Overheads are indirect costs which can not directly be traced to cost units. The task of the cost accountant is to charge these overhead costs to cost units/products. There are two approaches of charging overhead costs to cost units Viz i. Traditional/conventional absorption costing method and, ii. Activity Based Costing (ABC)
Classification of overheads
Overheads can be classified as production or non production overheads. Production overheads are those incurred in the production departments or production support departments. Non production overheads pose no problem as they are written off in the profit and loss account as period costs. The task is that of chagrining production overheads to cost units.
A Traditional absorption costing method
This is a five stage process i.e.
i. Collection and classification of overheads (use of financial accounting and cost accounting documents) ii. Allotment of overheads-the charging of overheads to cost centers (preparing overhead analysis sheets)
Methods of allotment of overheads
➢ Allocation of overheads which is the assigning of overheads to cost centers to which they are unique, ➢ Apportionment of overheads which is the equitable sharing out overheads to qualifying cost centre. NB. Allotment of overheads is a two stage process i.e.
➢ Primary distribution/ analysis which charges overheads to all cost centers ➢ Secondary distribution which charges overheads from production support centers to production centers. Note; support centers are sometimes referred to as service centers iii. Computation of overhead absorption rates
iv. Absorption or recovery of overheads to cost units i.e. charging of overheads to cost units using rates in iii) above v. Disposition of over/under recovered overheads
The need for charging overheads to cost units
1) Determination of unit costs to enable determine the cost of sales for profit measurement IAS8 and valuation of stock IAS2 2) For pricing decisions
3) For profit planning
4) For cost control
Apportionment of overheads
As stated earlier is the equitable sharing out of overheads to all qualifying cost centers. The question to be answered here is what is the equitable base? Below is a brief of the guide to equity and the candidate should explore in more detail | |Basis |Overheads | |1 |Floor Area |Rent & Rates, Heat & Light | |2 |Number of employees |Indirect wages, staff welfare costs | |3 |Book values |Depreciation, insurance | |4 |Technical estimates |Power, heat, light | |5 |Volume |Heat , light |
Primary analysis of overheads
A company is preparing its overhead cost budget and determines the apportionment of these overheads to cost units. Cost center expenses and related data has been budgeted as follows: |Overhead |Total |Production departments |Support departments | | |UGX000 | | | | | |cutting |welding |finishing |Canteen |maintenance | |Indirect wages |78560 |8586 |9190 |15674 |2965 |15460 | |Consumable materials...