What is Overhead?

Overhead has been defined as the total cost of indirect materials, indirect wages and other indirect expenses. The word “indirect “ in this context means that which cannot be allocated but which can be apportioned to or absorbed by cost centers or cost units.

Classifications of overheads

Overhead can be classified into 3, which are:

By Function
By Element
By behavior

By function:

This can be further subdivided into:

Factory overhead
Admin overhead
Selling and distribution expenses

By element

This can be further subdivided into:

Indirect materials
Indirect labor
Indirect expenses

Behavioural Classification

This can be further subdivided into:

Fixed expenses
Variable expenses
Semi fixed or semi variable expenses

Why do we account for overhead? We account for them in order to be able to ascertain the costs and profits incurred in products.

Allocation and Apportionment of Overhead

Cost allocation means the allotment of whole items of cost to cost centres or cost units, whereas cost apportionment means the allotment of proportions of items of cost to cost centres or cost units. Thus, when a whole item of cost can be attributed to a single department or cost centre, it is allocation. But when an item of cost is to be subdivided on a suitable basis to a member of cost centres, it is apportionment. However, that which cannot be allocated must be apportioned.

Basis of apportionment

Capital Value basis: The capital value of each building or each portion of the building occupied by each department is taken as the basis for apportionment expenses connected with the building, e.g depreciation, taxes and insurance on building. Similarly, the values of machinery in each department can be the basis with respect to depreciation and insurance on machinery.

Floor area occupied or cubic capacity basis: Expenses like rent, lighting, heating, air conditioning, fire precaution measures and building maintenance can be apportioned on the basis of floor area occupied by various departments. If there is a difference in respect of height, the cubic capacity basis is preferred.

No of employees or departmental wages: This basis is suitable for canteen expenses, club recreation expenses, time keeping, hospital and general welfare expenses, compensation and other fringe benefits, contribution to provident funds etc.

Technical estimates: Wherever possible, expenses are apportioned on a careful technical assessment. Examples are lighting charges which is based on light bulbs, watts used, electric power etc.

Production hour basis: Majority of general overhead items are apportioned on the basis of departmental labour hours or mechanical hours, e.g factory management and supervision expenses, research and development cost, consumable stocks etc can be apportioned on this basis.

Let’s take an example:

X company limited is divided into two production cost centres A and B and two service centres X and Y. The following is the summary of overhead costs for a particular period.

Particulars		Amount
Works management Salary		4000
Power		21000
Contribution to NPF		9000
Plant Maintenance		4000
Depreciation of Plant and Machinery		20000
Canteen Expenses		12000
Rent		6000

The following is mad available from the various departments

	A	B	X	Y
No of employees	16	8	4	4
Area occupied (in sq.ft)	2,000	3,000	500	500
Value of plant	7,500	100,000	25,000	–
Wages	40,000	20,000	10,000	5,000
Horse Power	3	3	1	–

Apportion the cost to various departments on a more suitable basis.

Possible solution:

X Company Ltd

Departmental Overhead Distribution Summary

overhead_solution_1

Re-apportionment of service department costs to production departments

This is the next step in our attempt to ultimately apportion overhead cost to production unit. Some authors regard this process as secondary distribution process.

Basis of re-apportionment

The service department costs are apportioned to production departments on the basis of services rendered by the production department.

Table of basis of re-apportionment

Service dept.		Basis
Maintenance dept.		Direct Labor hour
Time keeping dept.		Direct Labor hour or machine hour
Project & Planning dept.		Direct labor hour
Payroll dept.		Direct Labor hour
Canteen or recreation		No of employees
Personnel dept.		No of employees
Labor welfare dept.		No of employees
Internal transport dept.		weight or value of material carried

Purchase dept.		no of purchase orders or value of materials consumed by each dept.
Store dept.		No of requisitions or value of material used
Building dept or building service		Floor area
Fire protection service		capital value of assets
Power house and other services		Horse power or wattage

Methods of reapportionment

Today, we would be treating examples of the two most common methods of re-apportionment, which are:

Direct redistribution
Step Method

Other methods include:

Reciprocal method
Repeated distribution method

Direct Distribution method: Under this method, services rendered by one service department to other service departments and vice versa are totally neglected. The service department costs are entirely distributed to only the products department.

Example: The particulars of on-cost incurred by a manufacturing concern commonly for production departments A and B and service department C are as follows.

Items	On-cost
Power	8,000
Labor, welfare expenses	4,500
Rent	7,200


Depreciation
Machinery	20,000
Building	7,200
Lighting	2,400

You are further supplied with the following information:

	Departments
Particulars	A	B	C
Kilowatt	12	10	2
Light Points	15	20	5
Area Occupied (in sq metres)	1000	800	600
No of employees	20	8	2
Machine hour	2000	1500	500

Note: The expenses of the service department C is shared between Production department A and B in the ratio of 1:2

Possible solution

Primary distribution summary (apportionment to the three departments)

overhead_solution_2

overhead_3_secondary_distributiuon

Step distribution Method

This method of reapportionment deals with a sequence of reapportioning service costs among the various departments. First we reapportion the service department with the larger/ largest amount of overhead, or the service than renders a larger amount of its services to other service departments. We do it sequentially, taking the highest first and progressing to the service department with the lowest amount of overhead or lowest percentage of its total services to other service departments

Let’s take an example

Enigma ltd has three production departments (A,B,C) and two service departments (X,Y). The estimated figures for a certain period are as follows: