Unit-II

Chapter -1
Overheads – Collection,
Classification, Allocation,
Apportionment and Absorption
Learning Objectives
 To learn the steps in Overhead
Accounting and Classification of
Overhead Costs.
 To know the Objectives and Methods of
Overhead Codification.
 To understand the Meaning & Methods
of Re-apportionment of Absorption of
Overheads.
 To know the Causes and effect on
Accounting of Under-Absorbed & Over-
Absorbed Overhead.
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Overheads Cost
 Cost pertaining to a cost centre or cost unit
may be divided into two portions like direct
and indirect.
 Indirect portion of total cost constitutes the
overhead cost which is the aggregate of
indirect material, indirect wages and indirect
expenses.

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Elements of Overhead Cost
 Following are the elements of Overhead
Cost:
Direct
Material
Direct Direct Prime
Cost Labour Cost
Direct
Expenses
Total Cost
Indirect
Material
Indirect Indirect Overhea
Cost Labour d
Indirect
Expenses

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Steps in Overhead
Accounting
 To ascertain the total cost, overheads are
added to the prime cost. The overheads
which cannot be specifically related to cost
units, are to be apportioned to various and
then to cost centre or production units.
 Following
• Collection steps are involved in this
• Re-apportionment of
of
procedure: Service Department
Overheads
Cost
• Classification and • Absorption of
Codification Overheads
• Treatment of over
• Allocation and
and under
Apportionment
absorption

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Collection of Production
Overheads
 Production overheads should be collected
under separate Standing Order Numbers
provided.
 Following are the source documents for
different items of overhead expenses:
Store
Requisitio
ns
Subsidia Wages
Analysis
ry Collectio Sheet
Records n of
Overhea Invoice
or
Journal
ds Purchase
Entries Cash Voucher
Book
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Classification of Overhead Costs
 The classification of overhead costs depends
upon the type and size of the business,
nature of the product or services rendered
and policy of the management.
Function-
 The various Behaviour-
classification Element-
are given in the
wise
following chart: wise wise
Production
Fixed Overheads Indirect Materials
Overheads

Administration
Variable Overheads Indirect Labour
Overheads

Semi-Variable
Selling Overheads Indirect Expenses
Overheads

Distribution
Overheads
Research and
Development
Expenses www.spjainlearnings.com
Codification of Overheads
 Coding is the technique of intelligently
describing in numbers or letters or a
combination of both the length description of
numerous cost accounting heads for ease of
recording and controlling of the cost data
generated.
 Methods of Codification:

Following are three well tried and acceptable

Mnemonic Method
methods of codification:

Decimal Method
Field Method Numerical
Codes www.spjainlearnings.com
Determination of Degree of
Variability of Expenses
 Segregation of semi-variable overhead costs into
fixed and variable overhead costs is very important
for correct cost ascertainment, cost control and
decision-making. It is termed as degree of variability
of expenses.
 Following methodsGraphical
may be employed for this purpose:
Presentation
Method

Least
Equation
Square
Method
Method

High and
Method of Low Points
Averages Method
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Type of Departments

In a manufacturing concern, there are three

types of departments
(a) Manufacturing or producing departments
(b) Service departments
(c) Partly producing departments (Ex.
Carpentry shop)

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Allocation and Apportionment
Allocation of Overhead Expenses:
 Allocation is the process of identification of
overheads
with cost centre.
 An expense which is directly identifiable with
a specific cost centre is allotment to that
centre.
 It involves- (i) allocation and apportionment
of overheads among production and service
departments and (ii) reapportionment of
service departments overheads among
production departments.
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Allocation and
Apportionment
Apportionment of Overhead Expenses:
 Allocation is the process of identification of
overheads with cost centres. An expense
which is directly identifiable with a specific
cost centre is allocated to that centre.
 For example, the whole of overtime wages
paid to the workers relating to a particular
department should be charged to that
department

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Apportionment of overhead
expenses
 Cost apportionment is the allotment of
proportions of items to cost centres or cost units
on equitable basis.
 The term refers to the allotment of expenses
which cannot be identified wholly with a particular
department. These are common costs or joint
costs.
 Such expenses require division and apportionment
over two or more cost centres or units.
 Common items of overheads are rent and rates,
depreciation, repairs and maintenance, lighting,
works manager’s salary etc.

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 Difference between Cost
Allocation and Apportionment
Aspect Cost Allocation Cost Apportionment
Distributing indirect
Assigning both direct
costs among different
Definition and indirect costs to a
departments or cost
cost object.
centers.
Nature of Involves direct and Focuses specifically on
Costs indirect costs. indirect costs.
Allocate costs in a
logical and systematic Divide indirect costs
manner for decision- among various
Objective
making and departments or cost
performance centers fairly.
evaluation.
Apportioning total
overhead costs
Allocating rent based
between production
Example on departmental
and administration
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Basis of Apportionment
 The common expenses have to be apportioned or
distributed over the departments on some equitable
basis. This process of distribution is usually known
as “Primary Distribution”.
 Following are the main bases of overhead
apportionment:
 Direct Allocation
 Direct Labour/Machine Hours
 Value of Materials Passing Through Cost Centres
 Direct Wages
 Number of Workers
 Floor Area of Departments
 Capital Values
 Light Points
 Kilowatt Hours
 Technical Estimates
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Example

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Re-apportionment of Service
Department Cost
Service department costs are to be reapportioned to the
production departments or the cost centre where
production is going on. This process of reapportionment
of overhead expenses is known as “Secondary
Distribution”.
Following chart depicts the methods of re-distribution of
service department costs to production department:

Secondary Distribution
of Overhead

Direct Re- Reciprocal

Step Down
distribution Services
Method
Method Method
Repeated Simultane
Trial and Distributi ous
Error Method on Equation
Method Method
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Direct Re-distribution
Method
 In this approach, the costs associated with
service departments are allocated directly to
production departments, without accounting for
any inter-service utilization.
 Consequently, a precise apportionment becomes
challenging, potentially leading to overcharging
or undercharging of production departments.
 The accurate determination of each service
department's share for control purposes
becomes difficult to calculate.
 Thorough preparation of departmental budgets
becomes problematic, hindering the accurate
ascertainment of Department Overhead rates.

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Step Down Method
 In this method, the cost of the primary service
department is initially allocated to other service
departments and production departments.
 Subsequently, each successive service
department is addressed, and its cost is
apportioned accordingly.
 This sequential process continues until the cost
of the final service department is apportioned,
ultimately allocating its cost solely to the
production departments.

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 Reciprocal Services
Method
 Simultaneous Equation Method: Under this
method, the true cost of the service departments
are ascertained first with the help of simultaneous
equations ; these are then redistributed to
production departments on the basis of given
percentage.
 Repeated Distribution Method: The totals are
put out in a line, and then the service department
totals are exhausted in turn repeatedly according to
the agreed percentages until the figures become
too small to matter.
 Trial and Error Method: The cost of one service
department is apportioned to another centre. The
cost of another centre plus the share received from
the first centre is again apportioned to the first cost
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Absorption of Overheads
 Absorption of overheads in simple words
means recovery of overhead costs from the
cost of production.
 Absorption is the distribution of the overhead
expenses allotted to a particular department
over the units produced in that department.
 There are two steps in the absorption of
overheads:
1. Computing Overhead Rates
2. Applying Overhead Rates to Cost Units
Comp Applyi
uting ng
Overh Overh
ead ead
Rates Rates

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Overhead Absorption
Rates
Overhead rates related to suitable bases or
factors must be determined in order to absorb the
overheads in costs of jobs, process or products.
 Clerical cost and degree of accuracy are two
important factors which determine the rate to be
calculated in a particular concern
 The overhead rate to be absorbed in a product
can be calculated as below:
 Formula:
Overhead Rate:
Overhead Expenses / Total Quantum of Basis (Quantity or
Value)
Overhead Absorbed in a Product:
Overhead Rate x Units of the base contained in the product

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 Following are the main overhead rates
usually followed for absorption of overheads:

Actual
Overhead
Rate

Supplement Predetermin
ary ed
Overhead Overhead
Rate Rate

Overhe
ad
Rates

Blanket or
Normal
Single
Overhead
Overhead
Rate
Rate

Multiple
Overhead
Rate

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Methods of Absorption
 Following
are the main methods of absorbing
Production Overheads:
Direct Material or Labour
Cost Method

Prime Cost Method

Direct Labour Hour Method

Machine Hour Method

Sales Price Method

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 Following
are the main methods of absorbing
Administration Overheads:

“Percentage of Works
Cost”

“Percentage on
Sales”

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 Following
are the main methods of absorbing
Selling and Distribution Overheads:

A Rate per A Percentage

Article of Works Cost

A Percentage
According to
of Turnover
the Number of
and Value
Orders
Added

A Percentage According to
of Cash the Number of
Collected Invoices

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Under-Absorption and Over-
Absorption of Overhead
Under-Absorption:
 IF the amount absorbed is less than the amount
incurred which may be due to actual expenses
exceeding the estimates and/or the output or hours
worked being less than the estimates.
Over-Absorption:
 On the other hand, if the amount absorbed is more
than the expenditure incurred due to expenses being
less then the estimates and/or the output or hours
worked exceeding the cost.

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Accounting Principles of Under-
Absorbed and Over-Absorbed
Overheads
 The accounting treatment of under and over
absorbed overheads depends upon the
extent of such under or over absorption and
the circumstances under which it arises.
 Following are the main methods of disposal
of under or over absorbed overheads:

Use of Supplementary
Rate

Writing off to Costing P&L A/c

Carry forward to Subsequent Years

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Reference

 Readers are advised to read: Unit-II

Chapter–1: Overheads – Collection, Classification,
Allocation, Apportionment and Absorption of Cost
Accounting by:

S.P Jain
K.L Narang
Simmi Agrawal
Monica Sehgal
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