Rate.
SOLUTION
In the books of Kalyani Steel Ltd., Kalyan
Statement Showing Secondary Distribution of Service Depts. Overheads
Cost to Production Depts. for the month ended 31st March, 2010
Particulars
Basis of Re-apportionment
Ratio
Total
Production Depts.
Cutting Milling Griding
`
`
`
`
25,000
7,000
8,000
10,000
Overhead Expenses as per
Departmental Overhead Summary
Service Depts. :
• Stores Depts.
Materials Requisitions
5:8:7
3,000
750
1,200
1,050
• Repairs Depts.
Direct Labour Hours worked
2:3:5
5,000
1,000
1,500
2,500
• Time-keeping Depts.
Employee Numbers
4:7:9
1,000
200
350
450
• Staff Welfare Depts.
Employee Numbers
4:7:9
4,000
800
1,400
1,800
38,000
9,750
(+)
 Total
12,450 15,800
Working Notes :
1)
Calculation of Overhead Absorption Rate
(Base Direct Labour Hours Worked)
Production Overheads
=
Direct Labour Hours Worked
Cutting
=
` 9,750
Milling
=
Hrs. 975
=
` 10
` 12,450
Grinding
=
Hrs. 2,075
=
`6
` 15,800
Hrs. 3,950
=
`4
Advanced Cost Accounting - II
147
Absorption of overheads,
Absorption of Factory Overheads
ILLUSTRATION 2
The following particulars relates to a new machine purchased by a
manufacturing company.
Purchase Price of the machine
NOTES
`4,00,000
Rent and Rates per quarter
` 15,000
Installation Expenses
` 20,000
Monthly Lighting Charges for the total area
` 1,000
Estimated Value of Scrap at the end of the 10th year
` 20,000
Foreman’s Salary for the year
` 30,000
Estimated Life of the machine - 10 years
Annual Insurance Premium for the machine
Running of the Machine in its lifetime
` 3,000
Hrs. 2,00,000
Estimated Repairs and Maintenance for the machine
for a period of 12 months
` 5,000
Machine occupies 25% of the total area
Consumable Stores
` 3,000 p.a.
Sundry Supplies
` 1,000 p.a.
Time devoted by the foreman- 1/6th of his time.
Power Consumption : 5 units per hour @ ` 5 per 100 units
You are required to prepare a statement showing computation of Machine
Hour Rate.
SOLUTION
Working Notes :
1) Depreciation :
Purchase Price of the machine + Installation Expenses - Estimated value of scrap
Estimated working life of the machine
` 4,00,000 + ` 20,000 - ` 20,000
=
2,00,000 Hrs.
` 4,00,000
=
2,00,000 Hrs.
= `2
2) Rent and Rates :
= ` 15,000 x 4 Quarters x 25% = ` 15,000
3) Lighting Charges :
148 Advanced Cost Accounting - II
= ` 1,000 x 12 months x 25% = ` 3,000
Absorption of overheads,
Absorption of Factory Overheads
4) Foreman’s Salary :
1
= ` 30,000 x
= ` 5,000
6
5) Repairs and Maintenance :
` 5,000
=
20,000 Hrs.
= ` 0.25
NOTES
6) Power :
= 5 units ` 0.05 = ` 0.25
7) Standing Charges :
` 30,000
=
Hrs. 20,000
= ` 1.50
In the books of a Company
Statement showing Computation of Machine Hour Rate
Machine No. ............
Department ..............
Particulars
A)
Per Hour
`
`
Standing Charges :
1.50
1) Rent and Rates
15,000
2) Lighting Charges
3,000
3) Foreman’s Salary
5,000
4) Insurance Premium
3,000
5) Consumable Stores
3,000
6) Sundry Supplies
(+)
 Total
B)
Per Annum
1,000
30,000
Machine Expenses :
1) Depreciation
2.00
2) Repairs and Maintenance
0.25
3) Power
 Machine Hour Rate
(+)
0.25
4.00
ILLUSTRATION 3
From the following particulars, calculate Machine Hour Rate for a machine
‘Texmo’.
Capital Cost of the machine
Rent and Rates of the shop per quarter
Freight and installation charges
Supervisor’s salary per month
` 9,500
` 900
` 1,500
` 400
Advanced Cost Accounting - II
149
Absorption of overheads,
Absorption of Factory Overheads
Estimated Scrap Value after 10 years of working life
General Lighting Charges per month
NOTES
` 1,000
` 300
Sundry Supplies per year
` 40
Monthly Insurance Premium
` 30
Estimated Cost of Repairs and Maintenance per annum
` 200
Consumption of power 8 units per hour @ ` 5 per 100 units
Effective running time per year
Hrs. 2,000
Space occupied by the machine - 1/3rd of the floor shop
Time devoted by the supervisor for Texmo - 1/4th of his time
Rent and Rates are to be apportioned in the ratio of floor space occupied by
the machine on the floor shop. Out of 12 light points 4 points, are being used for
‘Texmo’ machine.
SOLUTION
Working Notes :
1) Depreciation :
Capital cost of machine + Freight and Installation Charges - Estimated Scrap Value
Estimated working life of the machine
` 9,500 + ` 1,500 - ` 1,000
=
2,000 Hrs. x 10 years
` 10,000
=
Hrs. 20,000
= ` 0.50
2) Rent and Rates :
= ` 900 x 4 Quarters x 1/3 = ` 1,200
3) Supervisor’s Salary :
= ` 400 x 12 months x 1/4 = ` 1,200
4) General Lighting charges :
= ` 300 x 12 months x 1/3 = ` 1,200
5) Insurance Premium :
= ` 30 x 12 months = ` 360
6) Repairs and Maintenance :
` 200
=
2,000 Hrs.
= ` 0.10
7) Power :
= 8 units x ` 0.05 - ` 0.40
150 Advanced Cost Accounting - II
Absorption of overheads,
Absorption of Factory Overheads
8) Standing Charges :
` 4,000
=
Hrs. 2,000
=`2
In the books of a Company
Statement showing Computation of Machine Hour Rate
NOTES
Machine - Texmo
Department ..............
Particulars
A)
Per Year
Per Hour
`
`
Standing Charges :
2.00
1) Rent and Rates
1,200
2) Supervisor’s Salary
1,200
3) General Lighting Charges
1,200
4) Sundry Supplies
40
5) Insurance Premium
(+)
 Total
B)
360
4,000
Machine Expenses :
1) Depreciation
0.50
2) Repairs and Maintenance
0.10
3) Power
(+)
0.40
 Machine Hour Rate
3.00
ILLUSTRATION 4
Compute the Machine Hour Rate for the machine ‘Fowerluba’ from the
following particulars.
1)
Cost of the machine
`
52,500
2)
Machine Fixation Charges
`
2,000
3)
Octroi Duty on import of machine
`
3,500
4)
Estimated Scrap Value at the end of the 10th year
`
5,500
5)
Estimated Working Life of the machine per annum
Hrs.
3,000
6)
Estimated life of the machine 10 years
7)
Rent, Rates and Taxes for the department
`
28,500 p.a.
8)
Monthly Insurance Charges for the machine
`
75
9)
Electric Lighting
`
8,000 p.a.
10)
Consumable Stores
` 50 per month
11)
Cotton Waste, Oil etc.
` 100 per quarter
12)
Supervisor’s Salaries
` 8,000 p.a.
13)
Power - 13 units per hour @
` 5 per 100 units
Advanced Cost Accounting - II
151
Absorption of overheads,
Absorption of Factory Overheads
Repairs and Maintenance for the entire life of the machine ` 18,000
14)
Fowerluba occupies 1/3rd space of the total area of the shop. Out of the
total number of light points in the shop 20, only 4 points are used by this machine.
The supervisor devotes 1/4th of his time on this machine.
NOTES
SOLUTION
Working Notes :
1) Depreciation :
Cost of machine + Machine fixation Charges - Octroi duty - Estimatedscrap value
Estimated working life of the machine
` 52,500 + ` 2,000 + ` 3,500 - ` 5,500
=
3,000 Hrs. x 10 years
` 52,500
=
Hrs. 30,000
= ` 1.75
2) Rent, Rates and Taxes :
= ` 28,500 x 1/3 = ` 9,500
3) Insurance Charges :
= ` 75 x 12 months = ` 900
4) Electric Lighting :
= ` 8,000 x 4/20 = ` 1,600
5) Consumable Stores :
= ` 50 x 12 months = ` 600
6) Cotton Waste, Oil etc. :
= ` 100 x 4 quarters = ` 400
7) Supervisor’s Salaries :
= ` 8,000 x 1/4 = ` 2,000
8) Repairs and Maintenance :
` 18,000
=
30,000 Hrs.
= ` 0.60
9) Power :
= 13 units x ` 0.05 = ` 0.65
10) Standing Charges :
` 15,000
=
152 Advanced Cost Accounting - II
3,000 Hrs.
=`5
Absorption of overheads,
Absorption of Factory Overheads
In the books of a Company
Statement showing Computation of Machine Hour Rate
Machine - Fowerluba
Department ..............
Particulars
A)
Per Hour
`
`
Standing Charges :
9,500
2) Insurance Charges
900
3) Electric Lighting
1,600
4) Consumable Stores
600
5) Cotton Waste, Oil etc.
400
6) Supervisor’s Salaries
NOTES
5.00
1) Rent, Rates and Taxes
(+)
 Total
B)
Per Year
2,000
15,000
Machine Expenses :
1) Depreciation
1.75
2) Power
0.65
3) Repairs and Maintenance
(+)
 Machine Hour Rate
0.60
8.00
ILLUSTRATION 5
From the following data, compute the machine hour rate to be charged in
respect of jobs carried out during the month of March, 2010.
a)
The Cost of Machine is ` 7,30,000, its anticipated Residual Value at the
end of its working life i.e. 15 years is ` 10,000.
b)
Monthly running hours - 375, hours spent on trial runs and job setting - 25,
hours lost due to abnormal factors - 40, hours lost due to normal repairs and
maintenance - 25, overtime hours worked to complete the job in time - 75.
c)
Repairs and Maintenance
` 1,000
d)
Salaries to Supervisor’s
` 8,000
e)
Power
` 2,500
f)
Sundry Shop Expenses
` 6,500
g)
Departmental Overheads
` 4,000
h)
Production Service Charges
` 1,500
i)
Normal Rate of Wages per hour
j)
Rate of Overtime : 50% extra over normal time wages.
` 40
Advanced Cost Accounting - II
153
Absorption of overheads,
Absorption of Factory Overheads
SOLUTION
Working Notes :
1) Calculation of effective working hours per month :
Monthly running hours
NOTES
Less :
Hours
375
Time allowed for -
i)
trial runs and job setting
25
ii)
normal repairs and maintenance (+) 25
(-) 50
325
Add :
Time allowed for -
i)
Over-time

(+) 75
Effective Working Hours
400
Effective working hours per month
- 400 Hours
Effective working hours per year
- 400 Hours x 12 months
i.e. 4,800 Hours
2) Depreciation :
Cost of Machine - Residual value
Estimated value
` 7,30,000 - ` 10,000
=
=
4,800 Hrs. x 15 Years
` 7,20,000
= ` 10
Hrs. 72,000
3) Overtime Wages :
= 75 Hrs. x `60 (i.e. 50% extra over normal time wages of ` 40 per hour)
= ` 4,500
4) Repairs and Maintenance :
=
` 1,000
= ` 2.50
400 Hrs.
5) Power :
=
` 2,500
= ` 6.25
400 Hrs.
6) Standing Charges :
=
` 24,500
400 Hrs.
154 Advanced Cost Accounting - II
= ` 61.25
Absorption of overheads,
Absorption of Factory Overheads
In the books of a Company
Statement Showing Computation of Machine Hour Rate
Machine No. ............
Department ..............
Particulars
A)
Per Hour
`
`
Standing Charges :
NOTES
61.25
1) Overtime Wages
4,500
2) Salaries to Supervisors
8,000
3) Sundry Shop Expenses
6,500
4) Departmental Overheads
4,000
5) Production Service Charges
(+)
 Total
B)
Per Month
1,500
24,500
Machine Expenses :
1) Depreciation
10.00
2) Repairs and Maintenance
3) Power
2.50
(+)
6.25
 Machine Hour Rate
80.00
ILLUSTRATION 6
From the following particulars relating to a machine, calculate Machine
Hour Rate.
1)
Original Cost of the Machine
`
19,000
Carriage and Freight paid on purchase of machine
`
1,200
Residual Value of machine after ten years
`
200
Estimated Life
10 years
In a year of 50 weeks the machine is operated for 48 hours, which includes
300 hours toward machine maintenance down-time and 100 hours towards settingup time.
2)
Electric Power used by the machine is 6 units per hour @ ` 5 per 100
units.
3)
Repairs and Maintenance ` 75 per month.
4)
Two operators attend the machine during operation alongwith three other
machines, their total wages including fringe benefits amounted to ` 800 per
month.
5)
General Overheads attributable to this machine ` 600 per year.
6)
Rent and Taxes ` 1,500 p.a.
Advanced Cost Accounting - II
155
Absorption of overheads,
Absorption of Factory Overheads
SOLUTION
Working Notes :
1) Calculation of Effective Working Hours per annum :
Estimated yearly working hours
NOTES
Hours
2,400
(50 Weeks x 48 Hours)
Less :
Time allowed for -
400
i)
Machine Maintenance down-time 300 hours
ii)
Setting-up time

(+) 100 hours
Effective Working Hours
2) Depreciation :
Original cost of machine + Carriage and Freight paid
on purchase of machine - Residual value of machine
Estimated working life of machine
` 19,000 + ` 1,200 - ` 200
=
2000 Hrs. x 10 Years
` 20,000
= `1
=
Hrs. 20,000
3) Electric Power :
= 6 Units x `0.05
= ` 0.30
4) Repairs and Maintenance :
` 75 x 12 months
= ` 0.45
=
2,000 Hrs.
5) Operator Wages :
` 800 x 12 months
= ` 2,400
=
4 machines
6) Standing Charges :
` 4,500
= ` 2.25
=
Hrs. 2,000
156 Advanced Cost Accounting - II
2,000
Absorption of overheads,
Absorption of Factory Overheads
In the books of a Company
Statement showing Computation of Machine Hour Rate
Machine No. ............
Department ..............
Particulars
A)
`
`
3) Rent and Taxes
NOTES
2.25
2,400
2) General Overheads
600
(+)
 Total
1,500
4,500
Machine Expenses :
1) Depreciation
1.00
2) Electric Power
0.30
3) Repairs and Maintenance
(+)
 Machine Hour Rate
9.5
Per Hour
Standing Charges :
1) Operators Wages
B)
Per Year
0.45
4.00
Summary
Absorption of overheads means charging the amount of overheads to the
output produced or jobs completed. The step of absorption of overheads begins
after completion of the work of primary distribution and secondary distribution
of overheads becomes complete. The amount of overheads shown by a production
department is charged to or recovered form the output given by that department
or the jobs completed by that production department. This enables calculations of
the total cost of the output or the jobs of completed and by adding the desired
amount of profit to the total cost per unit or the total cost of a job, selling price to
be charged to the customer can be decided.
Actual rate of absorption of overheads and pre-determined rate of absorption
of overheads are the two ways in which the overheads absorption can be done.
When factory overheads, office and administration overheads and selling and
distribution overheads are the three groups in which all the overheads are recorded,
it becomes necessary to used different methods for absorption of overheads. In
this unit only the methods used for absorption of factory overheads have been
described. For absorption of factory overheads the methods used are as follows.
1.
Percentage of direct materials cost method,
2.
Percentage of direct wages method,
3.
Percentage of prime cost method,
4.
Machine hour rate method,
Advanced Cost Accounting - II
157
Absorption of overheads,
Absorption of Factory Overheads
NOTES
5.
Direct labour hour rate method, and
6.
Rate per unit of production.
9.6
Key Terms
i)
Absorption of overheads : Charging of overheads to unit of product, job,
contract, order, process or an operation of service to decide total cost of it.
Charging of overheads or recovery of overheads are other terms used for
absorption of overheads.
ii)
Actual Overhead Rate : It is a rate calculated for absorption of overheads
by dividing the actual amount of overheads by the actual quantity in the
base selected which may be actual number of units, actual value of materials
used, actual amount of wages, actual labour hours spent or actual number
of machine hours used.
iii)
Pre-Determined Overhead Rate : It is the rate calculated for absorption
of overheads by dividing the pre-determined or estimated amount of
overheads by pre-determined or estimated quantity in the base selected.
iv)
Standing Charges : These are the overheads which change according to
the change in period but which change according to the change in period
but which remain fixed for a certain period. Standing charges are also known
as fixed overheads or periodic overheads and these overheads from one
part in the calculation of Machine Hour Rate.
v)
Variable Charges : These are the overheads which change in amounts
according to the use or operation of a machine. These charges form the
second group under which the calculation of Machine Hour Rate is shown.
Variable charges are also called as Machine Expenses or Operating
Expenses.
9.7
Questions and Exercises
I - Theory Questions
158 Advanced Cost Accounting - II
1.
What do you mean by ‘absorption of overheads’? Why absorption of
overhead is necessary ?
2.
Distinguish between ‘actual rate of absorption of overheads’ and ‘predetermined rate of absorption of overheads’
3.
Describe the methods which are used for absorption of factory overheads
and state advantages and disadvantages of each method
4.
Explain the method of ‘percentage of direct wages’ for absorption of factory
overheads
5.
What is meant by ‘machine hour rate’ ? how it is calculated ?
6.
What is ‘direct labour hour rate’? how it is calculated ? what are the
advantages and disadvantages of using this method for absorption of factory
overheads ?
Absorption of overheads,
Absorption of Factory Overheads
NOTES
II - Multiple Choice Questions
1.
Actual overhead rate can be calculated only at the end of the ------- period.
(a) accounting
(b) production
(c) distribution
(d) one month
2.
Pre-determined overhead rate is a rate decided ----------- the commencement
of the period in which it is to be used.
(a) in advance before
(b) in advance after
(c) in past after
(d) in advance not before
3.
In ‘Percentage of direct material cost’ method for charging factory
overheads, attention is given only to the cost of ----------- material consumed.
(a) indirect
(b) direct
(c) total
(d) actual
4.
In ‘Percentage of prime cost method’ the rate of factory overhead is calculate
by finding out the amount of factory overheads and the amount of the -------- cost.
(a) secondary
(b) fixed
(c) current
(d) prime
Ans. : (1 - a), (2 - a), (3 - b), (4 - d).
Advanced Cost Accounting - II
159
Absorption of overheads,
Absorption of Factory Overheads
III - Exercises
1.
Calculate Machine Hour Rate for machine no.14 from the following
information provided :Purchase price of the machine
NOTES
`97000
Repair charges -50% of depreciation
`2000
Railway Freight
Lubricating oil @ `2 per day of 8 hours (effective)
` 1500
Errection charges for the machine
Consumable stores @ `3 per day of 8 hours (effective)
` 500
Estimated scarp value of Machine after 10 years of life
Estimated working hours 2150 per annum
`1500 p.a
Cost of Supervision
Hours lost due to normal tool-setting
150
Rent and Taxes `11 per day of 8 hours (effective)
`1000 p.a.
Electric power
Labour cost of operating the machine no.14 is to be ignored while calculating
Machine Hour Rate.
2.
From the following particulars, calculate Machine Hour Rate for a
Drilling Machine :`
Cost of the Machine
1,00,000
Rent and Rates for the shop per month
350
Installation charges of the Machine
7,500
General Lighting for the shop per month
400
Carriage on purchase of the Machine
2,500
Shop supervisor’s salary per
1,000
Estimated Scrap value of machine after
15 years of working life
Quarterly Insurance Premium for the Machine
5,000
337.50
Repairs and Maintenance per annum
1,000
Power consumption 10 units per hour at `10 per 100 units
160 Advanced Cost Accounting - II
Estimated working hours 2,200 per annum which includes setting-up time
of 200 hours. The machine occupies 1/4th area of the total area of the shop. The
supervisor is expected to devotes 1/5th of his time for supervising the machine.
General lighting charges and rent are to be apportioned in the ratio of floor space
occupied.
Absorption of overheads,
Absorption of Factory Overheads
3. The following expenses have been incurred in respect of a shop having four
identical machines :`
`
NOTES
Rent and Taxes for the year
60,000
Power Consumed by the shop @ ` 1.00 per unit
48,000 p.a.
Annual Repairs for four machines
12,000
Lighting for the shop for 12 months
5,000
Lubricant charges for the year
1,600
Depreciation per machine for the year
6,000
Supervisor looking after four machines and is paid
monthly salary
6,000
Hire Purchase Instalments for machines
63,000
(including `3,000 for hire purchase interest)
Attendants : two attendants looking after
Four machines, each is paid `600 salary per month
Each machine consumes 10 units of power per hour. Calculate Machine
Hour Rate.
4.
In a light Engineering factory, the following particulars have been collected
for a period of three months ended on 31st Dec. 2014. Compute the departmental
overheads rates for each of the production departments assuming that overheads
are recovered as a percentage of direct wages :Items
Production Departments Service Departments
A
`
B
`
C
`
D
`
E
`
Direct Wages
`
2000
3000
4000
1000
2000
Direct Materials
`
1000
2000
2000
1500
1500
No. of employees
100
150
150
50
50
Electricity KWH
4000
3000
2000
1000
1000
10
16
4
6
4
60000
40000
30000
10000
10000
150
250
50
50
50
No. of Light points
Assets Values
`
Area Occupied Sq.meters
The Expenses for the period were :Motive Power
`
550
Lighting Expenses
`
100
Stores Overhead
`
400
Advanced Cost Accounting - II
161
Absorption of overheads,
Absorption of Factory Overheads
NOTES
Amenities to Employees
`
Depreciation
` 15000
Repairs and Maintenance
`
3000
General Overheads
`
6000
Rent and Taxes
`
275
1500
Apportion the expenses of Service Department E proportionate to direct
wages and those of Department D in the ratio of 5 : 3 : 2 to deparments A, B and
C respectively.
5.
From the following budgeted figures of Bajaj Ltd., Bangaluru.
(a)
Prepare normal overhead application rate using :
1.
Direct Labour Hour Rate Method
2.
Direct Labour Cost Method, and
3.
Machine Hour Rate Method.
`
Estimated Factory Overheads for year
1,00,500
Estimated Direct Labour Hours for the year
1,34,000
Estimated Direct Labour Cost for the year
67,000
Estimated Machine Hours
50,250
(b) Prepare a Comparative Statement of cost showing the result of
application of each of the above rates to Job No. 321 from the data given
below :
`
6.
Cost of Direct Material consumed
250
Direct Labour Cost
120
Direct Labour Hours
80
Machine Hours
36
Calculate the machine hour rate from the following particulars :
`
-
Lighting charges (No. of light points in the dept. 20, 5 light
360
points are utilised by this machine ‘M’).
-
Rent of the dept. (area occupied by the machine,
1/
162
Advanced Cost Accounting - II
th
4 of the dept.
800
-
Sundry materials viz., oils and lubricants, cotton waste, etc.
50
-
Insurance charges
45
-
Repairs and maintenance
800
Absorption of overheads,
Absorption of Factory Overheads
(value of machine ‘M’ - `2,00,000)
-
Total value of all machines
-
Supervision (1/5th of supervisor’s time is
8,00,000
15,000
spent for machine ‘M’)
NOTES
The estimated residual value of the machine is ` 20,000.
The following are the further estimates.
i) The machine will work for 2,000 hours per year.
ii) There will be an expenditure of ` 1,300 as regards overhauling of the
machine.
iii) Its consumption of electric power is 10 units per hour @ 70 ps. per unit.
iv) The life of the machine will be 20,000 hours.
7.
Calculate the machine hour rate for recovery of overheads for a group of
four machines from the following data :
i) Original cost of the four machines ` 80,000.
ii) Depreciation on Straight Line Method @ 10% p.a. is charged for all
the machines.
iii) Power consumption @ 0.70 ps. per hour per machine.
iv) Repairs and Maintenance cost is ` 10 per day.
v) A day comprises of 8 hours for all the four machines and the factory
works for 300 days a year on a single shift.
vi) Supervisor’s salary ` 800 p.m. for all the machines.
vii) Depreciation on Building - ` 100 p.m. for all the machines.
viii)Factory overheads - ` 1,600 for all the half year for all the machines.
Idle time for all the machines is estimated at 10% which is normal.
8.
A department is having three machines. The figures indicate the departmental
expenses. Calculate the machine hour rate in respect of these machines
from the information given below :
`
Depreciation of Machinery
12,000
Depreciation of Buildings
2,880
Repair to Machinery
4,000
Insurance of Machinery
800
Indirect Wages
6,000
Power
6,000
Lighting
800
Miscellaneous Expenditure
4,200
Total
36,680
Advanced Cost Accounting - II
163
Absorption of overheads,
Absorption of Factory Overheads
Machine I Machine II
`
1,200
2,400
2,400
Units
30,000
10,000
20,000
Numbers
4
8
8
8
24
48
Sq. ft.
400
800
800
`
3,00,000
1,20,000
1,80,000
200
300
300
Direct Wages
Power
Number of workers
Light Points
NOTES
Space
Cost of machine
Hours Worked
9.
Machine III
The following are the figures of Kirloskar Ltd., Kirloskarwadi, for the month
of May 2006.
Cutting Dept.
Finishing Dept.
`
`
Raw Material
15,000
4,000
Direct Labour
20,000
3,000
5,000
1,000
40,000
8,000
30,000
5,000
Works Overhead
Direct labour hours worked
The details of Job No. 64 are given below Cutting Dept.
Finishing Dept.
`
`
Raw Material
300
40
Direct Labour
400
30
Direct Labour Hours
900
80
Machine Hours Worked
850
25
Find out the overhead rated for department using the following methods :
1. Direct Labour Hours
2. Direct Labour Cost
3. Machine Hour Rate
You are required to prepare a statement for Job. No. 64, under each of the
above methods, showing thereby the total cost.
9.8
164 Advanced Cost Accounting - II
Further Reading
i)
‘Advanced Cost Accounting’ - Nigam and Sharma
ii)
‘Cost Accounting’ - Principles and Practice’ - N. K. Prasad
iii)
‘Cost Accounting’ - Jawahar Lal
iv)
‘Theory and Practice of Cost Accounting’- M. L. Agrawal
v)
‘Cost Accounting’ - B. K. Bhar
Unit 10 Absorption of Office and
Administration and Selling and
Distribution Overheads
Structure
Absorption of Office &
Administration & Selling
& Distribution Overheads
NOTES
10.0 Introduction
10.1 Unit Objectives
10.2 Methods of absorption of office and administration overheads
10.2.1 Percentage of works / factory cost
10.2.2 Percentage of sales
10.2.3 Apportionment between manufacturing and selling divisions
10.2.4 Transfer to Costing Profit and Loss Account
10.3 Methods of absorption of selling and distribution overheads
10.3.1 Rate per unit
10.3.2 Percentage of selling price
10.3.3 Percentage of works/factory cost
10.4 Summary
10.5 Key Terms
10.6 Questions
10.7 Further Reading
10.0 Introduction
Office and administration overheads and selling and distribution overheads
are different from factory / works overheads. Therefore, they cannot be absorbed
by using the methods of absorption of factory overheads which have been explained
in Unit 9. Nature and amounts of these overheads depends upon the type of
organisation used by the business enterprise and the size of the markets in which
the enterprise sales its product to the consumers. The amounts spent on these
overheads must be included in the calculation of the total cost of the output or of
the jobs completed by the enterprise. The methods used for absorption of these
two types of overheads are explained in this unit.
Advanced Cost Accounting - II
165
Absorption of Office &
Administration & Selling
& Distribution Overheads
10.1 Unit Objectives
After study of information given in this Unit, you should be able to understand :
NOTES
•
Methods used for absorption of office and administration overheads,
•
Methods used for absorption of selling and distribution overheads, and
•
How to select and use a particular method depending upon situation and
nature of the overheads.
10.2 Methods of Absorption of Office and
Administration Overheads
Office and administration overheads which are also known as ‘office on
cost’ and ‘general overheads’ are the indirect costs related to the work of
determination of policies, planning work, directing the organisation and controlling
the operations of an undertaking. These are the overheads which are incurred
due to the activities of the Board of directors which decides the objectives of an
undertaking, prepares and directs the other departments to follow the policies for
achievements of the objectives, guides the executives and others persons working
in the undertaking is case of difficulties faced by them and exercises overall control
on the working of the organisation. Expenses incurred for office work, accounts
department and finance department are also included in the office and
administration overheads. These overheads are incurred for the undertaking as a
whole and compared to the amount of factory overheads the amount of office and
administration overheads is very small. These overhead include director’s fees
and other expenses, office rent and taxes, salaries of office staff, general lighting
expenses of the office building, telephone charges, insurance of office building,
printing and stationary expenses, expenses of finance department, audit fees, legal
expenses, depreciation of office furniture, repairs and maintenance expenses of
office furniture and office equipments, meeting expenses etc.
Office and administration overheads form a part of the total costs of an
undertaking and absorption of these overheads is done by using any one method
mentioned below :-
166 Advanced Cost Accounting - II
1.
Percentage of works / factory cost,
2.
Percentage of sales,
3.
Apportionment between manufacturing and selling divisions,
4.
Transfer to costing profit and loss account.
10.2.1 Percentage of works / factory cost
Works cost or factory costs is the cost obtained after addition of factory
overheads to the prime cost. Percentage of the office and administration overheads
amount to the works cost is calculated and used as a rate for absorption of the
office and administration overheads. The formula used for calculating the absorption
rate is as under :
overhead absorption rate =
Absorption of Office &
Administration & Selling
& Distribution Overheads
NOTES
office and administration overheads
x 100
Works cost
Thus, for an undertaking if the office overheads amount to ` 15,000 and
the works cost amounts to ` 2,00,000 the rate for absorption of office overheads
will be :
Overhead rate =
15,000
x 100
20,0000
= 7.5 %
If works cost of job is `20,000, it will be charged with office overheads of
` 1,500 calculated at 7.5 % of `20,000.
This method of absorption of office and administration overhead is used by
majority of the concerns.
10.2.2 Percentage of sales
In this method percentage of office and administration overheads to sales
is calculated and it is used as the overhead rate for absorption of the office and
administrations overheads. The percentage is calculated as under :Overhead absorption rate =
Office and Administration Overheads
x 100
Sales
If office and administration overheads incurred by a company amount to
` 20,000 and sales for the same period are ` 400000, the overhead absorption
rate will be :
Overhead absorption rate =
=
20,000
x 100
4,00,000
5 %
Office and administration overheads will be charged at 5% at the sales
value of a product or a job.
Since office and administration overheads and sales are not directly related
to each other, this method of absorption is not used by many concerns.
Advanced Cost Accounting - II
167
Absorption of Office &
Administration & Selling
& Distribution Overheads
NOTES
10.2.3
Apportionment between manufacturing and
selling divisions
In this method it is assumed that office and administration overheads are
incurred for providing necessary service to the manufacturing division and the
selling division and so instead of absorbing the office and administration overheads
separately they should be apportioned between the manufacturing and selling
divisions in the proportion in which the office has rendered service to these divisions.
For example, if office and administration overheads amount to ` 16,000 and it is
estimated that the office renders 40% service to manufacturing division and 60%
service to the selling division the apportionment of the office and administration
overheads will be done as follows :
40% of `16,000 = `6,400 apportioned to manufacturing division.
60% of `16,000 = `9,600 apportioned to selling division.
These apportioned amounts will be included in the total overheads of the
factory overheads and selling overheads respectively and will be absorbed as
factory overheads and selling overheads by the particular methods used for
absorption of the factory overheads and selling overheads.
10.2.4 Transfer to Costing Profit and Loss Account
In this method the office and administration overheads are not treated as
the product cost but they are treated as the period costs. The amount of office
and administration overheads is, therefore, debited to the Costing Profit and Loss
Account for the period; the cost of a product or of a job does not include any
amount for office and administration overheads.
This method is not a proper method of obserption of office and administration
overheads because there is no absorption of these overheads in the cost of products
or jobs performed by the concern. The cost of a product or cost of a job does not
include any amount for office and administration overheads and so the cost
calculated for a product or a job is less than its proper cost. This also results in
undervaluation of stock of the finished products.
10.3 Methods of absorption of selling and
distribution overheads
168 Advanced Cost Accounting - II
Selling overheads are the overheads incurred for making the prospective
customers aware about the products or service which the undertaking is offering
to them and thus create and maintain demand for the product or service. Selling
overheads are also known as marketing overheads and they include overheads
such as remuneration of salesman, travelling and other expenses to travelling
salesmen, advertising expenses, show-room or window display expenses, leaflet
printing and quotation expenses, commission of sales agents, cost of free samples,
sales department’s expenses like rent, rates and taxes of the sales department,
lighting and telephone expenses of the sales department, salary of sales manager
and other staff working in the sales department, insurance charges of sales depots,
and show-rooms, depreciation and repairs and maintenance expenses of sales
department furniture and other equipment, etc.
Distribution overheads are the overheads incurred for fulfilling the orders
received from the customers and for delivering the product or service to the
customers. These overheads take place after receipt of orders from customers
and include the expenses incurred for providing the after-sales services such as
replacement of parts or replacement of the total product if it is defective (during
the guarantee period), servicing and maintenance of the product as mentioned in
the terms and conditions of sales contract, packing of the material for safe
transportation, cost of fuel used for delivery vans and other vehicles, octroi charges,
insurance in transit while goods are being transported from sales depot or
warehouse to the market places or customer’s homes, loading and unloading of
the products, etc.
Absorption of Office &
Administration & Selling
& Distribution Overheads
NOTES
Generally the selling overheads and distribution overheads are combined
and the total amount of the selling and distribution overheads is absorbed by applying
one rate which is calculated by using one of the following methods :
1.
Rate per unit,
2.
A percentage of selling price, and
3.
A percentage of works cost.
10.3.1 Rate per unit
When an undertaking is engaged in the activity of manufacturing and selling
only a single and uniform type of product, this method of absorbing selling and
distribution overhead is regarded as the best method. The amount of selling and
distribution overhead is estimated for a specific period and the total units to be
sold in the same period are also estimated. The amount of estimated overheads is
divided by the estimated units to be sold and the rate so obtained is used for
charging the selling and distribution overheads to the number of units of the
product sold. For example a concern has estimated an amount of ` 75,000 as the
selling and distribution overheads to be incurred for a period of 3 months and
2,500 units of the product are estimated to be sold in the same 3 months. The
overheads rate for absorption of the selling and distribution overheads will be
calculated as under
Estimated amount of selling and distribution overheads
=
Number of units estimated to be sold
` 75,000
=
2,500 units
=
` 30 Per unit
Advanced Cost Accounting - II
169
Absorption of Office &
Administration & Selling
& Distribution Overheads
Therefore if an order for supplying 200 units of the product is received
and executed, it will be charged with ` 6,000 as the selling and distribution
overheads calculated as 200 units of the product x 30 per unit = ` 6,000
10.3.2 Percentage of selling price
NOTES
In this method the amount of selling and distribution overheads and the
amount of sales are decided on the basis of the previous year’s records and the
percentage of the selling and distribution overheads to sales amount is calculated
as under :Overheads Absorption Rate =
Selling and distribution overheads
Sales
x 100
At the rate so calculated selling and distribution overheads are added to
the cost of production to decide the total cost of the product or job.
For example the selling and overhead amount for 2012 year is `50,000 and
the sales for the same year amounted to `2,50,000. The percentage of selling
and distribution overheads to sales is 50,000
x 100 = 20 %
2,50,000
If selling price of one unit of the product is fixed as `150 for the year 2013,
20% of `150 i.e. `30 will be added to the cost of production of one unit of the
product to calculate the total cost of one unit of the product. For using this method
the selling price of the products must be pre-determined. Use of this method can
be made by the concerns which produce and sell more than one type of products.
10.3.3 Percentage of works cost
Check Your Progress
i)
Which
methods
are
available for absorption of
office and administration
overheads ?
ii) Which methods can be
used for absorption of
selling and distribution
overheads ?
170 Advanced Cost Accounting - II
In this method the percentage of selling and distribution overheads to the
works cost is calculated and it is used for absorption of the selling and distribution
overheads. Calculations of the percentage is done as under :Selling and distribution overheads
x 100
Amount of works cost
Selling and distribution overheads are actually not dependent on the works
cost of a product or a job and so this method is used only when the amount of
selling and distribution overheads is very small and insignificant.
10.4 Summary
A business concern incurrs office and administration overheads and also
selling and distribution overheads. Office and administration overheads are incurred
for determination of policies, preparation of plans for working of different
departments, division etc., for guiding the persons working in the concern, for
preparation and maintenance of records needed by the concern and for keeping
control on the working of the concern. Selling and distribution overheads are
incurred for selling products manufactured by the concern by creating demand
for the products and for looking after the work of distributing and delivering the
products to customers as per their orders. These overheads are also required to
be recovered and absorbed in the costs of the products. There are four methods
used for absorption of office and administration overheads. They are as under :1.
Percentage of works / factory cost,
2.
Percentage of sales,
3.
Apportionment between manufacturing and sales divisions, and
4.
Transfer to Costing Profit and Loss Account.
Absorption of Office &
Administration & Selling
& Distribution Overheads
NOTES
For absorption of selling and distribution overheads following three methods
are available :1.
Rate per unit,
2.
Percentage of selling price, and
3.
Percentages of works / factory cost.
10.5 Key Terms
i)
Office and Administration Overheads : The overheads incurred for
carrying on office work and management and administration work are called
office and administration overheads. The other terms used for them are
‘office oncost’ and ‘general overheads’.
ii)
Selling and Distribution Overheads : Overheads incurred for creating
demand and increasing sales are selling overheads and overheads for fulfilling
the orders received from customers and delivering the products to them are
known as distribution overheads.
Advanced Cost Accounting - II
171
Absorption of Office &
Administration & Selling
& Distribution Overheads
NOTES
10.6 Questions
1.
What do you understand by ‘absorption of office and administration
overheads’ ?
2.
Explain methods used for absorption of office and administration overheads
and comment on suitability of these methods ?
3.
What is meant by absorption of selling and distribution overheads ? Why
such absorption is necessary ?
4.
Which methods are available for absorption of selling and distribution
overheads ? which of these methods is suitable in your opinion ?
10.7 Further Reading
172 Advanced Cost Accounting - II
i)
‘Advanced Cost Accounting’ - Nigam and Sharma
ii)
‘Cost Accounting’ - Principles and Practice’ - N. K. Prasad
iii)
‘Cost Accounting’ - Jawahar Lal
iv)
‘Theory and Practice of Cost Accounting’ - M. L. Agrawal
v)
‘Cost Accounting’ - B. K. Bhar
Unit 11 Under and Over Absorption of
Overheads
Under & Over Absorption
of Overheads
Structure
NOTES
11.0 Introduction
11.1 Unit Objectives
11.2 Meaning of under and over absorption of overhead
11.3 Causes of under and over absorption
11.4 Treatment of under and over absorption
11.5 Illustrations
11.6 Summary
11.7 Key Terms
11.8 Questions and Exercises
11.9 Further Reading
11.0 Introduction
Amount of overheads absorbed by the output, jobs completed, processes
completed, etc. should be equal to the amount of overhead actually incurred during
the period. When this happens, exact amount is included in the total cost calculated
for the output produced or jobs completed. When actual rate is used for absorption
of overhead, this becomes possible but use of actual rate overhead causes delay
because actual overheads incurred and actual quantity of output produced or
number of jobs completed during the period become known at the end of the
period. There fore pre-determined rate is used for absorption of overhead but this
may cause a difference in the amount of overhead absorbed and the amount of
overheads actually incurred. This difference is known as under or over absorption
of overhead. In this Unit, information about meaning, causes and treatment to be
given for under and over absorption of overhead is provided.
11.1 Unit Objectives
After studying the information given in this Unit you should be able to :•
Understand meaning of under and over absorption of overheads,
•
Understand causes of under and over absorption, and
•
Know the treatment to be given to under or over absorbed amount of
overheads.
Advanced Cost Accounting - II
173
Under & Over Absorption
of Overheads
NOTES
11.2 Meaning of under and over absorption of
overheads
Under absorption of overheads means the amount of overheads absorbed
by the output produced or jobs or processes completed or orders fulfilled or
operations carried out in a specific period is less than the actual overheads amount
incurred in the same period. Under absorption of overheads is also called underrecovery of overhead; e.g. in the month of November, 2014 the amount of
overheads absorbed by the out-put is ` 9,800 and actual amount of overhead
incurred is ` 10,500. It means amount of overhead absorbed is `700 less then
the actual amount of overhead incurred and so we say that in November, 2014
there is under absorption of ` 700. Under absorption of overheads results in
showing the total cost of the output less by the amount of under absorption of
overheads.
Over absorption of overheads is exactly opposite to under absorption. The
amount of overheads absorbed in a specific period is more than the amount of
overheads actually incurred in that specific period. The excess amount of overheads
absorbed over the actual amount of overheads incurred is the amount of over
absorption of overheads. Over absorption is also known as over recovery of
overhead; e.g. in December, 2014, a manufacturing company has absorbed of
` 25,000 and the actual overheads incurred in December, 2014 amount to `23,800.
It means there is a difference of `1,200 between overheads absorbed and
overheads actually incurred and since overheads absorbed are more than overheads
actually incurred, this difference of `1,200 is amount of over absorption of
overheads. Over absorption of `1,200 will result in increasing the total cost of
output in December, 2014.
Under or over absorption of overheads does not take place when actual
rate of absorption of overheads is used for absorption of overheads. When predetermined rate is used for absorption of overheads there is a possibility of under
or over absorption of overhead taking place.
11.3 Causes of under and over absorption
Under and over absorption of overheads may arise due to any one or
more of the following causes :A) Error in estimating overheads :
174 Advanced Cost Accounting - II
For calculation of the pre-determined rate of absorption it is necessary to
estimate amount of overheads for the future specified period. The estimation is
done on the basic of past experience of the overheads and changes likely to take
place in the future period. The estimated amount of overheads may be wrong and
the amount estimated may be more or less than the actual amount of overheads.
If the estimated amount is more the pre-determined rate of overhead absorption
will be more and naturally amount of overheads absorbed at that rate will be more
than the actual amount of overheads incurred in the specified period and this will
cause over absorption of overheads.
If estimated amount of overheads is less than the actual overheads amount,
the pre-determined rate of absorption of overheads will be lower than what it
should have been. Absorption of overheads done at the low rate will result in less
amount of overheads absorbed than the actual amount of overheads incurred in
the period and so under absorption of overheads will take place.
Under & Over Absorption
of Overheads
NOTES
B) Error in estimating the quantity of production :
While estimating the quantity to be produced in the future specific period an
error may be committed. Estimated quantity of production may be more or less
than the actual quantity produced. The estimated amount of overheads is divided
by the estimated quantity of production in order to determine the pre-estimated
rate of overheads absorption. When more quantity of production is estimated, the
pre-determined rate will be lower and overheads absorbed at such lower rate will
result in under absorption of overheads. If estimated quantity of production is less
than the actual quantity produced, the pre-determined overhead absorption rate
will be higher than what it should have been. Overheads absorbed at the higher
rate will result in more amount being absorbed than the actual amount of overheads
incurred during the period and this will result in over absorption of overheads.
C) Seasonal fluctuations in overheads from time to time :
Overhead amounts may not be same every month or every quarter of a
year. Some items of overheads may show a tendency to fluctuate over a period of
time and accurate estimation about the amount of fluctuation and the period for
which it will continue is very difficult. If the assumptions made about the fluctuations
go wrong, the pre-determined rate decided and used for overheads absorption will
not enable the exact amount of overheads absorption and this will cause under or
over absorption of overheads.
D) Unexpected change in the productive capacity :
For determination of the pre-determined rate of overheads absorption it is
necessary to consider the productive capacity of the concern or of the department.
Due to some unexpected situation the productive capacity anticipated does not
remain same; it may increase or decrease; e.g. due to unexpected strike of the
workers, a few days or a few weeks time is lost and the productive capacity
cannot be used for such time. Similarly due to installation of a machine with a
greater capacity, more productive capacity becomes available and due to it more
quantity is produced. Any such changes will result in either under or over absorption
of overheads.
E) Sudden change in the method of production or use of latest machinery
in place of existing machinery :
Pre-determined rate of absorption of overhead is calculated on the basis of
present method of production used in the concern and by considering the machinery
currently being used for production work. When the new method of production is
introduced in the middle of the period or modern machinery is installed for production
Advanced Cost Accounting - II
175
Under & Over Absorption
of Overheads
work, the overheads undergo changes. Overhead amount may increase or decrease
due to such change and if the change is not made in the pre-determined overhead
absorption rate, the amount of overheads absorbed and the actual amount of
overheads incurred will not be same. The difference in these two amounts may
result in under absorption or over absorption of overheads.
NOTES
11.4 Treatment of under and over absorption
Check Your Progress
i)
Explain the meaning of
‘under absorption’ and
‘over absorption’ ?
ii) State the causes of under
and over absorption
iii) Which method are used
for treating under and
over absorption ?
When under or over absorption of overheads is found, the net amount to be
adjusted is calculated by adding the amounts of under and over absorption. The
net amount may be under absorption or over absorption. By considering the amount
to be adjusted - whether it is a small or large amount- and the cause due to which
it has arisen the treatment to be given to the net amount is decided. There are
following three types of treatments out of which a proper treatment is decided-:
i)
Writing off to Costing Profit and Loss Account,
ii)
Carrying over to the next year’s account, and
iii)
Use of Supplementary Rates.
i) Writing off to Costing Profit and Loss Account :
When the amount of under or over absorbed overheads is very small and it
is not considered worthwhile to change the cost calculation already done, the
amount of under or over absorbed overheads is transferred to the current year’s
Costing Profit and Loss Account. Under absorbed amount of overheads is debited
to the Costing Profit and Loss Account and the amount of over absorbed overheads
is credited to the Costing Profit and Loss Account. When under absorption of
overheads is caused by abnormal factors, the amount of under absorption is debited
to the Costing Profit and Loss Account.
ii) Carrying over to the next year’s account
When over or under absorbed amount is not transferred a minus rate since
amount of overheads absorbed by the pre-determined rate of absorption is required
to be reduced by using the supplementary rate.
Supplementary rate is used to adjust the cost of work-in-progress, finished
stock and cost of sales. Supplementary rate should not disturb the jobs already
completed and so supplementary rate is used to adjust the costs of Work-in-progress,
finished stock and Cost of Sales. When use of supplementary rate is done, the
absorbed amount of overheads and the amount of overheads actually incurred
become equal.
176 Advanced Cost Accounting - II
Under & Over Absorption
of Overheads
11.5 Illustrations
ILLUSTRATION 1
Viraj Manufacturing Company has given following information about Factory
Overheads of its three production departments A, B and C for year ending on 31st
march, 2014.
NOTES
Factory overheads actually incurred :A Department
` 36, 200
B Department
` 45, 600
C Department
` 57, 700
Absorption of the Factory Overheads has been done for the three
departments as stated below :A Department
` 6 per direct labour hour for 6000 direct labour hour
B Department
75% of direct wages of `70, 000
C Department
` 9 per unit for 6000 units.
You are required to calculate the amount of under or over absorption of the
Factory Overheads for the Company for the year ending 31st march, 2014 and
also prepare a statement showing the amount of under or over absorption
department wise.
SOLUTION
Calculation of Factory Overhead absorbed :
Department
Basis of Absorption
A
` 6 per direct labour hour
Amount Absorbed
`
for 6000 hours
B
36,000
75% of direct wages
C
of `70, 000
52,500
`9 per unit for 6000 units
54,000
Total
1,42,500
Statement showing department wise under or over absorption
Department
Actual Factory
Factory Overheads
Under
Over
Overheads
Absorbed
Absorption
Absorption
`
`
`
`
A
36,200
36,000
200
-
B
45,600
52,500
-
6,900
C
52,700
54,000
-
1,300
Total
1,34,500
1,42,500
200
8,200
Advanced Cost Accounting - II
177
Under & Over Absorption
of Overheads
Net amount of absorption
= ` 8,200 – `200
= ` 8,000
Factory O.H. Absorbed - Factory O.H. actually incurred = Amount of over
absorption
NOTES
` 1,42,500 – ` 1,34,500
= ` 8000
ILLUSTRATION 2
Zed company has incurred `5,25,000 as the Factory Overheads during the
year ended on 30th June, 2014. The company has used pre-determined rate of
`3.50 per hour for absorption of the factory overheads. During the year actual
hours worked amounted to 1,40,000. The company has produced 8000 units of
which 7000 units have been sold. The work-in-progress at the end of the year
consists of 500 equivalent units. 20% of the under absorbed overheads are due to
a major accident that has taken place in the factory during the year and balance of
under absorbed overheads amount is due to increase in the price of indirect materials
to current year’s Costing Profit and Loss Account, the second alternative treatment
which can be used to adjust the amount of under or over absorption of overheads.
An account called Overheads Absorption Account is opened to which the various
amounts of under and over absorption of overheads shown by different departments,
sections, divisions etc. are transferred. At the end of the year, the balance shown
by this Account is carried to the next year’s account and such balance is expected
to be adjusted by the amounts of under and over absorbed overheads transferred
in the next year. This treatment is criticised on the ground that cost of one year
are absorbed in the next year while as per cost accounting principle the costs
should be charged to output of the year in which the costs are incurred. Use of
this treatment can be regarded as proper only when the pre-determined rate of
overheads absorption is decided for a long period exceeding one year or when the
under or over absorption of overheads is in respect of a new product introduced in
the current year. The quantity produced and sold of the new product is lees in the
first year but it is expected to increase in the subsequent year.
iii) Use of supplementary rates :
When the amount of under or over absorption of overheads is significant, to
adjust it this treatment is used. The per-determined rate of overhead absorption
was not proper and it has caused the under or over absorption of overheads. The
per-determined rate of absorption should be corrected by making use of the
supplementary rate. The supplementary rate is calculated as under.
Amount of under or over absorption
Supplementary Rate =
Actual absorption base
178 Advanced Cost Accounting - II
If amount of under absorption is to be adjusted the supplementary rate is a
positive rate or a plus rate because the amount of overheads already absorbed is
required to be increased. On the other hand, if there is over absorption of overheads,
the supplementary rate is a negative or calculate the amount of under absorbed
overheads and show how you will treat the amount of under absorption.
Under & Over Absorption
of Overheads
SOLUTION
Calculation of amount of under absorption Factory overheads actually incurred
`5,25,000. Factory overheads absorbed to the per-determined rate of ` 3.50 per
hour for 1,40,000 hours actually worked :
1,40,000 hours x ` 3.50 = ` 4,90,000
NOTES
 Under absorbed overheads = ` 5,25,000 – ` 4,90,000
= ` 35,000
Treatment to be given for under absorbed overheads :20% of under absorption is due to accident in the factory which is an abnormal
cause and so an amount of 20% of ` 35,000 i.e. `7000 is transferred to the
Costing Profit and Loss Account of the year.
Balance 80% of under absorption is caused by the increase in the price of
indirect materials. Therefore, ` 28,000 of under absorbed overheads amount is
to be treated by calculating the supplementary rate and applying it to the Cost of
Sales, stock of Finished Goods and Stock of Work-in-progress.
Amount of under absorption
Supplementary Rate =
Total number of units produced + stock of equivalent
units in work in-progress
` 28,000
=
8000 units + 500 units
` 28,000
=
8500 units
=
` 3.294 per units
 Under absorption of ` 28,000/- is apportioned as under :Cost of sales 7000 units x ` 3.294 = ` 23,058
Closing stock of Finished Goods 1000 units x ` 3.294 = ` 3,294
Closing stock of work-in- progress 500 Equivalent units x ` 3.294 = ` 1,647
As there was under absorption of overheads, the supplementary rate is a
plus rate and so addition of the above mentioned amounts should be done to cost
of sales, stock of finished goods and stock of work-in-progress.
Under absorption of ` 7,000 due to accident should be debited to the
Costing Profit and Loss Account.
[ Note : Total of under absorbed amount treated comes to ` 34,999. Difference
of ` 1 is caused by rounding up of supplementary rate as ` 3.294 per unit]
Advanced Cost Accounting - II
179
Under & Over Absorption
of Overheads
ILLUSTRATION 3
X Ltd. provided following particulars for the year ended 31st March 2013 :`
Manufacturing overheads incurred
NOTES
8,50,000
Manufacturing overheads absorbed
On the basis of pre-determined rate
7,50,000
Work-in-process on 31-3-2013
2,40,000
Finished goods stock on 31-3-2013
4,80,000
Cost of goods sold during the year
16,80,000
Calculate the amount of under or over absorption of manufacturing overheads
and explain how you will treat it in the Books of x std. Also explain the effect of
treatment given on the profit amount of the company.
SOLUTION
`
Manufacturing overheads incurred
8,50,000
Manufacturing overheads absorbed on the
basis of pre-determined rate of absorption
7,50,000
 In the year ended 31st March, 2013 there has been under absorption of
manufacturing overheads of ` 1,00,000
Treatment for under absorbed amount of ` 1,00,000 can be given by
apportionment of `1,00,000 among Work-in-Progress, Finished Goods stock and
Cost of Goods Sold in the proportions of their costs.
Work-in-progress
`
2,40,000
Finished Goods Stock
`
4,80,000
Cost of Goods Sold
` 16,80,000
` 24,00,000
Total Cost
i)
2,40,000
x 1,00,000
24,00,000
Amount apportioned to work-in-progress :
= ` 10,000
ii)
Amount apportioned to Finished Goods Stock :
4,80,000
24,00,000
= ` 20,000
180 Advanced Cost Accounting - II
x 1,00,000
iii)
Amount apportioned to Cost of Goods Sold :
16,80,000
24,00,000
x 1,00,000
Under & Over Absorption
of Overheads
= ` 70,000
As amount of `1,00,000 is of under absorbed overheads the apportioned
amounts will be added to cost of work-in-progress, stock of finished goods and
cost of goods sold during the year.
NOTES
Addition to the stock of work-in-progress and stock of finished goods will
increase their value and the amount of profit for the year will increase by
` 30,000.
Addition to the cost of goods sold during the year will increase the cost of
goods sold by ` 70,000 and will decrease the profit by ` 70,000
The net effect on the profit amount will be ` 40,000 decreas;
(`70,000 (-) and ` 30,000 (+)).
11.6 Summary
When overheads incurred and overheads absorbed for the same period are
not same, under or over absorption of overheads results. When actual rate is used
for absorption of overheads, the amount of overheads incurred and the amount of
overheads absorbed are exactly equal and so there is no under or over absorption
of overheads. Actual rate of absorption of overheads can be calculated and used
only at the end of the year and this difficulty compels the business concerns to
make use of the pre-determined rate of absorption of overhead. Pre-determined
rate is calculated by estimating the amount of overheads in the future and by
dividing this amount by estimating the quantity of output, jobs, labour hours or
machine hours, etc which is used as a base. If there is error committed in estimating
the amount of overheads or in the estimated quantity used as a base or in both the
estimates, there arises a difference between the actual amount of overheads
incurred and the absorbed amount of overheads on the basis of the pre-determined
rate of absorption. If actual amount of overheads incurred is more than the amount
of absorbed overheads, the difference is called ‘Under absorption overheads’ and
if actually incurred overheads amount is less than the amount of overheads absorbed
the difference is known as ‘over absorption of overheads’.
Under and over absorption can be treated in the following ways :i)
Transfer to Costing Profit and Loss Account,
ii)
Carry over to next year’s Account, and
iii)
Use of supplementary rates for absorption of under or over absorbed amount
of overheads.
By considering factors like amount of under or over absorption, the causes
due to which it has come into existence and whether the new product is introduced
Advanced Cost Accounting - II
181
Under & Over Absorption
of Overheads
in the market in middle of the year or not, a proper type of treatment is selected
and used.
11.7 Key Terms
NOTES
i)
Under Absorption : When the actual overheads amount is more than the
amount of overheads absorbed, the difference is known as under-absorbed
amount of overheads.
ii)
Over Absorption : When the amount of overheads absorbed is more than
the actual amount of overheads incurred, the difference is known as overabsorbed amount of overheads.
iii)
Supplementary Rate : It is an additional overhead recovery rate calculated
for treating the amount under absorbed or over absorbed. The supplementary
rate is calculated as under :Amount of under or over absorption
Supplementary Rate =
Actual absorption base
Supplimentary Rate is a positive rate when the amount of under absorbed
overheads is to be treated and it is a negative supplementary rate when it is
to be used for treatment of over absorption of overheads.
11.8 Questions and Exercises
I - Theory Questions
182 Advanced Cost Accounting - II
1.
Explain the concept of ‘under absorption’ and ‘over absorption’ of overheads.
2.
What is meant by under absorption of overheads ? What are the causes of it ?
3.
What is meant by over absorption of overheads ? What are its causes ?
4.
Under which situation under and over absorption of overheads takes place ?
Explain how under and over absorption of overheads can be treated.
5.
State how ‘actual rate of overheads absorption’ and ‘per-determined rate
of overheads absorption’ are calculated. Which of the two rate may result
in under or over absorption of overheads?
6.
What do you understand by ‘supplementary rate of absorption of overheads’ ?
How it is calculated ? How it is used for treatment of or over absorption of
overheads ?
Under & Over Absorption
of Overheads
II - Multiple Choice Questions
1.
2.
3.
Under absorption of overheads is also called ---------- of overheads.
(a)
Primary distribution
(b)
Secondary distribution
(c)
Under recovery
(d)
Allocation
NOTES
Over absorption of overheads is also known as -------- of overheads.
(a)
Overtime
(b)
Over recovery
(c)
Over valuation
(d)
Over consideration
When under or over absorption of overheads in found, the -------- amount
to be adjusted is calculated by adding the amounts of under and over
absorption.
(a)
Gross
(b)
Less
(c)
Minimum
(d)
Net
Amount of under or over absorption
4.
Supplementary Rate =
Absorption base
(a)
Net
(b)
Gross
(c)
Actual
(d)
Normal
Ans. : (1 - c), (2 - b), (3 - d), (4 - c).
III - Exercises
1.
In a manufacturing concern, overheads are recovered at a per-determined
rate of `25 per man-day. The total factory overheads incurred and the man-days
actually worked were `41,50,000 and 1,50,000 days respectively. Out of the 40000
units produced during a period, 30000 were sold. On analysing the reasons, it was
found that 60% of unabsorbed overheads were due to defective planning and the
rest were attributable to increase in overhead costs.
Advanced Cost Accounting - II
183
Under & Over Absorption
of Overheads
How would unabsorbed overheads be treated in cost accounts ?
2.
A manufacturing company absorbs factory overheads on pre-determined
rates. For the year ending 31st December 2013, Factory Overheads absorbed
were ` 3,66,250. Actual amount of overheads incurred amounted to ` 4,26,890.
NOTES
The following figures are also derived from the Trial Balance as on 31st
December, 2013 :
Finished Stock
` 2,30,732
Cost of Goods sold
` 8,40,588
Work-in-Progress
` 1,41,480
 Total Cost
` 12,12,800
Give two methods for the disposal of under-absorbed overheads and show
the profit implications of each method.
11.9 Further Reading
184 Advanced Cost Accounting - II
i)
‘Advanced Cost Accounting’ - Nigam and Sharma
ii)
‘Cost Accounting - Principles and Practice’ - N. K. Prasad
iii)
‘Cost Accounting’ - Jawahar Lal
iv)
‘Theory and Practice of Cost Accounting’ - M. L. Agrawal
v)
‘Cost Accounting’ - B. K. Bhar.
Unit 12 Some Special Items of Overheads
Some Special Items
of Overheads
Structure
12.0 Introduction
NOTES
12.1 Unit objectives
12.2 Special items of overheads and treatment to be given to them
12.2.1
Interest on capital
12.2.2
Cash discount
12.2.3
Packing expenses
12.2.4
Defective or spoiled work
12.2.5
Depreciation
12.2.6
Obsolescence loss
12.2.7
Idle capacity cost
12.2.8
Research and development cost
12.2.9
Cost of fringe benefits to employees
12.2.10 Drawing and designing office cost
12.2.11 Expenses of cost accounting department
12.3 Summary
12.4 Key Terms
12.5 Questions
12.5 Further Reading
12.0 Introduction
In units 1 to 11 you have studied the meaning of overheads, the classification
of overheads, allocation and apportionment of overheads, primary and secondary
distribution of overheads and absorption of the factory, office and administration
and selling and distribution overheads and various methods used for such absorption.
There are, however, some special items of overheads which are treated in different
ways by different concerns. Study of these items of overheads and different
ways in which they are treated is explained in this unit.
Advanced Cost Accounting - II
185
Some Special Items
of Overheads
12.1 Unit Objectives
After completing the study of Unit 4, you should be able to :
•
Understand why these items of overheads are considered as the special
items of overheads;
•
Understand the nature of special items of overheads, and
•
Understand the various ways in which these items of overheads can be
treated.
NOTES
12.2 Special items of overheads and treatment to be
given to them
12.2.1 Interest on capital
There is difference of opinion among the cost accountants regarding
inclusion of interest on capital as a cost of production. Some cost accountants say
that interest on capital is an expense of financial nature and so it should be excluded
in cost accounting while some other cost accountants say that interest on capital
is a cost just like any other items of cost and so it should be included in calculation
of cost of production. Some cost accountants say that only interest on capital
actually paid or payable should be included in cost calculation while some others
say that interest on capital whether paid or notional (i.e. interest on owned capital)
should be included in cost calculation. There are arguments for inclusion of interest
on capital which are as under :-
186 Advanced Cost Accounting - II
i)
Capital is a resource used for production and as rewards for other resources
like land and labour are included in cost calculation, interest, which is a
reward for use to capital, should also be included in cost calculation of a
product or a job.
ii)
The comparison of operations, different processes etc. can be correctly
done and reliable conclusions can be drawn only when interest on capital
used for the operations, processes etc. is included in their cost calculations.
iii)
Interest is calculated on time basis and since time is an important factor in
cost calculation, interest on capital should be included in cost calculation. A
job or a product which needs a short time for completion will be charged
with a small amount of interest and another job or product which requires
a long period for completion will bear a larger amount of interest on capital.
iv)
When a concern manufactures different types of products and the values
of these products differ considerably, it is necessary to include interest on
capital for determining their costs since capital investment made in these
product is not equal.
v)
Interest paid on borrowed capital (loans, issue of debentures) is regarded
as an item of cost. On the same lines interest on owned capital should also
be regarded as an item of cost. If one company has raised capital by issue
of equity shares and another company doing the same business has raised
most of its capital by issue of debentures their costs will not be comparable
unless interest on capital is calculated for both companies irrespective of
whether it is owned capital or loan capital.
Some Special Items
of Overheads
NOTES
vi)
To find out the true cost of maintaining heavy stock the interest on capital
invested in such stock has to be taken into consideration.
Those who say that interest on capital should not be included in the
cost calculation put forward following arguments in support of their
view :
i)
Interest on capital is a concept of economics and it has no place in cost
accounting. Cost accounting considers only the actual costs and so the
notional cost like interest on capital has no place in calculation of costs.
ii)
Interest on capital is purely dependent upon the financial policy in regard to
raising of capital to be used for investing it in the business. If capital is
raised by issue of only equity shares, interest on capital is not required to be
paid. In such situations it is better to exclude interest on capital from cost
calculation.
iii)
If interest on capital is included in the cost of the products manufactured,
the value of stock of the finished goods and of work-in-progress is increased
and unearned profit is shown by the final accounts.
iv)
There are various concepts of capital such as total capital, working capital,
capital invested in the fixed and long term assets and capital invested in the
current assets. Thus the problem arises on which capital the interest on
total capital invested and other company charges it on the working capital,
the total costs of these two companies do not remain comparable. It is,
therefore, better to exclude the item of interest on capital from the calculation
of costs.
v)
The rate at which interest should be calculated on capital is another problem
to be faced if it is decided to include interest on capital in the calculation of
costs. Interest charged at different rates by different companies do not
make their costs comparable.
Treatment to be given to the item of interest on capital. The following
treatments are suggested :
1.
Interest on capital actually paid or payable or notional interest on capital
should be included in the cost calculation of a product.
2.
Interest actually paid or payable on borrowed capital should be included in
the cost calculation. The notional interest (interest on own capital) should
not be included in the cost calculation. The reasoning behind this treatment
is that interest paid or payable results in affecting the cash out flow but
notional interest does not affect the cash outflow.
Advanced Cost Accounting - II
187
Some Special Items
of Overheads
3.
NOTES
Interest on capital whether paid or payable and notional interest on own
capital should not be included in the cost calculation. Interest on capital is
not a cost related to the cost of manufacturing but it come in existence due
to the decision or policy decided by the management regarding financing of
the activities of the enterprise. Therefore, interest on capital is not included
in the cost calculation of a product or a job but it is charged against the
profits earned by the enterprise in the period.
Out of the above mentioned treatments which treatment should be adopted
is decided by the management by taking into consideration the amount of interest
on capital and the structure used for the capitalisation by the enterprise. The
treatment should remain unchanged over a period so that the comparisons made
of the costs for different years will enable to draw proper conclusions.
12.2.2 Cash discount
Cash discount is of two types-cash discount received by the enterprise for
making prompt payment to the suppliers for the purchases made from them and
cash discount allowed by the enterprise to its customers for prompt payments
made by them. Thus it is an item which depends on the financial policy decided by
the management of the enterprise. Generally cash discount received by the
enterprise is credited to the Profit and Loss Account as a financial gain. Cash
discount given to the customers of enterprise helps in increasing the sales and in
collection of the debts immediately or within a short period and thus reduces the
risk of bad debts. The cash discount allowed to the customers may be treated as
item of selling overheads or it may be treated as a financial expense and directly
debited to the Profit and Loss Account. One the decision is taken about the
treatment to be given to the item of cash discount, it should be followed for a long
period of time so that costs calculated for different periods remain comparable.
12.2.3 Packing expenses
Packing expenses include the cost of materials used for packing of products
and the cost of labour used for doing the packing of products. Depending upon the
nature of product to be packed materials such as paper, cloth, cartons, bottles,
plastic containers, glue, nails, threads or strings, saw-dust, cotton, etc. are used as
per the requirement. The materials used for packing can be divided into following
three categories.:-
188 Advanced Cost Accounting - II
a)
Primary packing materials which are used to pack the product and to provide
protection to it, e.g. liquid products such as medicines, oils are packed in the
bottles or plastic containers, thick paper is used for packing the cake of the
soap (inner packing). The cost of such packing is treated as the part of
prime cost.
b)
Secondary packing materials which are used for handling of the product
and for giving identification to the product and for giving instructions to the
customers as to how the product should be used and care to be taken to
protect the product during storage. For example the soap cake packed in
the inner packing is put in the outer wrapper which provides information
about the product such as the brand-name, name of the manufacturer, weight
of the product, price of the product, etc. Medicine which is packed, in the
plastic or glass bottle is put in thick paper-box (or carton) which gives
additional protection to the product and also provides information about
name of the medicine, manufacturing company, contents of the medicine,
dose in which the medicine is to be given to the patient, price, date of
manufacture, date of expiry, etc.
Some Special Items
of Overheads
NOTES
Cost of such secondary packing may be treated as cost of manufacturing
or it may be treated as the selling overheads.
C)
The third category of packing materials is the materials used for
convenience in handling and transportation of the products from
manufacturer to wholesalers and retailers or to the sales depots. For this
type of packing wooden boxes, gunny bags, racks and plastic or metal
boxes, drums, etc. are used.
The cost of this type of packing is treated as the distribution overheads
since the purpose of this packing is transportation of the product in bulk
and distribution of it to the dealers, agents, traders, etc.
12.2.4 Defective or spoiled work
Defective work or spoiled work arises in the manufacturing process. If the
amount of such work is within the normal limit it is included in the cost of production
of the good units produced, especially when the defective or spoiled work is inherent
in the process of manufacturing.
If the amount of defective or spoiled work is beyond the normal limit it is
treated as abnormal loss and it is transferred to costing Profit and Loss Account.
If the amount of defective or spoiled work is very large a report is prepared for it
giving the reasons for such work. The reasons may be use of inferior quality
material, carelessness on the part of workers engaged in the production process
or break-down of the machine. In such case the amount of defective or spoiled
work is debited to a separate account called Cost of Defective Work Account. If
there is any recovery for such defective work by way of supply of good material
by the supplier for the defective or inferior quality material supplied earlier or fine
collected from the workers for their carelessness, the amount of such recovery is
credited to the Cost of Defective Work A/c and the net balance of this account is
treated as under :
1)
If the defective work is caused by research and development work carried
out, the net balance should be transferred as an overhead to the research
and development cost account.
2)
If the defective or spoiled work is sold out as it exists, the amount received
from the sale is credited to the Cost of Defective Work A/c and the net
balance of this account is transferred as production overheads.
Advanced Cost Accounting - II
189
Some Special Items
of Overheads
NOTES
3)
If the improvement of the defective or spoiled work is done by carrying out
some additional process the cost incurred for such process is debited to the
Cost of Defective Work A/c and the sale proceeds of the improved work
are credited to the Cost of Defective Work A/c. The balance shown by
this account is transferred to the cost of production of the entire production.
If the defective or spoiled work is caused by abnormal reasons such as
accident, machine break-down etc, it is treated as abnormal loss and it is debited
to Costing Profit and Loss Account.
12.2.5 Depreciation
I.C.M.A. has defined depreciation as ‘the diminution in the value of a fixed
asset due to use and /or the lapse of time.’
Depreciation of factory building or plant and machinery is caused due to
wear and tear to these fixed assets due to their use and /or lapse of time. It occurs
in spite of the repairs and maintenance arrangement made on day-to-day basis.
The value of the asset decreases due to the use of the assets for production
activity to be carried out in the enterprise and sometimes only due to the passage
of time. The amount of depreciation is treated as an item of factory or
manufacturing overhead. The amount of depreciation is provide by using any of
the following methods :
1)
Straight line /fixed installment method of depreciation.
2)
Diminishing balance/ reducing balance method.
3)
Production unit method.
4)
Production hour method.
5)
Annuity method.
6)
Sinking fund method.
7)
Endowment policy method.
1)
Straight line / fixed installment method
In this method the amount of asset to be written off is found out by deducting
the scrap value of the asset at the end of its life from the total value of the asset.
On this amount the depreciation is calculated at a certain percentage every year.
The amount of depreciation per annum remains fixed and so this method of
depreciation is also called as fixed installment method. For example if purchase
price of a machinery is `1,20,000/- installation expenses of the machinery amount
to ` 15,000/- and the estimated scrap value of the machinery is `5,000 and
depreciation is decided to be provided at 10% per year the amount of depreciation
per year will be calculated as under :Depreciation p.a. =(Purchase price + Installation expenses) –Scrap Value x10%
= (` 1,20,000 + ` 15,000) – ` 5,000 x
10
100
190 Advanced Cost Accounting - II
= ` 13000
If in the above example instead of depreciation rate, the life of the machinery
is given as 10 years, the depreciation per year wikk be calculated as under :-
Some Special Items
of Overheads
(purchase price + Installation expenses) – Scrap Value
Depreciation p.a. =
Life in number of years
` 1,20,000 + ` 15,000 – ` 5,000
NOTES
=
10 years
` 1,30,000
=
10
= ` 13,000
2)
Diminishing balance / reducing balance method
In this method depreciation rate per year remains same but the amount on
which the depreciation is calculated is the reduced amount of the asset remaining
after deduction of the depreciation for the year. Thus the amount of depreciation
is calculated on the opening balance of the asset arrived at after depreciation has
been deducted for the previous year. The amount of depreciation charged goes
on decreasing in this method. For example, if an asset is purchased and installed
at a cost of `2,00,000 and it is decided to charge depreciation at 10% p.a. according
to the diminishing balance method, the amount of depreciation in first three years
will be as under. :-
3)
First year at 10% p.a. on ` 2,00,000
= ` 20,000
Second year at 10% p.a. on ` 1,80,000
= ` 18,000
Third year at 10% p.a. on ` 1,62,000
= ` 16,200
Production unit method
In this method the amount of asset to be written off (i.e. Purchase price
carriage and installation charges - scrap value, if any) is divided by the number of
units estimated to be produced during the life time of the asset and the rate so
obtained is the rate of depreciation per unit of production. At this rate the depreciation
is charged for the number of units actually produced in the year for which
depreciation is to be calculated.
When this method is used, the amount of depreciation is accurately charged
as it depends upon the number of units produced by using the asset; when more
number of units are produced depreciation amount charged is more and when less
number of units are produced the depreciation charged will be a small amount.
Depreciation Purchase price + freight and Installation charges-Residual value
=
per unit
Estimated units of production during life of asset
Assuming that purchase price of a machine is ` 5,00,000, freight charge
incurred for the machine amount to ` 10,000 and cost of installation of the machine
Advanced Cost Accounting - II
191
Some Special Items
of Overheads
NOTES
is ` 5,000 and scrap value at the end of its working life is estimated as ` 15,000.
It is estimated that the machine will produce 400000 units of the product in its
working life. The depreciation rate per unit will be calculated as number :Depreciation
per unit
` 5,00,000 + ` 10,000+ ` 5,000 - `15,000
=
400000 units
` 5,00,000
=
400000 units
= ` 1.25
If the machine has produced 36000 units in a year, the machine will be
charged with deprecation (36000 units x ` 1.25) = ` 45,000 for the year.
4)
Production hour method
This method is similar to the production unit method with one change. The
working life of the asset is estimated in production hours and the amount of asset
to be written off is divided by estimated production hours of the asset to calculate
the depreciation rate per production hour. Depreciation amount to be charged is
calculated by multiplying the number of production hours for which the asset is
used during a year by the depreciation rate per production hour.
Total Cost of Asset - scrap value
Depreciation per production hour =
Life of asset in production hours
5)
Annuity method
It is assumed in this method that the amount of depreciation provided for a
fixed asset should cover not only the amount of the asset but also the interest
calculated at a fixed rate on the written down value of the asset. The reasoning
behind this is the enterprise which has purchased the asset would have earned
interest on the amount spent for purchase of the asset if it had invested that
amount outside the business. In this method the asset account is debited with the
amount of interest calculated at a fixed rate on the reducing value of the asset
each year and the asset account is credited with the amount of depreciation decided
by using the Annuity Table. The amount of depreciation remains fixed year after
year and in the last year of the life of the asset when depreciation is provided the
balance of the asset account will become nil or equal to the scrap value of the
asset estimated in the beginning.
This method of depreciation is used only when the value of the asset is very
high and the life of the asset can be accurately decided. For depreciating asset
like lease obtained for a fixed period and by paying a large amount to the leassor.
6)
192 Advanced Cost Accounting - II
Sinking fund method
Under this method yearly amount of depreciation is decided with the help
of the Sinking Fund Table. The depreciation amount remains same every year.
The amount of depreciation is debited to the Profit and Loss Account each year
and credited to Sinking Fund Account. Amount equal to the deprecation amount
is taken out in cash from the business and invested in the securities on which
interest at a fixed rate is received by the enterprise. Interest received on the
Sinking Fund Investments together with amount of depreciation provided for the
year is used for purpose of additional securities of the same type. Thus the amount
of sinking Fund / Depreciation Fund A/c and Sinking Fund Investment A/c goes
on increasing over the life of the asset. In the last year of the life of asset, the
sinking fund investment (securities) are sold in the market at the market price.
Any gain or loss on sale of the securities is transferred to Sinking Fund /Depreciation
Fund Account. The book value of the asset is transferred from the asset account
to the Sinking Fund/Depreciation Fund A/c. Any balance remaining to Sinking
Fund/Depreciation Fund A/c is transferred to Profit and Loss A/c. as gain or loss.
The amount received on sale of the securities becomes available to the enterprise
for purchase of a new asset without causing any strain on the financial resources
of the enterprise.
Some Special Items
of Overheads
NOTES
This method of depreciation thus provides cash for replacement of the asset
at the end of its life by purchasing a new asset and so this method is most suitable
for assets like large machinery or lease which require huge amount of investment.
This method takes out the amount of depreciation and invests it in outside securities
and when the time for replacement of the old asset arrives the required cash is
obtained by sale of these securities without affecting the normal working of the
enterprise.
7)
Endowment policy method
In this method the enterprise takes out an insurance policy of such a value
which can enable it to receive cash for purchasing a new asset to replace the old
asset. The premium of such insurance policy is same every year and is required to
be paid to the amount of the premium is the depreciation provided for the asset.
When the policy matures, the insurance company pays the amount of the policy to
the enterprise by using which the enterprise can purchase a new asset to replace
the old one.
This method is similar to the Sinking Fund Method with the difference that
the insurance premium is paid at the beginning of each year and no securities are
to be purchased in this method. The risk of fluctuation in the market price of the
securities is, thus, avoided in this method.
The enterprise should select one or more of the above mentioned method
for depreciating its fixe assets. The amount of depreciation provided on the assets
which are used in the factory for manufacturing activities is the manufacturing
overhead and it should be included in the total amount of factory overheads to be
apportioned and absorbed by the products manufactured or jobs completed.
Depreciation provided on office furniture and office equipment is included
in the office and administration overheads and depreciation provided on delivery
vans, vehicles used for transportation of finished goods to be delivered to the
market or traders and customers, depreciation provided on sales depot building,
show-rooms and furniture used in sales office is an item of selling and distribution
overheads.
Advanced Cost Accounting - II
193
Some Special Items
of Overheads
NOTES
12.2.6 Obsolescence loss
Obsolescence means sudden fall in the value of a fixed asset due to the
decision taken by the management to stop the use of that fixed asset. The
management is compelled to take such decision due to sudden and permanent fall
in the demand for the product which is produced by using the fixed asset, change
in the size or design of the product or availability of a new and improved type of
the fixed asset with greater capacity of production and which enables production
of a better quality product with a low cost of production or some other reason.
The asset becomes obsolete because even though it has not completed its expected
working life, it is decided to stop use of it. This causes a considerable reduction in
the value of the asset and it cannot be sold at its book value. It is sold as scrap or
it is required to be written off. This causes a huge capital loss and such loss is
called obsolescence loss. It is caused by the economic factors or by the technological
factors.
Some enterprises create Obsolescence Reserve Fund to meet the
obsolescence loss as and when it arises and a certain amount is transferred every
year out of the profits to build up the reserve fund. When obsolescence loss
actually takes place, the amount of such loss is transferred to the Obsolescence
Loss Reserve Fund A/c. If the obsolescence loss is more than the Fund balance,
the balance remaining to the Obsolescence Loss Reserve Fund A/c is transferred
to Costing Profit and Loss Account as abnormal loss. If the Obsolescence Loss
Reserve Fund Account has not been created by the enterprise, the entire amount
of the obsolescence loss is transferred to Costing Profit and Loss Account as
abnormal loss. If the amount of obsolescence loss is very large, instead of charging
it fully to the Costing Profit and Loss Account of the year in which such loss has
occurred, if may be spread over equally in the year of loss and subsequent 2-3
years. This result in charging a proportionate amount of such loss over the decided
number of years and profit of only one year is not burdened with it.
12.2.7 Idle capacity cost
Idle capacity may be of a machine or an asset or of an entire plant. It is
that capacity which is available for use but has not been used and the cost of such
idle capacity is known as the idle capacity cost. In order to understand the idle
capacity, it is necessary to know the various concepts of capacity. They are as
under :1.
Maximum capacity
It is that capacity of a machine or plant which will be achieved under 100%
operating time. Since no plant or machine can remain operative for the 100 %
time, the maximum capacity is only a theoretical capacity. A plant needs some
time for repairs and maintenance, change over from one job to another and for
rests and holidays but this requirement is not taken into consideration in the
maximum capacity.
194 Advanced Cost Accounting - II
2.
Some Special Items
of Overheads
Practical Capacity
Practical capacity is decided by deducting the normal and unavoidable
operating interruptions from the maximum capacity. These normal and unavoidable
operating interruptions are caused by the time required for repairs and maintenance
waiting for the next job, breakdown of machine and rest time needed by the
workers and operators.
3.
NOTES
Normal Capacity
Normal capacity is decided by taking into consideration the ability to produce
and ability to sell. The enterprise has ability to produce but may find it difficult to
sell its full production due to the market conditions. The entire demand of the
market is divided among the various enterprises which are engaged in producing
the same type of product. Sometimes the demand becomes less and the enterprise
may not be able to sell the output produced by it. In such situations, the enterprise
may be required to reduce its output below its ability to produce and the plant
remains unused or operates at a level which is below its practical capacity level.
Normal capacity is thus the capacity at which the plant operates in normal period.
When a machine or an asset or a plant cannot be used at a normal capacity,
the capacity not used is called the idle capacity. When there exists idle capacity
some costs, especially the fixed costs or periodic costs are continued to be incurred
during the time the machine or plant remains idle and these costs like depreciation,
repair and maintenance charges, rent, insurance charges, salary of supervisors
and managers working at high level cannot be charged to the production as during
the idle time there is no production done. These costs are the costs of idle capacity.
The formula used for calculating the idle capacity cost is as under :Aggregate overheads related to plant
Idle capacity cost =
x Idle capacity
Normal capacity of plant
Idle capacity cost so calculated is treated in the following ways :1.
If the idle capacity cost is due to normal or unavoidable causes such as
repairs, maintenance, time lost in change over of jobs or setting-up time required
in the beginning a supplementary overhead rate is calculated and use to recover
the amount of the idle capacity cost. The supplementary overhead rate is calculated
as under :Actual overheads – overheads absorbed
Supplementary rate =
Hours, Units or Rupees
2.
If the idle capacity cost has occurred due to avoidable reasons such as
improper planning, delay in management decisions, power failure, shortage in supply
of materials and consumable, lack of instructions to he operator, etc. the amount
of idle capacity cost is treated as the abnormal loss and it is charged to the Costing
Profit and Loss Account.
3.
If the idle capacity cost has taken place due to seasonal factors like change
in demand for the product the idle capacity cost should be treated as production
Advanced Cost Accounting - II
195
Some Special Items
of Overheads
NOTES
cost and it is recovered by charging the manufacturing overheads to the actual
production at an inflated rate. For example the normal production planned is 20000
units and the factory overheads amounting to `40,000 were to be charged at `2
per unit of the product. Due to shortage of demand actual production during the
period was restricted to 16000 units. The idle capacity cost caused due to reduction
of production will be recovered by calculating the inflated overhead rate as
` 40,000 / 16000 units = ` 2.50 per unit produced. The overhead rate is inflated
from `2 per unit to ` 2.50 per unit and by charging overheads at this inflated
rate the full amount of overheads are recovered from the actual production of
16000 units.
12.2.8 Research and development cost
Research and development activity involves conducting experiments to
improve the existing product or find out a better method of production or to create
a product which can be suitably handled or transported or which increases the
durability of the existing product. Research may also be carried out for creating a
new product and for this a series of experiments and tests are required to be
conducted and if they become successful, the enterprise can develope a new
product not produced by any other enterprise. The cost of materials used, the
cost of the equipment used for conducting the experiments, the rent, rates and
taxes of the laboratory where such experiments are conducted the salary of the
researchers and the assisting staff are some of the items which are included in the
research and development cost.
If the research and development activity is undertaken to do the job as
required by the customer, then the research and development cost should be entirely
charged to that particular job as direct cost.
If the research and development cost is incurred for improving the quality
of the existing product or to develop a new machine for its production or to find
out a new method to produce the product, it should be charged to that particular
product.
If the research cost is incurred to improve the sale or distribution of a
product, it should be charged as the selling and distribution overheads to that
product.
If the research is undertaken to create a new product or to find out a new
method or technique or production and the research becomes successful, the
research and development cost should be treated as deferred expenditure and
should be charged to the Profit and Loss Account proportionately over the
subsequent years to be decided by the management.
If the research and development activity fails, the cost incurred for it should
be treated as abnormal loss and charged to Costing Profit and Loss Account. If
the cost is less, it may be charged fully to that year’s Costing Profit and Loss
Account. However, if the cost is large it may be spread over a few years and
proportionate amount charged to Costing Profit and Loss Account in those years.
196 Advanced Cost Accounting - II
12.2.9 Cost of fringe benefits to employees
Fringe benefits are given to employees in addition to the basic salary and
dearness allowance. They may be given in the form of medical facilities,
entertainment facilities, canteen facilities (free or subsidised canteen facilities),
reimbursement of leave travel expenses (LTA), holiday pay, sick pay, etc. The
benefits given are not dependent upon the quantity of work done by the employees
and with some exceptions they are given to all the employees working in the
enterprise. The cost of fringe benefits given to the employees is not treated as
wages or salaries but they are treated as wages or salaries but they are treated as
overhead expenses. The cost of the fringe benefits given to factory workers is
treated as the factory overheads, the costs of fringe benefits given to office
employees and sales department employees are included in the office and
administration overheads and selling and distribution overheads respectively. The
apportionment of the overheads to the different departments is done on the basis
of number of employees working in each department.
Some Special Items
of Overheads
NOTES
12.2.10 Drawing and designing office cost
Drawing office does the work of preparing drawings and designs for the
products to be manufactured and jobs to be done according to the requirements
of customers. Drawing are prepared on paper giving specifications of the parts to
be produced, the quality to be maintained, the materials to be used and shape and
size of the products to be created by assembling the parts in a particular manner.
This work is performed by draftsmen, engineers and experts in designing of the
products.
When the drawings and designs are prepared according to the requirements
of a customer, the cost incurred for the drawing and designing work is treated as
a direct expenses and charged to the specific job or product ordered by the
customer.
When the drawings and designs are prepared for the products or jobs to be
done for a long period of time, the cost of drawings and designing is treated as
production overheads and it is apportioned to the production departments on the
basis of number of drawings and design prepared for each production department
or in the ratio in which the service is estimated to be given to different departments.
When drawings and designs are prepared for packing to be used for the
products or to make them attractive with the intention of making the prospective
customers curious and thereby increase demand for the product, the cost of
drawings and designs should be treated as selling overheads.
12.2.11 Expenses of cost accounting departments
Expenses of cost accounting department include rent, rates, taxes of the
cost accounting department, stationery expenses, printing expenses of various
forms and reports used in cost accounting department, salary of cost accountant
and other staff, lighting and air-conditioning expenses, depreciation on furniture
Advanced Cost Accounting - II
197
Some Special Items
of Overheads
NOTES
Check Your Progress
i)
Why some items of
overheads are treated as
special
items
of
overheads ?
ii) What are the arguments
for and against inclusion
of ‘interest on capital’ in
overheads ?
ii) What is ‘depreciation’?
Mention the methods
used for calculating
amount of depreciation.
iv) How is ‘Research and
Development
Cost’
treated ?
v ) What is meant by
‘drawing and designing
office cost’ ? How it can
be treated ?
and other equipment used in cost accounting departments, repairs and maintenance
expenses incurred or charged to the cost accounting department etc.
The expenses of the cost accounting department are generally treated as
office and administration overheads. Another way they can be treated is to apportion
such expenses among factory, office and selling and distribution on the basis of
estimated service provided to each function by the cost accounting department.
The cost accounting department, in other words, is considered as a service
department.
12.3 Summary
There are some items of overheads which are required to be treated in a
special manner. These items may be treated in different ways by different
enterprises and sometimes there is difference of opinion amongst even among
cost accountants regarding the treatment to be given to these items. Though there
are a number of such items, in this Unit only 11 such items have been included.
Interest on capital is the first item out of these. Some experts say that it
should not be treated as an item of overhead and should be excluded from cost
accounts while some others say that it should be treated as an item of overhead
and should be charged to cost of production. Interest on capital actually paid or
payable should be included as an item of cost and notional interest on capital
(interest on own capital) should be ignored as it does not affect the outflow of
cash. It is also suggested by some that whether interest is paid or not depends
upon the policy decided by management as to how the business activity should be
financed and so interest on capital should not be included in cost but should be
charged against the profit earned by carrying on the business activity. For
comparison of costs over years, the treatment decided should be followed
consistently over a period of few years.
Other special items of overheads included in this Unit are cash discount,
packing expenses, defective or spoiled work, depreciation, obsolescence loss, idle
capacity cost, research and development costs, cost of fringe benefits to employees,
drawings and designing office cost and expenses of cost accounting department.
The nature of theses special items of overheads and the treatment which can be
given to these items has been explained.
12.4 Key Terms
198 Advanced Cost Accounting - II
i)
Packing Expenses : Packing expenses are selling overheads which are
incurred for packing the products to be sent and delivered to the customers
for fulfilling their orders.
ii)
Obsolescence Loss : It is a loss caused due to sudden fall in the value of
fixed asset due to the decision taken by the management to stop the use of
that fixed asset.
iii)
Idle Capacity Cost : It is the cost caused due to non-use of available
capacity of an asset. The cost of unused capacity of a machine becomes
the idle capacity cost.
12.5 Questions
Some Special Items
of Overheads
NOTES
I - Short Answer Questions
1.
What is ‘defective work’?
2.
What treatment is given to ‘interest on capital’?
3.
How will you treat the item of ‘cash discount received ?
4.
Mention any there methods of depreciation ?
5.
How does obsolescence loss arise ?
6.
What is meant by ‘idle capacity’ ?
7.
What work is performed by ‘drawing and designing office’?
8.
Give three examples of fringe benefits provided to employees.
9.
What are packing expenses ?
10.
How is research and development cost of a failed research treated ?
II - Lengthy Answer Questions
1.
Why is interest on capital treated as a special item of overheads ? Give
arguments for and against the inclusion of interest on capital in cost
accounts ?
2.
What is interest on capital ? Explain the treatment given to interest on
capital.
3.
What is meant by defective work and spoilage ? how is it treated in cost
accounts ?
4.
What is obsolescence loss ? How it arises ? Explain the treatment given
to the obsolescence loss.
5.
Define the term ‘depreciation’. Explain any two methods of providing
depreciation with their merits and demerits.
6.
Explain the following methods of depreciation :i) Straight Line Method and
ii) Sinking Fund Method
7.
What is meant by ‘idle capacity cost’ ? What are the different capacities ?
Advanced Cost Accounting - II
199
Some Special Items
of Overheads
How idle capacity cost is treated in cost accounts ?
8.
What do you mean by ‘research and development cost’ ? Briefly explain
the treatment given to research and development cost.
9.
What is meant by ‘packing expenses’? Explain how packing expenses are
treated in cost accounts.
10.
How will you treat the following items in cost accounts ?
NOTES
a) Cash discount
b) Fringe benefits provided to employees
c) Research and development cost
d) Drawing and designing office cost
11.
Write short notes on :a) Obsolescence
b) Production unit method of depreciation
c) Normal capacity and practical capacity
d) Expenses of cost accounting department
III - Multiple Choice Questions
1.
2.
3.
To find out the true cost of Maintaining heavy stock the ----------- in such
stock has to be taken into consideration.
(a)
interest on drawings
(b)
interest on capital invested
(c)
interest on revenue items
(d)
interest on loan taken
Interest on capital whether paid or payable and notional interest on own
capital should ----------- in cost calculation.
(a)
not be included
(b)
be included
(c)
allocated
(d)
determined
Generally cash discount received by the enterprise is credited to ---------Account.
(a)
200 Advanced Cost Accounting - II
Profit and loss
4.
(b)
trading
(c)
manufacturing
(d)
realisation
If the amount of defective or spoiled work is beyond the normal limit it is
treated as ----------(a)
normal gain
(b)
normal loss
(c)
abnormal loss
(d)
overhead loss.
Some Special Items
of Overheads
NOTES
Ans. : (1 - b), (2 - a), (3 - a), (4 - c).
12.6 Further Reading
1.
‘Advanced Cost Accounting’ - Nigam and Sharma - Published by Himalaya
Publishing House
2.
‘Cost Accounting - Principles and Practice - N.K.Prasad
3.
‘Cost Accounting’ - Jawahar Lal
Published by Tata Mc Graw Hill Publishing Co. Ltd.
4.
‘Theory and Practice of Cost Accounting’ - M. L. Agarwal
Published by Sahitya Bhawan, Delhi
5.
‘Cost and Management Accounting’ - M. N. Arora
Published by Himalaya Publishing House.
Advanced Cost Accounting - II
201