AFM AFM Cost Assignment and Costing Systems By Isuru Manawadu B.Sc in Accounting Sp. (USJP), ACA 1 1

By Isuru Mananwadu 2 What is overhead? The total cost of indirect materials, indirect labor and indirect expenses

By Isuru Mananwadu 3 Overhead Allocation Systems  Traditional Costing System  Activity Based Costing

By Isuru Mananwadu 4 Overhead cost/ common cost would be allocated to each unit of production through; (1) Allocation (2) Apportionment (3) Absorption

By Isuru Mananwadu 5 Overhead Allocation Cost allocation is the assigning of a common cost to several cost objects. For example, a company might allocate or assign the cost of an expensive computer system to the three main areas of the company that use the system. A company with only one electric meter might allocate the electricity bill to several departments in the company.

By Isuru Mananwadu 6 Cost centre is a responsibility centre where managers are accountable for the expenses that are under their control. Cost centers classification:  Production cost centres  Service cost centres  Process cost centres

Cost allocation and cost apportionment are the two procedures which describe the identification and allotment of costs to cost centers or cost units. Cost allocation refers to the allotment of all the items of cost to cost centers or cost units. Cost apportionment refers to the allotment of proportions of items of cost to cost centers or cost units. By Isuru Mananwadu 7

8 Basis of Allocation Rent, Rates & Taxes, Lighting & Heating Insurance & depreciation of Building, Cost of repairs & maintenance of Building, Air Conditioning Floor Area Occupied Insurance & Depreciation on Plant & Machinery (PM), maintenance of PM, Insurance on building, etc Capital Value (Source: Paramjit Sharma –

Basis of Allocation No.Of Employees Repairs & Maintenance of Plant & Machinery Machine Hours Welfare Expenses, time-Keeping,pay-roll Office, Canteen, Recreation, Supervision Medical Expenses (Source: Paramjit Sharma – 9 9

Basis of Allocation Store Keeping Expenses Value or Weight of Materials Transport Service Expenses Truck Mileage Tonnage Truck Hours No.Of Pakages (Source: Paramjit Sharma – 10

P1 S1 P2P3 S1 Prod DepartmentsService Dept. Factory Overheads Allocation & Apportionment 11 By Isuru Mananwadu 11

Production Departments Service Departments Carry out the central purposes of an organization. Provide support that facilitates the activities of production departments. Service Department Cost Re-Apportionment 12 By Isuru Mananwadu 12

13 Service cost centre cost apportionment Service Cost centre Basis of apportionment Stores No. of material requisitions Maintenance Hours of maintenance work done for each cost centre 13 By Isuru Mananwadu 13

The Need for Cost Apportionment First Stage Apportionment Service department costs are apportioned to operating departments. Service Department (Cafeteria) Service Department (Accounting) Service Department (Personnel) Operating Department (Machining) Operating Department (Assembly) The Products 14 By Isuru Mananwadu 14

There are several methods of re- apportioning the service department overheads to production departments 1. Direct Method 2. Reciprocal Method  Repeated Distribution Method  Simultaneous Equation Method 15 By Isuru Mananwadu 15

Example- Direct method of reapportionment Product.D ept. A Product. Dept. B Stores Dept. Maintenan ce Dept. Overhead costs Cost of material requisitions Maintenance hrs needed By Isuru Mananwadu 16

Algebraic approach ( Equation Method) Setup the overhead re-apportionment process as a set of equations. Let A = the total overhead apportioned to department A B = the total overhead apportioned to department B, etc By Isuru Mananwadu 17

By Isuru Mananwadu 18 Re- apportionment Basis Purchase Department Stores No of Purchase Orders or value of Materials Purchased for each Production Department Value or Quantity of Materials Issued No. of Materials Requisitions

By Isuru Mananwadu 19 Re- apportionment Basis Internal Transport inspection Inspection Hrs. Devoted to each Department Weight & Distance

By Isuru Mananwadu 20 Overhead Absorption It is a systematic process of distributing the OH, (allocated, apportioned and reapportioned to production department) among the units produced. Absorption rate – A rate at which overheads are charged to the cost units.

By Isuru Mananwadu 21 OVERHEAD ABSORPTION RATE Actual rate Predetermined overhead rate

By Isuru Mananwadu 22 Actual and predetermined OAR The purpose of absorbing production overheads is to ensure the full production cost of the product is known. If actual overheads and activity levels were to be used, it would only be known at the end of period. For this reason predetermined or budgeted figures are normally used to calculate absorption rates.

By Isuru Mananwadu 23 Predetermined OAR The budgeted production overhead for each production cost center is then divided by the budgeted level of activity to give the predetermined overhead absorption rate (OAR). This OAR can then be used for planning and control purposes and also pricing.

By Isuru Mananwadu 24 OVERHEAD ABSORPTION RATE Actual OHEs for the period Actual No. of the units Actual rate

By Isuru Mananwadu 25 Budgeted OHEs for the Period Budgeted No. of Units Pre-determined Rate OVERHEAD ABSORPTION RATE

By Isuru Mananwadu 26 Methods of overhead absorption I.Production unit method II.Percentage methods a)% on direct labour b)% on direct material cost c)% on prime cost III.Hourly rate methods a)Direct labour hour rate b)Machine hour rate

By Isuru Mananwadu 27 Single or Blanket overhead absorption Blanket overhead absorption is where the total production overheads of the organization are absorbed on a single absorption basis. Only one Rate for entire Unit/plant /Department

By Isuru Mananwadu 28 I.Production unit method OHAR = POH for the period No.of Units of Output

By Isuru Mananwadu 29 OHAR = POH for the period x 100 Direct labour cost 2. Percentage on direct labour

By Isuru Mananwadu Percentage on direct material cost OHAR = POH for the Period x 100 Direct material cost

By Isuru Mananwadu Percentage on prime cost OHAR = POH for the period x 100 Prime Cost

By Isuru Mananwadu Direct labour hour rate OHAR = POH for the period Labour hours

By Isuru Mananwadu Machine hour rate OHAR = POH for the period Machine hours

By Isuru Mananwadu 34 THANK YOU