1. OVERHEADS Definitions Types Classifications Distribution of Overheads Cost to Various Cost Center Overhead Analysis Sheet

2. Definition - Overheads Costs that cannot be traced and attributed to the physical units of a product. A combination of all indirect costs which consist of indirect materials, indirect labour and indirect expenses.

3. Definition - Overheads Indirect Materials ◦ Materials cost other than direct materials ◦ Materials which are not traceable to the product being made ◦ Ex. Oil and grease used in operating and maintaining of machines in the factory, glue in shoe making and nails used in furniture trade.

4. Definition - Overheads Indirect Labour ◦ Labour cost other than direct labour ◦ Cost incurred to pay for the factory employees who are not directly involved in production. ◦ Ex. Supervisor’s salary, salary paid to cleaners and security guards

5. Definition - Overheads Indirect Expenses ◦ Expenses other than direct expenses ◦ Expenses incurred for the business as a whole ◦ Ex. Electricity expenses, depreciation of assets, rent and telephone expenses

6. Types of Overheads 1. Manufacturing/Production Overhead - - Indirect cost incurred in production process such as indirect material, indirect labour, insurance on plant and machinery, and rent of factory.

7. Types of Overheads 2. Non Manufacturing Overhead - Costs that is not related directly with the production of the products such as administrative overhead, selling and distribution overhead

8. Production Overhead Indirect materials, indirect factory wages, insurance on plant and machinery, factory of rent Administrative Overhead Officers salaries, audit fees, stationeries and office rent Selling Overhead Advertising cost, salesman commission Distribution Overhead Transportation charges and packing costs Types of Overheads

9. Methods of Classifying Overheads Behaviour Nature of expenditure Traceability Function

10. Overhead Classification Behaviour: ◦ Fixed overheads ◦ Variable overheads ◦ Semi-variable overheads

11. Overhead Classification Nature of expenditure: ◦ Indirect materials cost ◦ Indirect labour cost ◦ Indirect expenses

12. Overhead Classification Traceability to Department: ◦ Direct departmental overheads ◦ Indirect departmental overheads

13. Overhead Classification Function: ◦ Factory overheads ◦ Administrative overheads ◦ Selling overheads ◦ Distribution overheads

14. Distribution of Overhead Cost to Various Cost Center Overheads are apportioned to the cost center/department to facilitate absorption of overheads into cost units. 2 broad categories of cost center: ◦ Production Cost Center – department where the production is carried on. Ex. Machining, Assembly and Finishing Department ◦ Service Cost Center – department that provide service to production department. Ex. Canteen, Stores, Maintenance and Inspection Department.

15. Distribution of Overhead Cost to Various Cost Center Steps to assign overheads cost to product: 1.Assign all factory overheads to production and service cost centers. i.Cost allocation ii.Cost apportionment 2.Reallocation of service center overheads to production cost centers 3.Calculation of Overhead Absorption Rates (OAR) of production cost centers. 4.Charging overheads to product.

16. i. Cost Allocation Is part of cost attribution which charge a specific cost to a cost centre or cost unit. To allocate the cost, two conditions must be met: i.Specific cost or exact amount is known. ii.Cost centre must have caused the overhead to be incurred (can be clearly identified with a cost centre) Cost allocation is used when overhead can be directly traced to a cost centre. If cost cannot be allocated, they have to be split over several cost centers on some agreed basis known as apportionment.

17. Example: Cost Allocation OverheadsProduction Cost CenterService Cost Center Machining (RM) Assembly (RM) Maintenance (RM) Store (RM) Indirect Materials 7,0005,0003,0002,000 Indirect Expenses 3,3001,500500300

18. ii. Cost Apportionment Is part of cost attribution which shares costs among two or more cost centers or cost units in proportion to the estimated benefit received that is known as ‘fair basis’. “Fair basis” should produce fair and equitable share of the common cost for each of the receiving cost centers – cost apportionment reflect the benefits received. The choice of fair basis is subjective and the apportionment of overhead cost is arbitrary, depend on the information given.

19. ii. Cost Apportionment – cont’d Suggested apportionment basis are given below: Overhead CostsCommon Basis of Apportionment Rent, Rates, Depreciation on Building, Insurance on Building, Fire Insurance on office, Heating, Lighting, Utilities, Air Conditioning Area Space Occupied Floor Area Supervision, Welfare, Wages, Canteen expenses, Pension Funds, Administration Number of employees Material handling, Material StorageNumber of material requisitions Material Handling Power Expenses (electricity consumed)Kilowatt hours Horse Power Depreciation on assets (Machinery), Insurance on Plant & Machinery Asset Value Book Value of Assets Fire Insurance on stock / storeroomValue of stock MaintenanceMaintenance hours Cost of Maintenance InspectionNumber of inspection Number of Production Employees

20. Example: Cost Apportionment Other CostRM Rent on Building36,000 Depreciation of Machinery10,000 Electricity (Power)3,920 Production Cost Center Service Cost Center Total MachiningAssemblyMaintenanceStore Kilowatt hours150100 50400 Machinery Value RM50,000RM30,000RM10,000 RM100,000 Floor Area (sq m) 2,500 2,0005007,500

21. iii. Reapportionment of Service Cost Center Costs After the overheads cost have been analysed an totaled, service cost centers cost has to be charged to production cost centers. The method used is repeated or continuous allotment. Under this method, the first service cost center is allotted in the normal way, and then the appropriate proportion of the second department is allotted back to the first department. This process will be repeated until the amount of overheads involve become insignificant or zero for the service department.

22. iii. Reapportionment of Service Cost Center Costs Suggested possible basis for reapportionment are given below: Service DepartmentPossible Basis MaintenanceMaintenance Hours Maintenance cost/wages StoresNumber of requisition Material Handling Weight of Materials Issued InspectionNumber of Inspection Number of Production Number of Prod. Employees Personnel DepartmentNumber of Employees CanteenNumber of Employees PowerTechnical Estimates Metered Usage

23. iv. Overhead Absorption Once the overhead have been analysed to production cost centers, they can be charged to the cost unit. This will be done by using overhead absorption rate (OAR) *There are six bases that can be used to calculate OAR OAR = Budgeted Production Overheads Budgeted Units of Basis* Used

24. Bases of Calculating OAR: 1. Units Basis (OAR=RM/u) 2. Direct Labour Hr Basis (OAR= RM/DLH) 3. Machine Hour Basis (OAR= RM/MH) 4. Direct Labour Cost Basis (OAR= ?% of DLC) 5. Direct Material Cost Basis (OAR= ?% of DMC) 6. Prime Cost Basis (OAR= ?% of PC)

25. Format of Overhead Analysis Sheet (Example) OVERHEAD ANALYSIS SHEET.docx

26. Departmental OAR and Blanket OAR Departmental OAR ◦ Used in a situation where a number of products are produced in a number of departments and the products do not receive an equal amount of time in each of these departments. ◦ Different department will have its own OAR regarding to the basis used for the department. Blanket OAR ◦ Where a single OAR established for the factory as a whole and is charged to all jobs irrespective to the departments in which they were produced. ◦ This OAR may be used under one of these situations:  Only one type of product is produced  Each job receives equal amount of benefits from the production departments.

27. Blanket OAR = Budgeted Prod. Overheads of ALL Prod Dept Budgeted Units of Basis Used of ALL Prod. Dept Budgeted Units of Basis Used of ALL Prod. Dept Blanket OAR = Budgeted Prod. Overheads of ALL Prod Dept Budgeted Units of Basis Used of ALL Prod. Dept Budgeted Units of Basis Used of ALL Prod. Dept

28. Example: Blanket OAR Dept ADept BDept CTotal Overheads (RM)12,000100,0008,000120,000 Direct Labour Hour (DLH) 20,000 60,000 OAR per DLHRM0.60RM5.00RM0.40RM2.00 Departmental OARBlanket OAR

29. Actual OAR Vs Predetermined OAR Actual OAR – based on the actual production overheads and actual units of base. Predetermined OAR ◦ established based on budgeted annual overhead expenditure and budgeted activity. ◦ Calculated prior to the accounting period ◦ Predetermined OAR has to be used because of the following reasons:  Actual costs are not known until the end of a costing period – to wait for the actual cost will not only be inconvenient but will also be too late to determine the total cost and the selling price of a product.  Using actual costs will produce fluctuating unit cost when the activity is seasonal.  The use of predetermined rates enables product costs to be calculated as soon as production is completed.

30. Predetermined OAR = Budgeted Prod Overheads Budgeted Units of Base Budgeted Units of Base

31. Over/Under Absorption Over or under absorption of overheads occurs when: ◦ The amount of overhead expenditure incurred differs from the amount budgeted ◦ The actual production units (volume) differs from budgeted production Overhead Absorbed = OAR x Actual Units of Base

32. Treatment of Over/Under Absorption Under Absorbed = Overheads Absorbed < Actual Overheads Incurred Dr Profit & Loss Cr Production Overheads Over Absorbed = Overheads Absorbed > Actual Overheads Incurred Dr Production Overheads Cr Profit and Loss Account