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Accounting for Overheads

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Abby Ashraff

on 22 March 2013

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Transcript of Accounting for Overheads

Accounting for Overheads 2) Second stage - costs accumulated in the cost centres are assigned to products.-A measure is selected for allocating production centre expenses to products (allocation base eg. direct labour hours and machine hours)-An overhead rate (burden rate) for each production cost centre is computed by dividing the total costs assigned to the centre by the total quantity of the allocation base.-Overhead expenses are allocated to products by multiplying the overhead rate of each centre by the second stage allocation base consumed by each product.
PAT0075 Cost & Management Accounting Procedure for Allocating Overheads to Products Two stage procedure:
1) First stage - overheads are assigned to cost centres.The objective is to assign all manufacturing costs to production cost centres.Serves two purposes:
-The expenses assigned to cost centres are used for cost control and performance evaluation purposes.
-The accumulated production cost centre expenses are assigned in the second stage of the procedure to products to satisfy financial accounting requirements for inventory valuation.
Step 3: Calculation of appropriate
departmental overhead rates
To allocate the overheads of each production department to products passing through that department.
Some common allocation bases are volume-related and based on the amount time products spend in each production centre eg. direct labour hours (non-machine departments), machine hours (machine departments) and direct wages.
The annual overhead costs for a factory with three production departments (two machine shops (X and Y) and one assembly shop) and two service departments (stores and maintenance departments) are as follows: Illustration of the Overhead Allocation Procedure Step 2 : Reallocation of service centre overheads to production cost centre
Service departments are those departments that exist to provide services of various kinds to other units of the organization.
eg. stores and maintenance departments (support departments)
They render essential services that support the production process, but they do not deal directly with the products.
It is not possible to allocate service department costs to products passing through these departments.
The costs must be apportioned to production departments that actually work on the manufactured product. Step 1: Assign overheads to production and service department.
Some overhead expenses such as machine depreciation or indirect materials can be directly assigned to production cost centres.

Some cannot be directly attributed to specific departments because they are incurred for the benefit of many departments.

It is necessary to establish a logical basis for apportioning the overheads to cost centres / departments Procedure for Calculating Cost Centre Overhead Rates If product Alpha requires 20 direct labour hours in department C but does not pass through department A and B
Blanket overhead rate = RM2 x 20 hours = RM40 will be allocated to product Alpha
(all the factory overhead rates would be averaged out and product Alpha would be indirectly allocated with some of the overheads of department B)
Departmental overhead rate = RM0.40 x 20 hours = RM8
Blanket overhead rate is only satisfactory when all products consume cost centre overheads in approximately the same proportions. Some organization omit the first stage of the overhead allocation procedure.
A single overhead rate for the factory as a whole is established.
This rate is assigned to all products irrespective of the departments.
eg. Total factory overheads RM120,000, 60,000 direct labour hours are worked.
Blanket overhead rate = RM2 per direct labour hour (all products)
Blanket overhead rate is not a satisfactory method in a situation where a factory consists of a number of different production centres, and products consume cost centre overheads in different proportions. Blanket Overhead Rates Example RM100,000 overheads are assigned to production centre. Direct labour hours is selected as an allocation base - 20,000 hours are used
Overhead rate = RM100,000 / 20,000 hours = RM5 per direct labour hour
If the product consumes 10 direct labour hours,
 RM5 x 10 hours = RM50 overheads will be allocated to the product. The main objective is to choose a method that measures the resources consumed by each department Cost Basis of apportionment Rent, lighting and renting Area Employee-related expenditure –
works management, works canteen
time, and wages office Number of employees Depreciation and insurance of plant
and machinery Value of plant
and machinery Example Assembly
Department A Assembly
Department B Machine
Department C Overheads
allocated RM80,000 RM160,000 RM240,000 Direct labour
hours 80,000 40,000 10,000 Machine hours 80,000 Overhead rate RM1 per direct labour hour RM4 per direct labour hour RM3 per machine hour Example Dept. A Dept. B Dept. C Total Overheads RM12,000 RM100,000 RM8,000 RM120,000 Direct labour hours 20,000 20,000 20,000 60,000 Overhead rate RM0.60 RM5 RM0.40 RM2 A company produces product Alpha. The following are the overhead incurred for each department. This company is using the direct labour hours as a basis of allocation of the overhead. Example If all products spend the same proportion of time in each department as product X (10:6:5), it will be unnecessary to analyze overheads to departments, since a blanket rate would yield the same overhead allocation. Example: Product X Assembly
Department A Assembly
Department B Machine
Department C Total 10 hours 6 hours 5 machine
hour 10 hrs x RM1
= RM10 6 hrs x RM4
= RM24 5 hrs x RM3
= RM15 RM49 Step 4: Charging overheads to products
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