BBA Study Material to Cost Accounting Topic Wise Short Notes of Overheads

BBA STUDY MATERIAL TO COST ACCOUNTIG  SHORT NOTES OF ALLOCATION

Allocation

CIMA defines cost allocation as “the charging of discrete, identifiable items of cost to cost centres or cost units. Where a cost can be clearly identified with a cost centre or cost unit, then it can be allocated to that particular cost centre or cost unit.

Allocation is the process by which cost items are charged direct to a cost unit or cost centre. It is the process of charging the traceable amount of overhead to cost centre or cost unit. Overhead costs by their nature cannot often be related to one particular cot centre. Where a cost is directly attributable to a department e.g. electricity metered to that department, allocation can take place. If a cost can be specifically identified with a department that cost is allocated to that department.

For example depreciation of machinery of machining department can be directly allocated. To machining department. The salary of stores clerk can be allocated to stores department cost of coal used in boiler can be directly allocated to boiler house division.

BBA STUDY MATERIAL TO COST ACCOUNTING SHORT NOTES OF APPORTIONMENT

Apportionment

CIMA defines apportionment “the allotment of two or more cost centres of proportions of the common items of cost and the estimated basis of benefits received”.

Some cost s cannot be identified as arising from the activities of one specific department or function. Non – allocable costs, however, must be apportioned on some logical basis to be divided between the related cost centres. For example, rent, rates and taxes incurred for the entire factory cannot be directly allocated to different cost centres, but can be apportioned to more than one cost centre on some equitable basis for benefits received. The basis normally used for rent, rates and taxes being the floor area occupied by various cost centres. Apportionment is the division of cost among two or more cost centres in proportion to the estimated benefits received, using a proxy e.g. square feet. The choice of an appropriate basis is a matter of judgment to suit the particular circumstances of the organisation and where possible there should be a cost /cause relationship. The representative type of overheads and their basis of apportionment is given below:

BBA STUDY MATERIAL TO COST ACCOUNTING  SHORT NOTES OF CRITERIA FOR OVERHEADS ALLOCATION AND APPORTIONMENT

Criteria for Overheads Allocation and Apportionment

The following are the criteria based on which cost will be allocated:

Neutrality – A cost allocation scheme is neutral if it does not interfere, after or in any way distort the decision making process. Any departure from the principle of neutrality is assumed to lead to economic inefficiency. However, a neutral allocation scheme will lead to decisions that satisfy marginal optimality conditions. It thereby avoids distorting the decision making process. An allocation scheme which is neutral with respect to one decision may not be neutral for all other decisions.

Ability to bear – costs should be assigned to cost objects in proportion to their ability to bear those costs. Sales revenues, gross profit, total value of assets and total costs are examples of bases used to relate costs to cost objects. The presumption is that ‘larger cost objects can afford to bear larger share of overhead costs.

Cause and Effect Relationship – this criterion requires a meaningful casual relationship between the cost objects and the costs to be allocated. Here the basic principle is to allocate costs to those factors which cause the costs for example, factory maintenance costs might be allocated among divisions in proportion to the hours of maintenance work performed in each division.

Benefits Received – this criterion is primarily concerned with allocating cost in proportion to the benefit received by each cost object. The premise is that cost objects should be charged for the amount of service they receive. For example, the costs of a power plant might be allocated in proportion to the consumption of power by the different department or divisions.

Equity or Fairness – it implies that the scheme should produce an allocation which is just and fair to all parties involved. Each party should bear an equitable share of the allocated costs.

Bba Study Material to Cost Accounting Topic Wise Short Notes of, Overheads: Apportionment and Absorption, Topic is Apportionment of Service Centre Costs

Apportionment of Service Centre Costs

Service departments may exist to provide services of various kinds to other departments. For example, personnel, maintenance, boiler house, pump house, power generation departments are service departments which provide service to the production and other service centres. In some instances the service departments may even consume part of their services themselves. It is common that in all organisations the overheads will be incurred by both production and service departments. Hence , in the first step, all the overhead  costs should be allocated or apportioned to the production and service department on some equitable basis. This is called ‘primary distribution’ of overheads. The service departments render service (benefit) to the production departments and in ascertainment of production departments cost the expenses of service departments are to be apportioned amongst production departments only. This process of redistribution of service department cost to production departments is called ‘secondary distribution’ of overhead. The methods generally used in allocation of service department costs are given below:

BBA STUDY MATERIAL TO COST ACCOUNTING  SHORT NOTES OF DIRECT METHOD

Direct Method

Under this method, the service department’s total costs are directly allocated to production departments. This method ignores any services rendered by one service department to another.

BBA STUDY MATERIAL TO COST ACCOUNTING  SHORT NOTES OF STEP-DOWN METHOD

Step – Down Method

This method recognises the services provided to other service department using a sequence of reallocations in which service department costs are allocated in turn to production departments and to other service department. But no further costs are allocated to a service department once its costs have been allocated. The basic assumption of this method is that when one service department’s costs are apportioned, that particular department is then eliminated from any apportionment of the other service departments. This method ignores the concept of ‘reciprocal service’. Thus , this method ignores the complexity of situations  in which two or more service department’s simultaneously provide services to each other, as well as to production departments. This method is also called as ‘elimination method’.

BBA STUDY MATERIAL TO COST ACCOUNTING  SHORT NOTES OF REPEATED DISTRIBUTION METHOD

Repeated Distribution Method

This method takes into account the reciprocal services of services departments. Under this method the primary distribution of overheads is made to production and service departments on regular basis. Then, service department costs are repeatedly allocated in the specified percentage. This process continues until all the service costs have been fully transferred into the production departments. This is a laborious method and a computer can be used in the calculations. This method is also known as ‘continuous allotment’ method.

BBA STUDY MATERIAL TO COST ACCOUNTING  SHORT NOTES OF SIMULTANEOUS EQUATIONS METHOD

Simultaneous Equations method

Under this method mathematical simultaneous equations are formulated and then equations are solved. This method is also called ‘algebraic ‘method.

Bba Study Material to Cost Accounting Topic Wise Short Notes of, Overheads: Apportionment and Absorption, Topic is Absorption of overhead

Absorption of overhead

CIMA defines absorption of overheads as “the process of absorbing all overhead costs allocated or apportions or apportioned over a particular cost centre or production department by the units produced”.

Absorption of overheads refers to charging of overheads to individual products or jobs. It is a process of distribution of overheads allotted to a particular department or cost centre over the units produced. The absorption of overhead is done by applying overhead absorption rates. The overheads allocated or apportioned over different cost centres or cost units are again absorbed into unit cost on some equitable basis. Overheads absorption is a process of charging of overheads to cost units by means of rates separately calculated for each cost centre. In most cases the rates are pre – determined . the overhead to be absorbed by a particular cost unit produced by that centre in the period. When a cost centre produces dissimilar units e.g. jobs to customer order, the volume of production must be expressed in a common measurement e.g., direct labour hours, machine hours etc. when a cost unit passes through several centres, the overhead absorbed should be separately for each centre. The overhead absorption rate is calculated as follows:

Bba Study Material to Cost Accounting Topic Wise Short Notes of, Overheads: Apportionment and Absorption, Topic is Methods of Overhead Absorption

Methods of Overhead Absorption

The important method used in absorption of overhead is discussed below:

Production Unit method

Under this method overhead absorption rate is calculated by dividing the overhead cost by number of units produced or expected to be produced as shown below:

For example, the budgeted overhead is Rs. 2,00,000 p.a. and the budgeted production is 50,000 unit p.a.

Advantages

  • Where the manufacturing methods are simple and the company makes only one product, this method can be used.
  • It is simple to understand and easy to apply.
  • This method is suitable if production consists or products that are more or less identical and which take approximately the same time to produce.

BBA STUDY MATERIAL TO COST ACCOUNTING  SHORT NOTES OF PERCENTAGE OF DIRECT MATERIAL COST METHOD

Percentage of Direct Material Cost Method 

Under this method overhead is absorbed based on the actual or predetermined absorption rate calculated by expressing the overhead cost as percentage of direct material for the same period. The absorption rate is calculated as follows:

For example, budgeted overhead is Rs. 1,000 and the budgeted direct material cost is Rs. 4,00,000, then overhead absorption rate is:

Advantages

  • This method is useful if materials are a major part of the cost of units made in the cost centre.
  • This method is simple to understand and easy to apply.

Disadvantages

  • The cost of material is often subject to considerable fluctuations which will not be accompanied by similar fluctuations in overhead.
  • Most of the overheads are attributable to time spent on the job or cost unit and this factor is completely ignored in this method. For example, cheap raw material may take longer time for process than expensive quality material. The unit with cheap raw material should absorb higher overhead cost than the unit processed with high quality raw material.

BBA STUDY MATERIAL TO COST ACCOUNTING  SHORT NOTES OF PERCENTAGE OF DIRECT LABOUR COST METHOD

Percentage of Direct Labour Cost Method

Under this method, overhead absorption rate is calculated by expressing the overhead expense to be absorbed as a percentage of cost of direct labour for the same period, as shown below:

For example , the budgeted overhead is Rs. 1,00,000 and the budgeted direct labour cost is Rs. 5,00,000. The absorption rate is calculated as shown below:

Advantages

  • This method is used where labour cost is an important part of total unit cost.
  • This method is fair in situation where more than one product is made, and each product requires different amounts of various grades of labour, which are paid at different rate.
  • It is simple to understand and easy to apply.
  • This method is better than percentage of direct material cost, since a labour rate fluctuates less frequently than the rate of materials.

Disadvantages

  • Ignores time taken for completion of the job or unit, as job performed by a skilled worker It takes lesser time than an unskilled worker.
  • It ignores the work performed by machine where the labour is a mere attendant.
  • If a job undertaken by a skilled worker may have a higher labour cost than one undertaken by an unskilled worker, but if the two jobs take equal amounts of time to complete, it might be unfair to change different amounts or overhead to them.

BBA STUDY MATERIAL TO COST ACCOUNTING  SHORT NOTES OF PERCENTAGE OF PRIME COST METHOD

Percentage of Prime Cost Method

This method is a combination of both direct material cost and direct labour cost method. The overhead absorption is calculated as follows:

For example, the budgeted overhead is Rs. 2,00,000 and the budgeted prime cost Rs. 8,00,000.

Disadvantages

  • This method suffers from the disadvantages of both the methods.
  • It gives equal weight age to both material and labour .
  • Where the cost of material is predominating item of prime cost, insufficient allowance is given for the time factor.


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