Meaning and Definition
Aggregate of all expenses relating to indirect material cost, indirect labour cost and indirect expenses is known as Overhead. Accordingly, all expenses other than direct material cost, direct wages and direct expenses are referred to as overhead.
According to Wheldon, Overhead may be defined as "the cost of indirect material, indirect labour and such other expenses including services as cannot conveniently be charged to a specific unit."
Blocker and WeItmer define overhead as follows :
"Overhead costs are operating cost of a business enterprise which cannot be traced directly to a particular unit of output. Further such costs are invisible or unaccountable."
Importance of Overhead Cost
Nowadays business is a dynamic organism. Advancement of technological development and innovation, economic situations and social considerations are the important factors for modernization of industries at mass production to meet its more demand. The overhead charges are heavily increased and they represent major portion of total cost. Therefore, it assumes greater importance for cost control and cost reduction.
•
Classification of Overheads
Classification of overheads is the process of grouping of costs based on the features and objectives of the business organization. The following are the important methods on which the overheads are classified:
(a) On the basis of Nature.
(b) On the basis of Function.
(c) On the basis of Variability.
(d) On the basis of Normality.
(e) On the basis of Control.

403 Overheads
The following chart can explain the further classification of overhead :
Classification of Overhead
On the Basis of
Nature t
(1) Indirect Material
(2) Indirect Labour
(3) Indirect Expenses
Variability
(1) t
Fixed Overhead
(2) Variable Overhead
(3) Semi-Variable Overhead
Normality t
(1) Normal Overhead
(2) Abnormal Overhead
1
Function
1
(1) Manufacturing Overhead
(2) Administrative Overhead
(3) Selling Overhead
(4) Distribution Overhead
1
Control
1
(1) Controllable Overhead
(2) Uncontrollable Overhead
(1) On the Basis of Nature
One of the important classifications is on the basis of nature or elements. Based on nature the aggregate of all indirect material cost, indirect labour cost and indirect other expenses are known as overheads. Accordingly, overheads are grouped into (a) Indirect Material Cost (b) Indirect Labour Cost and (c) Indirect Expenses.
(a) Indirect Material Cost: Indirect materials do not form part of the finished products. Indirect materials are indirectly or generally used for production which cannot be identified directly. For example, oil, lubricants, cotton waste, tools for repairs and maintenance etc. are indirect materials.
(b) Indirect Labour Cost: Indirect labour is for work in general. The importance of the distribution lies in the fact that whereas direct labour can be identified with and charged to the job, indirect labour cannot be so charged and has, therefore, to be treated as part of the factory overheads to be included in the cost of production. Examples are salaries and wages of supervisors, storekeepers, maintenance labour etc.
(c) Indirect Expenses: Any expenses that are not specifically incurred for or can be readily charged to or identified with a specific job. These are the expenses incurred in general for more than one cost centre. Examples of indirect expenses are rent, insurance, lighting, telephone, stationery expenses ·etc.
(2) On the Basis of Function
The classification overheads on the basis of the various function of the business concern is known as function wise overheads. Here there are four important functional overheads such as :
(a) Production Overhead
(c) Selling Overhead
(b) Administration Overhead
(d) Distribution Overhead
(a) Production Overhead: Production overhead is also termed as manufacturing overhead or works overhead or factory overhead. It is the aggregate of all indirect expenses which are incurred for work in

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

Overheads
Usefulness of Overhead Classification
(1) It ensures effective cost control.
405
(2) It helps the management for effective decision making.
(3) The application of marginal costing is essentially for profit planning, cost control, decision making etc. are based on the classification of overheads.
(4) On the basis of classification of fixed and variable cost, flexible budgets are prepared at different levels of activity.
(5) It facilitates fixing of selling price.
(6) Cost classification is useful for break-even analysis. Break-even analysis mainly depends on overall.cost and profi"t which can be useful for making or buying decision.
(7) It helps to find out the unit cost of production.
Codification of Overhead
Codification is a process of representing each item by a number, the digits of which indicate the group, the subgroup, the type and the dimension of the item.
Advantages of Codification
(1) It enables systematic grouping of similar items and avoids confusion caused by long description of the items.
(2) It serves as the starting point of implication and standardization.
(3) It helps in avoiding duplication of items and results in the minimisation of number of items, leading to accurate records.
(4) It ~elps in allocation and apportionment of overheads to different cost centres.
(5) It assists the grouping of overheads for cost control.
(6) It helps in reducing clerical efforts to the minimum.
Methods of Codification
There are different methods used for codification. The following are the three important methods used:
(1) Numerical Codes Method.
(2) Decimal Codes Method.
(3) Codes with a Combination of Numbers and Alphabets.
(1) Numerical Method: Under this method, numerical codes are assigned to each item of expenses.
For example,
100 Indirect labour.
400 Power.
500 Maintenance.
800 Fixed charges.

406 A Textbook of Financial Cost and Management Accounting
(2) Decimal Codes: Under this method, the whole numbers are allotted to indicate master group and the decimals indicate the sub-group. For example,
Factory Overheads:
1.1.1 Indirect materials.
1.1.2 Consumable stores.
1.1.3 Lubricating oils.
(3) Codes with a Combination of Numbers and Alphabet : Under this method the alphabet indicates the main group and the type of expenses is indicated by the numerical. For example,
Rl - Repairs to machinery.
R2 - Repairs to plant.
R3 - Repairs to furniture.
Procedure or Steps in Overhead
Overheads are incurred for work in general. Overhead is added tQ the prime cost in order to measure the total cost of production or cost of goods sold. For allocation and apportionment of overhead in the cost of production or cost of goods sold the following procedures are involved:
(1) Classification of Overhead
(2) Collection of Overhead
(3) . Overhead Analysis:
:~; "i.;.:~:-
(a) Distribution of overhead to production and service departments, i.e., AllocatiOllnmd
.,,'
Apportionment of overhead to cost centre. ' .
'
(b) Re-distribution of overhead from service department to production department, i.e.,
Allocation and Apportionment of service centres to production centres or departments.
(4) Absorption of overhead by cost units, i.e., computation of overhead absorption rates.
(1) Classification Overhead: We have already discussed the classification of overh~ad in the preceding pages, and the discussion on other procedures would follow in this chapter and the subsequent one.
(2) Collection of Overhead: The production overheads or factory overheads are collected and identified under separate overhead code numbers or standing order numbers. These overheads are collected from different sources and documents. The following are the important sources and documents :
Overhead Expenses
(1) Indirect Materials
(2) Power and light
(3) Indirect wages
(4) Salaries
(5) Depreciation
(6) Rates
(7) Rates
(8) Office Stationery
(9) Postage
Sources and Documents Used
Materials Requisition
Meter Reading
Time Cards, Pay Rolls, Wage Analysis
Salaries Sheet
Plant Register, Machinery Register
Lease
Local Government Assessment
Supplier's Invoices
Postage Book

Overheads
(3) Overhead Analysis : (a) Allocation and Apportionment of Overhead to Cost Centres
407
The first step of overhead analysis is distribution of overhead to production department and service department. Before analysing overhead, we should know the concept of Allocation, Absorption and
Apportionment.
Allocation: Cost allocation refers to the allotment of whole item of cost to cost centres. The technique of charging the entire overhead expenses to a cost centre is known as cost allocation.
Absorption: Cost absorption refers to the process of absorbing all overhead costs allocated to apportioned over particular cost centre or production department by the unit produced.
Apportionment: Apportionment is the process of distribution factory overheads to cost centres or cost units on an equitable basis. The term apportionment refers to the allotment of expenses which cannot be identified wholly with a particular department. Such expenses require division and apportionment over two or more cost centres in proportion to estimated benefits received.
Allocation Vs Apportionment
(1) Allocation deals with whole amount of factory overheads while apportionment deals with proportion of item of cost or proportion to cost centres.
(2) The item of factory overhead directly allocated and identified with specific cost centers.
Whereas apportionment requires suitable and equitable basis. For example, factory rent may be allocated to the factory and has to be apportioned among the producing and service departments on an equitable basis.
Basis of Apportionment
Overhead apportionment depends upon matching with principles. Accordingly the basis for apportionment should be related to the basis on which the expenditure is incurred. The following are the usual basis adopted for apportionment of overhead :
Basis of Apportionment
Overhead Cost
(1) Lighting
(2) Rent, Rates and Taxes
(3) Insurance of building
Depreciation of building,
Heating
}
(4) Depreciation of plant and Machinery and
Equipments
}
(5) E S I, Canteen, Safety, } compensation, supervision welfare, fringe benefits
(6) Delivery Van, }
Internal Transport
(7) Audit fees
(8) Storekeeper's expenses
(9) Power
-
-
-
-
Basis of Distribution
No. of light points, floor space or meter reading
Floor Area
Area of floor
Book value
No. of employees
Weight, volume ton
Sales or Total Cost
Weight, value of materials or Number of requisitions
H. P. Hours or
W. Hours

408
Illustration: 1
A Textbook of Financial Cost and Management Accounting
A departmental store has several departments. What bases would you recommend for apportioning the following items of expenses to its departments :
(I) Fire Insurance of building
(2) Sales commission
(3) Advertisement
(4) Salesmen's salaries
(5) Commission paid to salesmen
(6) Show room expenses
(7) Depreciation on plant
(8) Rent of finished goods, warehouse
(9) Factory power
(10) Delivery Van expenses
Solution:
Items
(I) Fire Insurance Building
(2) Sales Commission
(3) Advertisement
(4) Salesmen's Salaries
(5) Commission paid to Salesmen
(6) Show room expenses
(7) Depreciation on plant
(8) Rent of finished goods warehouse
(9) Factory power
(10) Delivery Van expenses
Illustration: 2
Basis of Apportionment
Floor space or Value
Sales value
Sales value
Sales value
Sales value
Sales value or Total cost
Value of plant
Floor space or Area
H.P. Power (or) K.W. hours
Weight, Volume
A factory has three production departments and two service departments. The following figures have been extracted from the financial books :
Supervision
Repairs of Plant and Machinery
Rent
Light
Power
Employer's contribution to ESI
Canteen Expenses
Rs.
6,000
3,000
8,000
2,000
3,000
600
1,000
The following further details have been extracted from the books of the respective departments :
Particulars
Direct Wages (Rs.)
Area of Square feet
No. of Employees
Value of Machinery
Light Points
H.P. of Machines
A
4,000
2,000
50
10,000
80
200
B
3,000
1,000
40
5,000
60
100
C
2,000
500
20
3,000
30
50
D
2,000
500
20
3,000
30
50
E
1,000
100
10
1,000
20
20

Overheads 409
Particulars
Supervision
Repairs of Plant } and Machinery
Rent
Light
Power
Employers
Contribution to ESI
Canteen Expenses
Basis of
Apportionment
Total
Rs.
Production Department
A
No. of Employees
5:4:2:2:1
6,000
Value Machinery
10:5:3:3:1
3,000
Area of square feet 8,000
20:10:5:5:1
2,000 Light points
8: 6: 3 : 3: 2
H.P. of Machines
20:10:5:5:2
Direct Wages
4: 3 : 2 : 2: 1
No. of Employees
5:4:2:2:1
3,000
600
1,000
Total
2,142
1,364
3,902
727
1,429
200
357
23,600 10,121
Departments
B
1,715
681
1,951
545
714
150
286
C
857
409
976
273
357
100
143
6,044 3,115
Sen'ice Dept.
Department
D
857
E
429
409
976
273
357
100
143
137
195
182
143
50
71
3,115 1,207
(b)
Re-distribution of overhead from various service departments to production departments is known as Re-apportionment or Secondary distribution. Accordingly, allocation and apportionment of overheads from service departments or centres to production centres or departments.
The following are the important bases adopted for apportionment of secondary distribution:
Service Department
(1) Purchase Department
(2) Maintenance and Repairs Department
(3) Stores Department
(4) Personnel Department
(Canteen, Welfare, Medical,
Employer's liability)
(5) Time Keeping Department
(6) Pay roll Department
(7) Accounts Department
(8) Tool Room
Basis of Apportionment
Number of Purchase Orders or Number of
Purchase Requision or Value of Materials
Hours worked
No. of Requisition or Value of Materials
No. of Employees or Direct wages
No. of Employee or Labour Hours or Direct Wages
No. of Employees or Direct Wages
No. of Employees
Direct Labour Hours or Machine Hours or Direct Wages
Service Department
(9) Transport Department
(10) Power House
(11) Fire Insurance
Basis of Apportionment
Car hours, Truck hours, Tonnage handled
K.W. Hours
Stock Value
The following are the important methods of re-distribution of service department overheads to production department :

410 A Textbook of Financial Cost and Management Accounting
(1) Direct Re-distribution Method
(2) Step Distribution Method
(3) Reciprocal Service Method this method further grouped into:
(a) Repeated Distribution Method
(b) Simultaneous Equiation Method
(c) Trial and Error Method
The following chart explains more about the method of re-apportionment of service department cost:
!
Direct Re-distribution
Method
Step
Method
1
Reciprocal Service
Method
Repeated Distribution
Method
Simultaneous
Equation
Method
Trial and Error
Method
Under this method, the cost of service department is directed to re-distribution to the production departments without considering the services rendered by one service department to another service department.
Ramesh Ltd. has three production departments A, Band C and six service departments. The following figures are extracted from the records of the company :
Production Departmentss
A
B
C
Rs.16,Ooo
Rs.IO,OOO
Rs.12,OOO
Rs.38,OOO
Service Departments
Stores
Timekeeping
Maintenance
Power
Walfare
Supervision
Total
Rs.2,OOO
Rs.3,OOO
Rs. 1,000
Rs.2,OOO
Rs. 1,000
Rs.2,OOO
Rs.49,OOO

Overheads
The other information available in respect of the production departments :
Particulars Production Departments
A B C
No. of Employees
No. of Stores Requisition
Horse Power of Machines
Machine Hours
40
30
500
2500
30
20
500
1500
20
10
600
1000
,
I
411
You are required to apportion the costs of various service departments to production departments.
Expenses Basis Total Production Departments
Rs. A
Rs.
B
Rs.
C
Rs.
As per primary
Departmental summary
}
S!<rvik~ Del2artm!<!lt§ ;
Stores
Timekeeping
Maintenance
Power
Welfare
Supervision
-
No. of Stores
Requisitioned
30: 20 : 10
No. of Employees
40:30:20
Machine Hours
25: 15: 10
Horse Power
5:5:6
No. of Employees
40:30:20
No. of Employees
40: 30: 20
38,000
2,000
3,000
1,000
2,000
1,000
2,000
16,000
1,000
1,333
500
625
445
889
10,000
667
1,000
300
625
333
667
12,000
333
667
200
750
222
444
Total 49,000 20,792 13,592 14,616
(2)
Under this method the cost of most serviceable department is first distributed to production departments and other service departments. Thereafter, the next service department is distributed and later the last service department until the cost of all the service departments are redistributed to the production department.
A manufacturing company has two production departments A and B and three Service Departments
Timekeeping, Stores and Maintenance. The departmental summary showed the following expenses for
Dec. 2003.
Production Departments: Rs.
32,000
10,000
A
B
Service Departments:
Timekeeping
Stores
Maintenance
8,000
10,000
6,000
Total Overhead Expenses 66,000

412 A Textbook of Financial Cost and Management Accounting
The following information about departments is available and is used as a basis for distribution :
Particular
No. of Employees
No. of Stores Requisitions
Machine Hours
A
Production
Departments
20
12
1200
B
'15
10
800
Timekeeping
-
-
10
You are required to apportion these costs to production departments :
Departments
Timekeeping
Stores
Maintenance
A
B
Total
Primary
Distribution
Rs.
8000
10,000
6,000
32,000
10,000
66,000
8,000
3,334
2,500
1,333
833
(-) 13,334
1,600
6,400
5,334
Service Departments
Stores
-
-
8
(-) 10,100
6,060
4,040
Maintenance
-
5
3
45,793
20,207
66,000
Timekeeping: 20 : 15 : 8 : 5 (No. of Employees)
Stores: 12 : 10 : 3 ( No. of Stores Requisition)
Maintenance: 12 : 8 (Machine Hours)
This method recognizes the fact that if a service department receives services from other department, the services should be charged in the receiving department. Thus, the cost of inter departmental services is taken into account on reciprocal basis. The following are the three important methods available for dealing with reciprocal distribution :
(a) Simultaneous Equation Method.
(b) Repeated Distribution Method.
(c) Trail and Error Method.
Under this method, the true cost of total overhead of each service department is ascertained with the help of Simultaneous or Algebraic Equation. The obtained result reapportioned to production department on the basis of given percentage.
Under this method, the total overhead costs of the service departments are distributed to service and production departments according to given percentage of the service departments are exhausted, in tum repeatedly until the figures become too small to matter.
In this method, the cost of a service centre is apportioned to another service centre. Then, the cost of another service centre along with the apportioned cost from the first centre is again apportioned back to the first service centre. This process is repeated till the amount to be apportioned becomes zero or negligible.

Overheads
413
The following particulars related to a manufacturing company has three production departments : P,
Q, : and R and two service departments X and Y :
Production Departments:
P
Q
R
Rs.2,ooO
Rs.l,5oo
Rs.l,ooo
Service Departments:
S
T
Rs. 500
Rs.4oo
The service department expenses are charged on a percentage basis as folIows :
Productions Departments Service Departments
Service Depts. :
S
T
P
20%
30%
Q
30%
30%
R
40%
20%
S
20%
T
10%
Prepare a statement showing the distribution of the two service departments expenses to three production departments under (1) Simultaneous Equation Method and (2) Repeated Distribution Method.
(1) Simultaneous Equation Method:
Let X be the total expenses of Departments S
Let Y be the total expenses of Department T
X = 500 + 0.20 Y
Y = 400 + 0.10 X
X = 500 + 0.20 (400 + O.IOX)
X = 500 + 80 + 0.02X
X - 0.20X = 580
(or) 0.98 X = 580
580
.. X = - - = 59l.83
0.98
Y = 400 + 0.10 (592)
= 400 + 59
Y =459
Particulars
Overhead as per Summary
Department S
Department T
Total
Production Departments
P Q
Rs. Rs.
R
Rs.
2,000
118
138
2,256
1,500
178
137
1,815
1,000
237
92
1,329
Service Departments
S T
Rs. Rs.
500
(-) 592
92
-
400
59
(-) 459
-

414 A Textbook of Financial Cost and Management Accounting
Particulars
Total Department overhead as per
Primary Distribution
Service Department S
Service Department T
Service Department S
Service Department T
Total
Repeated Distribution Method
Production Departments
P Q
Rs. Rs.
R
Rs.
2,000
100
135
18
3
2,256
1,500
150
135
27
3
1,815
1,000
200
90
36
3
1,329
Service Departments
S
Rs.
T
Rs.
500 400
(-) 500 50
90 (-) 450
(-) 90
-
-
9
(-) 9
-
Illustration: 6
You are supplied with the following infonnation and required to work out the production hour rate of recovery of overhead in Departments X, Y and Z.
Particulars
Rent
Electricity
Indirect Labour
Depreciation
Sundries
Estimated working
Hours
Total
Rs.
12,000
4,000
6,000
5,000
4,500
Production Deplts.
X
Rs.
2,400
800
1,200
2,500
910
Y
Rs.
4,800
2,000
2,000
1,600
2,143
Z
Rs.
2,000
500
1,000
200
847
1,000 2,500 1,400
Service Deptts.
P
Rs.
Q
Rs.
2,000
400
800
500
300
800
300
1,000
200
300
Expenses of Service Department P and Q are apportioned as under :
X y z
P Q
P
Q
30%
10%
40%
20%
20%
50% 20%
10%
(C7A Inter,
Solution:
Particulars
Rent
Electricity
Indirect Labour
Depreciation
Sundries
Total
Departmental Overhead Distribution Summary
Total
Rs.
12,000
4,000
6,000
5,000
4,500
31,500
X
Rs.
2,400
800
1,200
2,500
910
7,810
Production Deptts.
Y
Rs.
4,800
2,000
2,000
1,600
2,143
12,543
Z
Rs.
2,000
500
1,000
200
847
4,547
Service Deptts.
P'
Rs.
Q
Rs.
2,000
400
800
500
300
4,000
800
300
1,000
200
300
2,600

Overheads
Particulars
Total Departmental
Overheads as per
Primary distribution
Exp. of P Dept
Total
Exp. of Q Dept.
Total
Exp. of P Dept.
Total
Exp. of Q Dept.
Total
Exp. of P Dept
Total
Working hours
Rate per hour
Total X
Production Depts.
Y
31.500
7.810
1.200
9.010
300
9.310
180
9.490
6
9,496
4
9.500
1.000
Rs.9.53
12.543
1.600
14.143
600
14.743
240
14.983
12
14.995
5
15.000
2.500
Rs.6
(ii) Simultaneous Equations Method
Let p be the expenses of Service Dept. P and
Let q be the expenses of Service Dept. Q
1
Then p = 1,000 + q (service 20% of q wi\1 be apportioned to dept. P) and
5
1 q=2,600+ -
10
P
1 q = 2.600 + -
10
1
(4,000 + q) (putting the value of p)
5
1 q = 2,600 + 400 + q
50
1 q= 3,000 + -
50 q
50q = 1,50,000 + q
49q
=
1,50.000 q = 3,061
1
P = 4.000 + (3061)
5
= 4612
Z
Service Depts.
P Q
4.574
800
5,437
1.500
6.847
120
6.967
30
6.997
3
7.000
1,400
Rs.5.oo
4.000 2.600
(-4.000)
-
12
12
(-12)
-
400
-
3.000
600 (-3000)
600
(-600) 60
-
60
(-60)
-
-
-
415

416 A Textbook of Financial Cost and Management Accounting
Departmental Overhead Distribution Summary x
Rs. y
Rs. z
Rs.
Total (given)
Exp. of P Dept. Rs. 4,612
Exp. of Deptt Q Rs. 3,061
Estimated Working Hours
Rate Per Hour Rs.
7,810
1,384
306
9,500
1,000
9.50
12,543
1,845
612
15,000
2,500
6.00
4,547
922
1,531
7,000
1,400
5.00
P
Rs.
4,000
(-4,612)
612
Q
Rs.
2,600
461
(-3,061)
-
Illustration: 7
RST Ltd. produces machine parts on a job order basis. Most of the business is obtained through bidding. Most of the firms competing. with RST Ltd. bid full cost plus a 20% markup. Recently, with the expectation of gaining mbre sales, RST Ltd. reduced its markup from 25% to 20%. The company operates two service departments and two producing departments. The budgeted costs and the normal levels of activity for each department are given below:
Particulars Service Department
A B
Production Department
C D
Overhead Costs
Number of Employees
Maintenance Hours
Machine Hours
Labour Hours
5,00,000
40
10,000
-
-
10,00,000
35
1,000
-
-
5,00,000
150
32,000
50,000
5,000
2,50,000
150
8,000
5,000
50,000
The direct costs of Department A are allocated on the basis of employees; those of Department B are allocated on the basis of maintenance hours. Departmental overhead rates are used to assign costs to products. Department C uses machine hours, and Department D uses labour hours. The firm is preparing to on ajob Gob Z) that requires three machine hours per unit produced in Department C and no time in Department D. The expected prime cost per unit is Rs. 85.
Required
(1) Allocate the service costs to the production departments using the direct method.
(2) What will be the bid for Job Z, if the direct method of allocation is used?
(3) Allocate the service costs to the production departments using the Sequential or Repeated Method.
(4) What will be the bid for Job Z, if the Sequential Method is used?
(5) Allocate the service costs to the production departments using the Reciprocal Method.
(6) What will be the bid for Job Z, if the Reciprocal Method is used?
(CA Inter., Nov. 2002)
Solution:
(1) Allocation of Service Costs to Production Department (Direct Method)
Particulars Service Department
A B
Production Department
C D
Direct Cost (Rs.)
Department A
(No. of Employees 1: 1)
Department B
(Maintenance hours4: 1)
Total Rs.
5,00,000
(5,00,000)
-
10,00,000
-
(10,00,000)
5,00,000
2,50,000
8,00,000
15,50,000
2,50,000
2,50,000
2,00,000
7,00,000

Overheads
Department C Overhead Rate =
=
(2) Product Cost and bid price for job Z
Rs.
85 Prime Cost
Overheads
(3 hours x Rs.31 per hour)
Total unit cost
93
Rs. 178
Total Cost
Machine Hours
15,50,000
50,000
=
Rs. 31 Per machine hours
:. Bid Price [Rs. 178 x 1.2] @ 20% makeup
=
Rs. 213.60
(3) Statement Showing allocation of Service Cost to Production Department (Sequential method)
Particulars Service Departments
A '8
Production Departments
C D
Over heads
Dept. A Cost allocated
[ No. of Employees ]
40 : 35 : 150 : 150
Dept. B Cost allocated
Maintance Hours
10 : 1 : 32 : 8
Dept. A Cost allocated
Dept. B Cost allocated
Dept. A Cost allocated
5,00,000
(5,00,000)
53,333
2,05,229
(2,58,562)
27,580
8,756
(36,336)
3,876
10,00,000
46,667
(l0,46,667)
20,523
24,132
(44,655)
875
3,391
(4,266)
84
5,00,000
2,00,000
6,56,732
1,03,425
28,019
14,535
2,677
2,50,000
2,00,000
1,64,183
1,03,425
7,005
14,534
669
Dept. B Cost allocated
836
(4,172)
503 1,884 1,885
Dept. A Cost allocated
440
(524)
10 329 82
Dept. B Cost allocated
103
(606)
65 243 242
Dept. A Cost allocated
Dept. B Cost allocated
Dept A Cost allocated
Total Costs
13
(78)
-
56
(66)
-
39
41
39
15,07,924
12
7,42,076
417

418 A Textbook of Fi1Ul1lciai Cost and Management Accounting
Department C Overhead Rate
=
=
Total Cost of Dept. C
Machine Hours
15,07,924
50,000
=
Rs. 30.16 per hour
(4) Product cost and bid price for job Z
Prime Cost
Overheads
(3 hours x Rs.30.16)
Total unit cost
Profit @ 20% of 175.48
Total
= Rs.85.00
= Rs.90.48
= Rs. 175.48
= Rs.35.10
= Rs.210.58
(5) Allocation of Service costs to production department (Reciprocal Method)
Working Notes:
•
Allocation of Ratios
A
Proportion of output used by
B C
'A'
(based on number of
Employees)
'B'
(based on maintenance hours)
-
20%
A
B
A
=
Rs.5,00,000 + 20% of B
=
Rs.IO,OO,OOO + 10.45% of A
=
Rs.5,00,000 + 20% [10,00,000 + 10.45% of A]
A = Rs.5,00,000 + Rs.2,00,000 + 2.09% of A
0.9791 A = Rs.7,OO~OOO
10.45%
-
A
7,00,000
= =
Rs.7,14,942
0.9791
B = Rs.IO,OO,OOO + 10.45% (7,14,942)
= 10,00,000 + 74,711
= Rs.IO,74,711
Statement of allocation of Service Department cost to Production Department
44.78%
64%
Particulars A B C
Direct Cost
Dept. B
(as per note above)
Rs.5.00,000 Rs.IO,OO,OOO Rs.5,00,000
-
(10,74,711) 6,87,815
(64%)
Dept. A
(as per note above) (7,14,942) -
Total Costs
3,20,151
(44,78%)
15,07,966
D
44.78%
16%
D
Rs.2,50,000
1,71,954
(16%)
3,20,151
(44.78%)
7,42,105

Overheads 419
Department C Overhead Rate
Total Cost
= - - - - - -
Machine Hours
=
15,07,966
50,000
=
Rs. 30.16 per machine hour
(6) Product cost and Bid price for job Z
Prime cost Overheads
(3 hours x Rs.30.16 per machine hours)
Total unit cost
Bid Price (Rs.l75.48
1.20)
= Rs.85
=
Rs.90.48
=
Rs.175.48
= Rs.210.58
e-books is an online book retailer. The Company has four departments. The two sales departments are Corporate Sales and Consumer Sales. The two support-departments are Administrative (Human resources, Accounting), and Information systems. Each of the sales departments conducts merchandising and marketing operations independently.
The following data are available for October, 2003 :
Departments Revenues Number of Employees
Corporate Sales
Consumer Sales
Administrative
Information Systems
Rs. 16,67,750
Rs. 8,33,875
-
-
42
28
14
21
Cost incurred in each of four departments for October, 2003 are as follows:
Corporate Sales
Consumers Sales
Administrative
Information Systems
Rs. 12,97,751
Rs. 6,36,818
Rs. 94,510
Rs. 3,04,720
Processing TIme used
(in minutes)
2,400
2,000
400
1,400
The company uses number of employees as a basis to allocate Administrative costs and processing time as a basis to allocate Information systems costs.
Required:
(I) Allocate the support department costs to the sales departments using the direct method.
(II) Rank the support departments based on percentage of their services rendered to other support departments. Use this ranking to allocate support costs based on the step-down allocation method.
(III) How could you have ranked the support departments differently?
(IV) Allocate the support department costs to two sales departments using the reciprocal allocation method.
(CA PE II, Nov., 2003)

420
Solution:
A Textbook of Financial Cost and Management Accounting
(i) Direct and step-down allocation
(i) Support Departments
Admn. Information Systems
Rs. Rs.
Costs incurred
Allocation of Admn.
( 42nO,28nO)
Allocation of
Information Systems
(24/44,20/44)
94,510
(94,510)
3,04,720
(3,04,720)
(ii) Operating Departments
Corporate Consumer
Rs. Rs.
12,97,750 6,36,818
56,706
1,66,211
15,20,667
37,804
1,38,509
8,13,131
(ii) Rank on percentage of services rendered to other support departments.
Administration provides 23.077% of its services to information systems
=
21
42+28+21
= -
21
91
,= 23.077%
Information system provides 8.333% of its services to administrative departmen~.
=
400
2,400+2,000+400
400 x 100 = - x 100 = 8.33%
4800
Thus 23.07% of Rs. 94,510 Admn. Dept costs is = Rs. 21,810
Thus 8.33% of Rs. 3,04,720 Information systems dept. cost is Rs. 25,392
Costs incurred
Allocation of Admn. }
(42n0,28nO)
Allocation of
Information Systems}
(24/44,20/44)
(i) Support Departments
Admn. Information Systems
Rs. Rs.
94,510 3,04,720
(94,510) 21,810
3,26,530
(3,26,530)
(ii) Operating Departments
Corporate
Rs.
12,97,750
43,620
1,78,107
Rs. 15,19,477
Consumer
Rs.
6,36,818
29,080
1,48,423
Rs. 8,14,321
(iii) An alternative
+ ranking is based on the Re-amount of services rendered to other service departments, using the numbers from requirement 2, this approach would use the following sequence.
• Allocation of information systems overheads first (Rs. 25,383 provided to a4ministrative).
• Allocated administrative overheads second (Rs: 21,810 provided to information systems).

Overheads
(iv) Administrative (AD)
=
Rs.94,510 + 0.08333 IS
Information Services (IS) = Rs.3,04,720 + 0.23077 AD
AD
=
94,510 + 0.08333 {3,04,720 + 0.23077 AD}
0.98077
AD = 94,510 + 25,392.32 + 0.01923 AD
AD
=
1,19,902.32
AD
=
Rs. 1,22,253
IS
=
Rs. 3,04,720 + 0.23077 x 1,22,253
= Rs. 3,32,932
(i) Suppon Depanments
Admn. Information Systems
Rs. Rs.
Costs incurred
Allocation of Admn. }
( 42170,28nO)
Allocation of
Information }
Systems
(24/44,20/44)
94,510
(1,22,253)
27,744
3,04,720
28,212
(3,32,932)
( it ) Operating Departments
Corporate Consumer
Rs. Rs.
12,97,750 6,36,818
56,424 37,616
421
1,66,466
15,20,640
1,38,722
8,13,156
QUESTIONS
1. What do you understand by overhead charges?
2. "Overheads may be classified according to their nature and a number of other charactertics." Discuss this statement while classifying cost.
3. Define overhead charges. Explain the different methods of classification of overhead.
4. Discuss the usefulness of overhead classification.
S. What do you understand by codification of overhead charges?
6. Discuss in brief the different methods used in codification of overhead.
7. What is meant by allocation and apportionment? Distinguish between a\1ocation and apportionment of overhead.
8. What basis you would adopt for apportionment of the fo\1owing items of overhead expenses to different departments?
(a) Power and light. (b) Depreciation on building. (c) Rent and Rates. (d) Postage. (e) Indirect Wages.
9. Explain the different methods of re-apportionment of overheads.
10. The following particulars were obtained from the books of a light Engineering Company for the half year ended 30th
September, 2003. Calculate the departmental overhead rate for each of the production departments assuming the overheads are recovered as a percentage of direct wages.
Particulars
Direct wages
Direct materials
Employees
Electricity
Light points
Assets value
Area occupied
A
Rs.
7,000
3,000
200
8,000
10
SO,OOO
800
Production Departments
B
Rs.
6,000
2,SOO
ISO
6,000
IS
30,000
600
C
Rs.
S,OOO
2,000
ISO
6,000
IS
20,000
600
Service Departments
X
Rs.
Y
Rs.
1,000
I,SOO
SO
2,000
S
10,000
200
1,000
1,000
SO
3,000
S
10,000
200
The expenses for 6 months were :
Stores overhead Rs.
Motive power
400
Rs. IS00
Electric lighting 200
Labour welfare Rs. 3000
Depreciation
Repairs & Maintenance
General overheads
Rent and Taxes
Rs.
Rs.
6,000
1,200
Rs. 10,000
Rs. 600

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

Overheads 423
14. The following particulars relate to a manufacturing company which has three production departments, A, B, C and two service departments X and Y :
Depanments
B C X Y A
Total departmental
Overhead as primary distribution Rs.63,OOO 74,000 28,000 45,000 20,000
The company decided to charge the service departments cost on the basis of the following percentages:
Service Dept. Production Depts. Service Dept.
A B C X Y
X
Y
40%
30%
30%
30%
20%
29% 20%
10%
Find the total overheads of production departments charging service departmental costs to production on the repeated distribution method.
[Ans : A Rs. 90,500; B Rs. 96,500; C Rs. 43,000]
15. In a factory, there are two service departments P and Q and three production departments A, Band C. In April 1988 the departmental expenses were:
Depanments Rs.
A
B
C
P
Q
6,50,000
6,00,000
5,00,000
1,20,000
1,00,000
The service departments, expenses are allocated on a percentage basis as follows :
Service Dept. Production Depts.
A B C
Service Dept.
X Y
X
Y
30%
40%
40%
30%
15%
25% 5%
15%
Prepare a statement showing the distribution of the two service departments expenses to the tree departments under the
"Repeated Distribution Method."
[Ans : Rs. 7,35,340; Rs. 6,86,045; Rs. 5,48,615]
16. A manufacturing concern has three production departments and two service departments. In July 2003, the departmental expenses were as follows :
Production Departments
X
Y
Z
Rs.
16,000
13,000
14,000
Service Depanments p
4,000
Q 6,000
The service department expenses are charged out on a percentage basis, viz. :
Expenses of dept. P
Expenses of dept. Q
X
20%
25%
"
25%
25%
Z
35%
40%
P
10%
Q
20%
Prepare a statement of secondary distribution under repeated distribution method.
[Ans: Total Cost of Dept. X Rs. 18,674; Dept. Y Rs. 15,908; Dept. Z Rs. 18,418]
17. A Company has three production departments and two service departments and distribution summary of overhead is as follows:
Production Depanments Rs.
A
B
C
Service Depanment
X
Y
30,000
20,000
10,000
Rs.
2,340
3,000

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