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THE INSTITUTE OF CHARTERED ACCOUNTANTS OF SRI LANKA . Thilanka Warnakulasooriya B.Com Special (Col), ACA . POSTGRADUATE DIPLOMA IN BUSINESS AND FINANCE - 2013/2014 Principles of Financial and Cost Accounting. Accounting for Overhead. - PowerPoint PPT Presentation
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THE INSTITUTE OF CHARTERED ACCOUNTANTS OF SRI LANKA
Thilanka WarnakulasooriyaB.Com Special (Col), ACA
POSTGRADUATE DIPLOMA IN BUSINESS AND FINANCE - 2013/2014
Principles of Financial and Cost Accounting
Accounting for Overhead
Overhead is the Expenditure incurred in the course of making a product, providing a service or running a department, but which cannot be traced directly and fully to the product, service or department
Classification of Overhead Overhead can be classified under 3 basis
Overhead
Element Base
Indirect Material
Indirect Labor
Indirect Expense
Behavior based
Fixed Overhead
Variable OH
Semi-VariableOH
Function Based
Production OH
Administration OH
Selling & Distribution OH
General OH
Overhead Allocation, apportionment & absorption Steps.
1. Identify OH cost & Accumulate the costi.e. Rent , Electricity,
2. Identify the Cost Center of the OrganizationIdentify the activity or item or equipment where the cost are accumulated.
Cost centers can be either production cost center or service cost center
i.e Garment Factory
Production cost centers
Service cost centers
Cutting, Sawing, washing, Packaging
Maintenance , HRM, Planning
3. Allocation of OH cost to cost centers
Some OH can be directly identify to a particular cost centers. Accordingly that OH cost can be allocated to that cost center called “allocation”
i.e. Cutting supervisor salary directly identified to the cutting cost center
4. Apportioning overhead cost to cost centersSome OH can not be directly identified to particular cost center. Accordingly such cost should be shared among the cost centers. These cost should be divided among cost centers based on most reasonable basis.
(Apportionment of overhead is distribution of overheads to more than one cost centre on some equitable basis)
i.e. Garment factory monthly electricity bill was Rs. 200,000. Factory consist of 4 cost centers . The floor area occupied by each cost center are as follows.
Apportion the electricity between cost centers.
OH Basis for Apportionment
Rent, rates, heating and light, repairs and depreciation of building
Floor area occupied by each cost centre
Deprecation and insurance of equipment
Cost or book value of equipment
Personnel, office, canteen, welfare, wages and costs of offices
Number of employees, or labor hours worked in each cost centre
Cost Center Floor area (Sq. Feet)Cutting 3,000Sawing 5,000HR 500Warehouse 1,500
5. Reapportioning the service cost centre cost to production cost centers.
Service cost centers cost should charged to production cost centers since salable units does not pass through service departments. The reasonable apportionment basis should be used
Service cost centre Possible basis of apportionment
Stores Number of cost value of material requisitions
Maintenance Hours of maintenance work done for each cost centre
Production planning Direct labor hours worked in each production cost centre
Reapportioning the service cost centre cost to production cost centers
Secondary Distribution with reciprocal Servicing overhead absorption rates
Direct Method
Only to Production
Department
To production & service department
Simultaneous Equation Method
Repeated Distribution Method
Step Down Method
6. Calculate the overhead absorption rate & absorb the cost
Overhead absorption is the process whereby overhead costs allocated and apportioned to production cost centers are added to unit, job or Cost object.
Overhead absorption is sometimes known as overhead recovery
Overheads are usually added to costs units using a predetermined overhead absorption rate, which is calculated using figures from the budget.
Overhead absorption rate (OAR)
“Attributing OH to particular product or service based on particular basis”
Generally OAR calculated by dividing the OH cost of the cost center by number of units/ Volume of absorption base which is appropriate for the cost center
Calculation of overhead absorption rateOAR = Budgeted Overhead cost
Budgeted volume
Estimate the overhead likely to be incurred during the period Estimate the activity level for the period Divide the estimated overhead by the budgeted activity
level Absorb the overhead into the cost unit by applying the
calculated absorption rate
Ex 06.
There is no ideal OAR, depending on the company some use machine hours or labor hours. The most appropriate OAR depends on factors such as cost, information availability, nature of the product, technology used etc.
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Choosing the appropriate absorption baseA percentage of direct materials costA percentage of direct labor cost A percentage of prime costA rate per machine hourA rate per direct labor hourA rate per unitA percentage of factory cost (for admin
overhead)A percentage of sales or factory cost
( for selling and distribution overhead)
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Over and under absorption of overheads
The rate of overhead absorption is based on estimates ( of both numerator and denominator) and it is quite likely that either one or both of the estimates will nit agree with what actually occurs
◦ Over absorption means that the overheads charged to the cost of sales is more than the overheads actually incurred
◦ Under absorption means that insufficient overheads have been included in the cost of sales
Actual Overhead incurred xxxxOverhead absorbed xxxx(budgeted OAR * actual activity level)
Under/ Over absorption xxx
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The reasons for over/under absorbed overheads The overhead absorption rate is predetermined from budget
estimates of overhead cost and the expected volume of activity.
Over or under recovery of overhead will occur in the following circumstances:-◦ Actual overhead costs are different from budgeted overhead◦ The actual activity level is different from the budgeted
activity level◦ Actual overhead costs and actual activity level differ from
the budgeted costs and levels
◦i.e . Following information with regard to “ A” Company
◦Budgeted overhead cost per month 80,000◦Actual Overhead cost per month 70,000◦Budgeted units plan to produce 10,000◦Actual units Produced 8,000
◦Calculate over or under absorption of overhead per month