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

Bba Study Material to Cost Accounting Topic Wise Short Notes of, Overheads: Apportionment and Absorption, Topic is Treatment of Special Items of Overheads in Cost Accounts

Treatment of Special Items of Overheads in Cost Accounts

Material Handling Expenses

These expenses are incurred while unloading the raw materials received from supplier, storing the raw materials, handling the raw materials to work place, handling of work – in – progress, storage of finished goods etc. it also includes costs incurred for weighing salaries of personnel involved in material handling,  wear and tear of weighting equipment. These costs are apportioned on the basis of physical quantities of different materials and goods handled in the factory. The stores overhead costs are apportioned to raw materials and finished goods as a percentage of issue rates. Other handling expenses are recovered through overhead recovery rates.

Market Research Expenses

Market research cost is an item of selling overhead, incurred for market intelligence to ascertain the tastes and habits, market penetration of product, increase in demand of existing products, competitive situation, trading practices, distribution channels, customers requirements, existing and potential market for the product etc. if the market research expenses are incurred for a single product it is absorbed into that particular product cost. If it is incurred for the product range for the enterprise as a whole, then the market research expenses are to be apportioned to different products in the proportion of sales value and absorbed into respective product cost. If the market research cost is substantial, it will be treated as deferred revenue expense and is taken into future period and absorbed  when sales or production takes place. Sometimes market research expenses are uncured for raw material availability, such expenses will be allocated or apportioned to purchase department and it is recovered through overhead rate of purchase department.

Subscriptions and Donations

The treatment suggested for subscriptions and donation in cost accounts as follows:

  • If these expenses are incurred for the benefit of or welfare of workers, it is treated as production overhead.
  • If subscription and donations for any technical and research institutions for obtaining data relating to technical, production or scientific nature, it is considered as production overhead. If subscriptions to journals etc. for obtaining market data which help in increase of sales, it is considered as selling overhead.
  • If the subscriptions and donations not incurred for the benefit of employees or the organisation, it should be excluded from the cost accounts.

After Sales Service Costs

The cost s are incurred for providing service to the customers after the sales took place during the warranty period. If the costs are incurred during the period of guarantee given to the customer, it is to be borne by the company, and hence it is treated as production overhead absorbed into product cost by applying predetermined absorption rates. If the after sales services costs are incurred after the guarantee period for which the organisation will charge for the services rendered, then such costs are treated as selling overhead.

Royalties and Patent Fees

The royalties and patent fees are payable for the use of technology, skill, brand, intellectual property rights etc. made in the form of periodical rent or based on the number of units produced or sold. If it is based on sales, the expenditure is charged to selling overhead. If it is a fixed periodical rent, it is treated as production overhead. Of it is payable on number of units produced, the expenditure is treated as a direct expense or chargeable expenses and is forming part of the cost of the product.

Training costs

The training costs are incurred for training the workers, apprentices, office, administrative and selling staff. The training expenditure incurred for training the workers, apprentices and other production staff is treated as production overhead. If it is incurred for training the office and administrative staff, it is considered as administration overhead. The expenses incurred for training the sales staff is treated as selling overhead. If there is any in house training college or centre is giving training , cost of running the centre or college is apportioned to the cost centres based on the number of personnel trained or on the basis of wages and salaries paid etc.

Taxation

Taxation is an appropriation of profit earned by the organisation and any payment of taxes is excluded from the cost accounts. But the taxes will also be considered for planning and decision making exercise wherever it is necessary and appropriate for special purposes.

Financing Charges for Acquisition of fixed Assets and Inventories

The finance charges like interest on working capital facilities from banks, interest on term loan for acquisition of fixed assets, interest on debentures etc. is payable by the company. Where financing charges are payable to outsiders on borrowing for acquisition of fixed assets, these charges are included in cost of fixed assets. If the financing charges are payable for financing working capital, then these charges are included in cost of inventories. Interest on capital provided by the owners is excluded from cost accounts except for comparing or evaluating profitability of alternative investments. If the charges are payable for storing the materials like timber, wine etc. the charges are included in the cost of material stored.

Major Repairs to Equipment to Prolong its Useful Life

The major repairs, if it useful life of an asset, the cost incurred on it is to be added to the existing value of assets and periodical depreciation is charged on the overall cost of the asset. If the repair charges are incurred for upkeep and maintenance of the machinery and if it does not prolong the life of the asset, these expenses are treated as production overhead and is charged to the respective cost centre as repairs and maintenance and recovered from the current period production. If the amount incurred is substantial, it is treated as deferred revenue expenditure carried forward to the subsequent accounting periods for write off.

Cost of Tools                                    

Tools are classified into (a) large tools, and

(b) Small tools

The cost of large tools is capitalized like any other machine and depreciation is provided on it each accounting period over its useful economic life. The costs of small tools are treated in any of the following three methods in cost accounts:

  • Capitalisation Method – Under this method the cost of small stools is capitalised and depreciation is recovered as production overhead. If the life of small tools is relatively small, this method is not suitable.
  • Revaluation Method – Under this method, the small tools are revalued at the end of each accounting year and the difference between original cost and the revalued cost is charged as production overhead.
  • Write off Method – under this method, the cost centre drawing such tools is debited with the value thereof. Alternatively, the total cost of tools is accumulated and apportioned to various cost centres on suitable basis.

Bad Debts

When the company allow credit to its customers as part of its selling policy, some credit sales may turned bad due to default by the customers intentionally or otherwise. As a safeguard ,a part of such default amount is treated as bad debt is recovered as recovered as selling overhead and absorbed into product cost. If the bad debt is abnormal in nature, the abnormal portion in excess of the standard normal portion should be excluded from cost accounts and transferred to costing profit and loss account.

Notional Rent

Notional rent is a cost included in the cost accounts so as to represent a benefit enjoyed by the organisation even though no actual cost is incurred for rent. The company owns premises does not pay rent, but it is considered as notional charge in the cost accounts for comparability of cost with different accounting periods and with other organisations. This would reflect the accurate cost of cost centre or cost unit. It is a reasonable or nominal charge included in the cost accounts for the owned premises as if it is a rented premises.

Packing Expenses

The packing is classified into (a) primary packing, and (b) secondary packing.

The ‘primary packing’ is done when the material is packed in tins, bottles, jars, etc., without which a product cannot be sold. For example, jam is packed in bottles, baby food packed in tins, beverages in bottles etc. the costs incurred on primary packing material is treated as part of direct material cost. If the packing is made to facilitate the transportation and distribution of the finished product, it called ‘secondary packing’ and the cost incurred for this is treated as distribution overhead. Sometimes, cost is incurred on packing the product to make it more attractive to the customers to increase sales. This cost is treated as advertisement cost and is included in selling overhead.

Data Processing Cost

In the environment of processing information with the help of computers, the data processing cost represents the cost incurred for processing data relating to accounts, secretarial, personnel, finance, marketing, sales etc. this  may be done either utilizing in house facilities or hiring outside facilities. The cost incurred is accumulated for separate service centre if in house facilities are made available. Where the costs of data processing centre or hiring charges are identifiable to a particular department or activity it should be charged with its portion of cost. In case of common costs incurred for service of all departments, the data processing cost should be apportioned to different departments on equitable basis.

Stores Overhead

The stores department in an organisation performs the function like receipt of material and stores items purchased, storing and issue of materials and stores items to different departments. The stores is considered as a separate cost centre and the stores expenditure like rent of stores, salaries and wages of stores personnel, freight, carriage inwards, insurance etc. are collected separately for the stores and will be apportioned to other cost centres. The following bases are used in apportionment of stores overhead:

  • Number of stores requisitions
  • Value of material requisitioned
  • Standard predetermined stores overhead absorption rate.

Erection and Dismantling of Plant and Machinery

The cost s incurred on erection and dismantling of plant and machinery are treated in cost account as follows:

  • The costs incurred on erection of plant and machinery is capitalised and treated forming part of capital cost and depreciation is recovered on the total cost.
  • If the plant and machinery is required to be shifted to different locations, the costs incurred in layout and shifting is treated as production overhead. When such costs are substantial, it may spread over a period of time as deferred revenue expenditure.
  • It the asset is replaced, before its useful economic life, with a new machine, the written down value of the asset less the scrap value plus the cost on dismantling is treated as capital loss and charged to profit and loss account. However, the erection cost of new machine is capitalised.
  • If expenses of dismantling and re – erection are incurred due to faulty planning or due to abnormal factors, then such expenses are charged to costing profit and loss account.

Transport Cost

The classification of transport costs and their treatment in cost accounts is given below:

  • The costs incurred for bring the materials to the production site is included in cost of materials.
  • The costs incurred for bringing the plant and machinery, equipment etc. is added to the capital cost of respective asset and depreciation is recovered.
  • The cost of dispatch of finished goods is treated as distribution overhead.
  • The costs incurred for internal movements within work are initially charged to specific cost centres and thereafter apportioned to different production and service centres on the basis of services rendered.

Insurance Cost

The treatment of insurance cost is categorised into the following:

  • Insurance premium on storage – cum – erection and commissioning is capitalised to the asset value.
  • Premium on transit of materials is included in cost of materials.
  • Premium on transit of finished products is treated as distribution overhead.
  • Premium on fire and breakdown of machinery policy is treated as production overhead.
  • Premium on loss of profit policy due to fire and breakdown of machinery is treated as production overhead.
  • Premium on miscellaneous policies like vehicles, burglary, accident etc. are treated as administration overhead.
  • Premium on raw materials and stores is treated as production overhead.
  • Premium on warehouse and finished stock is treated as distribution overhead.

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

Summary

  • Overhead include indirect material, indirect labour, indirect expenses which cannot be conveniently identified or allocated to any specific job, process.
  • Direct expenses are also called as ‘chargeable expenses’ which are specifically incurred and charged for a specific job, process, unit, centre etc. the direct expenses forming part of prime cost.
  • Classification of costs is the process of arranging the item if costs into groups according to their degree of similarity, based on the nature of expense or purpose to be fulfilled.
  • The element wise classification of overhead includes indirect material, indirect labour indirect expenses.
  • The indirect costs cannot be allocated but which can be apportioned to costs centres or cost units.
  • The functional classification of overheads includes production overhead and all other administration, marketing, distribution, research and development costs.
  • Collection of overheads is the process of recording each item of cost in the records maintained for the purpose of ascertainment of cost each cost centre or cost unit. The documents used for this purpose include stores requisitions, wage sheets, cash book, purchase orders, sales invoice , journal entries, plant registers etc.
  • For cost collection, allocation and absorption of costs, and for ascertainment of costs total organisation is divided into number of department or centres called ‘departmentalisation’.
  • Allocation of overheads is the process by which cost items are charged direct to a cost unit or cost centre where the cost is directly attributable to it.
  • Apportionment of overhead is the process of allotment of cost item to more than one cost centre in proportions of estimated basis of benefits received.
  • Where the service departments exist, which render support to the production department, primarily the overhead costs are ascertained for all the centres and reapportion the service departments costs again to the production departments, basing on the service rendered to production departments.
  • In the secondary distribution, of service departments overheads to production departments, the methods commonly used are direct method, step down method, repeated distribution method, simultaneous equations method.
  • Absorption is the process of charging overheads to the individual products or jobs by applying overhead absorption rates.
  • Some of the important overhead absorption methods are like production units, percentage of direct material cost , percentage of direct labour cost , percentage of prime cost, direct labour hour rate, machine hour rate etc.
  • A common absorption rate used throughout a factory and for all jobs and units of output irrespective of the department in which they are produced is called ‘blanket absorption rate’.
  • An absorption rate is determined and used even prior to the actual cost is known or computed, based on the budgeted figures for the forthcoming accounting period , such overhead rates are called ‘predetermined absorption rates’.
  • If the overheads absorbed are higher than the actual overheads incurred during the accounting period it is called ‘over absorption’.
  • If overheads absorbed are lower than the actual overheads incurred during the accounting period, it is called ‘under absorption’.
  • The under or over absorbed overheads are disposed off by using any of the three methods viz, application of supplementary rates, write off to costing profit and loss account , carry forward to subsequent year.
  • Idle capacity is the difference between the practical capacity and capacity utilised.
  • Idle capacity costs generally related to depreciation, repairs and maintenance, insurance ,rent , management and supervisory costs.
  • Interest on capital is the imputed cost of funds employed in the manufacturing process. For managerial decision making, inclusion of interest on capital is suggested.
  • For ascertainment of true profitability and cost of products, inclusion of financing charges is necessary.
  • Depreciation is a gradual diminution, loss or shrinkage in the utility of value of an asset due to wear and tear in use , effluxion of time or obsolescence.
  • Depreciation is provided in cost accounts before working out the profitability of a job or cost unit.

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