Overhead
Content
OVERHEAD
An accounting term that refers to all costs not including or related to direct labor, materials, or administration costs. It is an aggregate of indirect labor ,indirect material and indirect expenses.
CLASSIFICATION OF OVERHEAD
By function Production overhead Administrative overhead Selling overhead Distributive overhead By element Indirect material Indirect labor Indirect expences By behaviour Fixed overhead Variable overhead Semi-variable overhead Overhead cost are the operating cost of the business enterprise which cannot be traced directly to the particular unit of output.
ALLOCATION AND APPORTIONMENT OF OVERHEAD AllocationThe process of spreading production overhead equitably over the volume of production of goods or services.It is the process of charging the whole amount of overhead cost to a particular cost centre.It is primary distribution of overhead cost .
Apportionment-
It is the process of splitting up an item of overhead cost and charging it to the cost centers on an equitable basis .
OVERHEAD COST
BASIS FOR APPORTIONMENT
1. Rent & other building expenses, Fire precaution services, Air conditioning
Floor area, or volume of department
2. Fringe benefits, Labour welfare exp, Time keeping, Supervision
Number of workers
3. ESI and PF contribution, Fringe benefits
Direct wages
4. Depreciation, repairs, insurance of machinery
Capital values
5. General overhead
Direct labour hours or direct wages, or machine hours
6. Electric power
Horse power of machines or machine hours or both
7. Lighting expenses
No of light points or area
8.Maintenance deptt
Actual service utilised or hours worked for each deptt
9.Payroll/Time keeping deptt
Direct labour hours, Machine hours, Number of employees
10.Personnel deptt
Number of employees, rate of labour turnover
11.Store keeping deptt
No of requisition, Qty or value of materials
12.Purchase deptt
No of purchase orders, value of materials purchased
13.Welfare deptt
No of employees
14.Internal transport service
Value or weight of goods transported or distance covered
WHAT IS OVERHEAD COST POOL?????
Traditionally, in a job order cost system and process cost system, overhead is allocated to a job or function based on direct labor hours, machine hours, or direct labor dollars. However, in some companies, new technologies have changed the manufacturing environment such that the number of hours worked or dollars earned by employees are no longer good indicators of how much overhead will be needed to complete a job or process products through a particular function. In such companies, activity-based costing (ABC) is used to allocate overhead costs to jobs or functions. Activity-based costing assumes that the steps or activities that must be followed to manufacture a product are what determine the overhead costs incurred. Each overhead cost, whether variable or fixed, is assigned to a category of costs. These cost categories are called activity cost pools. Cost drivers are the actual activities that cause the total cost in an activity cost pool to increase. The number of times materials are ordered, the number of production lines in a factory, and the number of shipments made to customers are all examples of activities that impact the costs a company incurs. When using ABC, the total cost of each activity pool is divided by the total number of units of the activity to determine the cost per unit.
Activity Cost Pools
Activity Cost Drivers
Purchasing Department Number of Purchase Orders Receiving Department Materials Handling Setup Inspection Number of Purchase Orders Number of Materials Requisitions Number of Machine Setups Required Number of Inspections
Engineering Department Number of Engineering Change Orders Personnel Processing Supervisors Number of Employees Hired or Laid Off Number of Direct Labor Hours
Activity categories While using cost drivers to assign overhead costs to individual units works well for some activities, for some activities such as setup costs, the costs are not incurred to produce an individual unit but rather to produce a batch of the same units. For other costs, the costs incurred might be based on the number of product lines or simply because there is a manufacturing facility. To assign overhead costs more accurately, activity-based costing assigns activities to one of four categories:
Unit-level activities occur every time a service is performed or a product is made. The costs of direct materials, direct labor, and machine maintenance are examples of unit-level activities. Batch-level activities are costs incurred every time a group (batch) of units is produced or a series of steps is performed. Purchase orders, machine setup, and quality tests are examples of batch-level activities. Product-line activities are those activities that support an entire product line but not necessarily each individual unit. Examples of product-line activities are engineering changes made in the assembly line, product design changes, and
Name of Company: Lumax DK Industries Pvt. Ltd. Company Profile: Engaged in production of spare parts for Maruti India Ltd. Person Incharge: CA Sanjay Mehta(CFO) Contact Person: Santosh Kumar ABOUT THE COMPANY As the most experienced automotive lighting solutions company in South Asia, LUMAX , enjoys a history of more than half a century of innovation, Technology, Manufacturing and Market Leadership. Today, Lumax Industries Limited is a full-capability provider of high quality automotive lighting solutions for Four wheelers and Two wheeler applications, serving automobile manufacturing in India as-well-as worldwide. Lumax strives for continual improvement of manufacturing processes with emphasis on consistent quality and cost effectiveness. Lumax signifies LUMINOSITY MAXIMA for today's demanding automobile users. Lumax has come a long way since its inception as a trading company in the year 1945, under the aegis of its founder Late Sh. S.C. Jain . Today Lumax accounts for over 60% market share in Indian Automobile Lighting Business, fueled in no small measure by its more than two decade old technical and financial collaboration with , Japan , a world leader in Vehicle Lighting and illumination products for Automobiles
ANAYLSIS: What types of costs are included in overhead? How large is overhead compared with direct materials and labor costs? ANS.Cost Included in Overhead: All type of indirect material, labour and other expenses. If they are directly related to a particular cost centre then charged to that otherwise allocated to each cost centre on a reasonable basis. Thereafter total cost of each cost centre is apportioned to product on reasonable basis. (On machine hour rate basis etc.) Overhead cost is around 70% of Prime cost. What types of overhead cost pools exist? Are there different pools by department? By activity? By costallocation base? By fixed or variable cost? ANS.Firstly, overhead cost pool means grouping of individual costs say for example in our company all the individual cost related to assembly grouped into the assemble activity(annexure.-----) Overhead cost is allocated to products on the basis of different activity cost pool. Yes, in this company there are different activities: Moulding Surface treatment Assembling Administration Stores etc.
How are overhead applied to final products or services? What cost-allocation bases are used? More portion of overhead applied to the product or a service that generates more portion of profit and the product which generates less profit is being applied less overhead. For cost allocation the company uses activity based costing (ABC). ACTIVITY BASED COSTING:- ABC uses many cost drivers in determining overhead. Firms closely monitor operations to determine which products use the various activities conducted by the firm’s operations. A single product may have cost drivers such as: number of batches produced, number of inspections per batch, and cost per machine setup. Cost drivers are then properly allocated to the products, and resources are measured as they are consumed by activity and product. ABC is a more accurate method of overhead costing because it measures a firm’s consumption of resources by using multiple cost drivers. Using multiple cost drivers is advantageous because higher volume products cease to subsidize the lower volume products. Products that do not require certain activities are not forced to share the burden
of costs as they would in the direct method of costing. For example if a firm produces low grade steel at high volume with little need for inspection, and high grade steel at lower volume with high need for inspection, the high grade steel will carry the burden of the inspection cost. The low grade steel does not use inspection activity and therefore should not be required to include the cost in its overhead allocation. The advantages of using ABC are clear. ABC allows for more accurate costing and pricing of goods and services. With this knowledge firms can lower prices on the products they make most, and be more price competitive in the market. This is especially true for firms that practice cost leadership as a part of their overall business strategy. But this method is not limited to cost leadership alone, ABC works for product differentiation also. Low volume goods and services are no longer under-costed and under-priced when using this method. Businesses can be confident that they are costing premium products correctly and can earn deserved profits for them. The overall advantage to using ABC is that firms get the most for their money and maximize profits in the long term. There are disadvantages to using ABC, however. ABC is very complex. Managerial accountants have been perfecting this method of costing for years. It is also
often difficult to figure out what a firm’s cost drivers are. Moreover, monitoring firm activities and assigning cost drivers can be a very time consuming and costly endeavor. Oftentimes, accounting experts are required to initiate and manage the system. This is especially true for service industry firms. Such businesses may conduct hundreds of activities in a given business day and pinpointing which activities are the most important can be very mind-numbing. Most firms implementing ABC use 15 to 20 cost drivers at the most. Though using Activity Based Costing may seem daunting, it is a very useful method to track costs. If properly implemented, ABC can be very cost effective and profitable. Overhead allocation is one of the more confusing and complex issues facing many businesses. Yet, figuring out how to best determine overhead is very important to a firm’s profitability. While using the direct method of cost allocation is simple, its simplicity makes it very inaccurate and costly to the bottom line. ABC is complex, but if used properly, can pay off greatly in a businesses long term.
An accounting term that refers to all costs not including or related to direct labor, materials, or administration costs. It is an aggregate of indirect labor ,indirect material and indirect expenses.
CLASSIFICATION OF OVERHEAD
By function Production overhead Administrative overhead Selling overhead Distributive overhead By element Indirect material Indirect labor Indirect expences By behaviour Fixed overhead Variable overhead Semi-variable overhead Overhead cost are the operating cost of the business enterprise which cannot be traced directly to the particular unit of output.
ALLOCATION AND APPORTIONMENT OF OVERHEAD AllocationThe process of spreading production overhead equitably over the volume of production of goods or services.It is the process of charging the whole amount of overhead cost to a particular cost centre.It is primary distribution of overhead cost .
Apportionment-
It is the process of splitting up an item of overhead cost and charging it to the cost centers on an equitable basis .
OVERHEAD COST
BASIS FOR APPORTIONMENT
1. Rent & other building expenses, Fire precaution services, Air conditioning
Floor area, or volume of department
2. Fringe benefits, Labour welfare exp, Time keeping, Supervision
Number of workers
3. ESI and PF contribution, Fringe benefits
Direct wages
4. Depreciation, repairs, insurance of machinery
Capital values
5. General overhead
Direct labour hours or direct wages, or machine hours
6. Electric power
Horse power of machines or machine hours or both
7. Lighting expenses
No of light points or area
8.Maintenance deptt
Actual service utilised or hours worked for each deptt
9.Payroll/Time keeping deptt
Direct labour hours, Machine hours, Number of employees
10.Personnel deptt
Number of employees, rate of labour turnover
11.Store keeping deptt
No of requisition, Qty or value of materials
12.Purchase deptt
No of purchase orders, value of materials purchased
13.Welfare deptt
No of employees
14.Internal transport service
Value or weight of goods transported or distance covered
WHAT IS OVERHEAD COST POOL?????
Traditionally, in a job order cost system and process cost system, overhead is allocated to a job or function based on direct labor hours, machine hours, or direct labor dollars. However, in some companies, new technologies have changed the manufacturing environment such that the number of hours worked or dollars earned by employees are no longer good indicators of how much overhead will be needed to complete a job or process products through a particular function. In such companies, activity-based costing (ABC) is used to allocate overhead costs to jobs or functions. Activity-based costing assumes that the steps or activities that must be followed to manufacture a product are what determine the overhead costs incurred. Each overhead cost, whether variable or fixed, is assigned to a category of costs. These cost categories are called activity cost pools. Cost drivers are the actual activities that cause the total cost in an activity cost pool to increase. The number of times materials are ordered, the number of production lines in a factory, and the number of shipments made to customers are all examples of activities that impact the costs a company incurs. When using ABC, the total cost of each activity pool is divided by the total number of units of the activity to determine the cost per unit.
Activity Cost Pools
Activity Cost Drivers
Purchasing Department Number of Purchase Orders Receiving Department Materials Handling Setup Inspection Number of Purchase Orders Number of Materials Requisitions Number of Machine Setups Required Number of Inspections
Engineering Department Number of Engineering Change Orders Personnel Processing Supervisors Number of Employees Hired or Laid Off Number of Direct Labor Hours
Activity categories While using cost drivers to assign overhead costs to individual units works well for some activities, for some activities such as setup costs, the costs are not incurred to produce an individual unit but rather to produce a batch of the same units. For other costs, the costs incurred might be based on the number of product lines or simply because there is a manufacturing facility. To assign overhead costs more accurately, activity-based costing assigns activities to one of four categories:
Unit-level activities occur every time a service is performed or a product is made. The costs of direct materials, direct labor, and machine maintenance are examples of unit-level activities. Batch-level activities are costs incurred every time a group (batch) of units is produced or a series of steps is performed. Purchase orders, machine setup, and quality tests are examples of batch-level activities. Product-line activities are those activities that support an entire product line but not necessarily each individual unit. Examples of product-line activities are engineering changes made in the assembly line, product design changes, and
Name of Company: Lumax DK Industries Pvt. Ltd. Company Profile: Engaged in production of spare parts for Maruti India Ltd. Person Incharge: CA Sanjay Mehta(CFO) Contact Person: Santosh Kumar ABOUT THE COMPANY As the most experienced automotive lighting solutions company in South Asia, LUMAX , enjoys a history of more than half a century of innovation, Technology, Manufacturing and Market Leadership. Today, Lumax Industries Limited is a full-capability provider of high quality automotive lighting solutions for Four wheelers and Two wheeler applications, serving automobile manufacturing in India as-well-as worldwide. Lumax strives for continual improvement of manufacturing processes with emphasis on consistent quality and cost effectiveness. Lumax signifies LUMINOSITY MAXIMA for today's demanding automobile users. Lumax has come a long way since its inception as a trading company in the year 1945, under the aegis of its founder Late Sh. S.C. Jain . Today Lumax accounts for over 60% market share in Indian Automobile Lighting Business, fueled in no small measure by its more than two decade old technical and financial collaboration with , Japan , a world leader in Vehicle Lighting and illumination products for Automobiles
ANAYLSIS: What types of costs are included in overhead? How large is overhead compared with direct materials and labor costs? ANS.Cost Included in Overhead: All type of indirect material, labour and other expenses. If they are directly related to a particular cost centre then charged to that otherwise allocated to each cost centre on a reasonable basis. Thereafter total cost of each cost centre is apportioned to product on reasonable basis. (On machine hour rate basis etc.) Overhead cost is around 70% of Prime cost. What types of overhead cost pools exist? Are there different pools by department? By activity? By costallocation base? By fixed or variable cost? ANS.Firstly, overhead cost pool means grouping of individual costs say for example in our company all the individual cost related to assembly grouped into the assemble activity(annexure.-----) Overhead cost is allocated to products on the basis of different activity cost pool. Yes, in this company there are different activities: Moulding Surface treatment Assembling Administration Stores etc.
How are overhead applied to final products or services? What cost-allocation bases are used? More portion of overhead applied to the product or a service that generates more portion of profit and the product which generates less profit is being applied less overhead. For cost allocation the company uses activity based costing (ABC). ACTIVITY BASED COSTING:- ABC uses many cost drivers in determining overhead. Firms closely monitor operations to determine which products use the various activities conducted by the firm’s operations. A single product may have cost drivers such as: number of batches produced, number of inspections per batch, and cost per machine setup. Cost drivers are then properly allocated to the products, and resources are measured as they are consumed by activity and product. ABC is a more accurate method of overhead costing because it measures a firm’s consumption of resources by using multiple cost drivers. Using multiple cost drivers is advantageous because higher volume products cease to subsidize the lower volume products. Products that do not require certain activities are not forced to share the burden
of costs as they would in the direct method of costing. For example if a firm produces low grade steel at high volume with little need for inspection, and high grade steel at lower volume with high need for inspection, the high grade steel will carry the burden of the inspection cost. The low grade steel does not use inspection activity and therefore should not be required to include the cost in its overhead allocation. The advantages of using ABC are clear. ABC allows for more accurate costing and pricing of goods and services. With this knowledge firms can lower prices on the products they make most, and be more price competitive in the market. This is especially true for firms that practice cost leadership as a part of their overall business strategy. But this method is not limited to cost leadership alone, ABC works for product differentiation also. Low volume goods and services are no longer under-costed and under-priced when using this method. Businesses can be confident that they are costing premium products correctly and can earn deserved profits for them. The overall advantage to using ABC is that firms get the most for their money and maximize profits in the long term. There are disadvantages to using ABC, however. ABC is very complex. Managerial accountants have been perfecting this method of costing for years. It is also
often difficult to figure out what a firm’s cost drivers are. Moreover, monitoring firm activities and assigning cost drivers can be a very time consuming and costly endeavor. Oftentimes, accounting experts are required to initiate and manage the system. This is especially true for service industry firms. Such businesses may conduct hundreds of activities in a given business day and pinpointing which activities are the most important can be very mind-numbing. Most firms implementing ABC use 15 to 20 cost drivers at the most. Though using Activity Based Costing may seem daunting, it is a very useful method to track costs. If properly implemented, ABC can be very cost effective and profitable. Overhead allocation is one of the more confusing and complex issues facing many businesses. Yet, figuring out how to best determine overhead is very important to a firm’s profitability. While using the direct method of cost allocation is simple, its simplicity makes it very inaccurate and costly to the bottom line. ABC is complex, but if used properly, can pay off greatly in a businesses long term.
