Budgeted production per quarter = 320,000/4 = 80,000 units
January - March (70,000 – 80,000) × Rs. 1.25(W3) Rs. (12,500) April - June (100,000 – 80,000)×Rs. 1.25 (W3) Rs. 25,000
Note : If overheads are underabsorbed, too little overhead is charged to product and
vice versa. The profit statement must be adjusted accordingly. The effect of the
adjustment is to make total production costs equal whether marginal costing or absorption costing is used.
Marginal costing Absorption costing
Rs. ’000 Rs.. ’000 Rs. ’000 Rs. ’000
Variable cost (1,155) (1,650) Production cost (1,242.5) (1,775.0) Fixed cost (100) (100) Under- over- absorbed (12.5) 25.0 (1,255) (1,750) (1,255.0) (1,750.0)
Question 6 :
(a) Explain the term “applied factory overheads”. What causes it to differ from “actual factory overheads” ? How will you account for the difference between “applied factory overheads” and “actual factory overheads” in costing ?
(b) Examine the different methods of accounting and controlling of administrative overheads8+8
Answer :
(a) Applied factory overheads :
This is the amount of factory overhead charged to the job or product. The total overhead of the production department is to be ultimately absorbed in the job or product on suitable bases or at predetermined rate so that each job or product gets a due share of such overhead as and when it passes through that department. The suitable bases of predetermined rates may be direct material cost percentage rate, direct wages percentage rate, machine hour rate, labour hour rate, etc.
When predetermined rate is used for absorption of overhead there is likely to be some difference between the amount of overhead absorbed and the amount of overhead actually incurred. This difference is termed as under- or over- absorption of overhead.
Over-absorption : Overhead absorbed > Actual Overhead incurred Under-absorption : Overhead absorbed < Actual overhead incurred.
Overheads
Causes of over-recovery :
1) When actual overhead incurred is less than budgeted overhead. 2) When the output or hours worked exceed the estimate.
Causes of under-recovery :
1) the total overhead incurred exceeds the estimated or budgeted overhead. 2) the output or hours worked are less than the estimate or budget.
Treatment of under or over-absorbed overhead :
a) to be transferred to an overhead reserve or suspense account for being carried forward to the next period’s account for absorption on the assumption that it may be counterbalanced next time.
b) to be written off to the costing profit and loss account.
c ) to be adjusted to work-in-progress, finished goods and cost of sales at supplementary rate.
(b) Administrative overhead is the cost incurred in formulating policies, planning and controlling the functions and motivating the personnel of an organisation towards attainment of its objectives. The cost is of general nature and is not directly related to the other functions namely production, sales, distribution, research and development. There are three methods of accounting for administrative overhead —
1) As a separate item of cost – In this method administration costs are treated as separate functional costs and charged to the products completed and sold in the period. The bases normally used for this purpose are cost of goods sold, sales, number of units sold, or gross profit on sales. The rate of absorption is determined by dividing the total administration costs by the base. The rate is applied to the products sold during the period to determine the administration cost chargeable to them.
2) Apportionment between production, selling and distribution functions: Under this method administrative overhead is divided between production and selling and distribution divisions on some suitable bases. When administration costs are apportioned to the production function these are included in the factory overhead and charged to all the cost centres on appropriate bases which are ultimately absorbed in the products completed or in the progress. Administration costs apportioned to the selling and distribution functions are transferred to the Selling and Distribution Overhead Account. The amount so transferred is treated in the same way as other items of selling and distribution expenses are treated in accounts.
3) Transfer to Profit and Loss Account: According to this method whole of this administration expenses are treated as period or fixed costs and written off to Costing Profit & Loss Account. The idea behind the method is that the amount of this type of cost is very small in relation to others and that these expenses have no direct bearing with production or sales.
Department Overheads apportioned/ Estimated level
allocated of activity
Control of Administration Overhead :
For exercising proper control any of the following methods may be adopted — i) By means of classification and analysis of overheads: Expenses incurred against
each class under a Cost Account Number should be collected for each of the administrative departments. Corresponding data for the past period should also be collected. Different levels of activities and the corresponding costs for the previous period should be compared with the present figures. The absorption rates should also be compared from period to period. The cost of any service department should be compared with the cost of similar service available from outside.
ii) By means of introducing budgetary control: In this method control is made through comparing present data with the past data. Control may be initiated with the introduction of budgets. In this method budgets of overhead for individual sections should be prepared and actual expenses should be compared with the budgets, the difference should be calculated and analysed. The people in charge of respective departments should report to the higher authority showing the causes of variances.
iii) Control through standards: Under this method suitable standards for each types of expenses are fixed and actual administration expenses are measured in terms of such standards. The performance of individual sections in terms of standards speak of efficiency of the respective departments.
Question 7 :
(a) A factory has three production departments (P1, P2 and P3) and two service departments (S1 and S2). Budgeted overheads for the next year have been allocated/apportioned by
the cost department among the five departments. The secondary distribution of service department overheads is pending and the following details are given to you :
P1 Rs. 48,000 5,000 labour hours P2 Rs. 1,12,000 12,000 machine hours P3 Rs. 52,000 6,000 labour hours Apportionment of service department costs S1 Rs. 16,000 P1 (20%), P2(40%), P3(20%), S2(20%) S2 Rs. 24,000 P1(10%), P2(60%), P3(20%), S1(10%)
Calculate the overhead rate of each production department after completing the distribution of service department costs.
Production Departments P 1 P 2 P3
Rs. Rs. Rs.
Direct allocation 48,000 1,12,000 52,000
Apportionment of overhead cost of S1 (20%) 3,755 (40%) 7,510 (20%) 3,755 Apportionment of overhead cost of S2 (10%) 2,776 (60%) 16,653 (20%) 5,551
Overheads
(b) State six sources from which overhead expenses may be collected. (c) Distinguish between standing order numbers and cost account numbers. Answer :
(a) Let X1 be the total overhead costs of S1 and X2 that of S2. Then we get the simultaneous equations:
X1 = 16,000 + 0.1 X2 X2 = 24,000 + 0.2 X1
Solving these equations we get :
X1 = 18,775 X2 = 27,755.
The allocation/apportionment of overheads to the three production departments would be as follows :
Total : 54,531 1,36,163 61,306
Budgeted capacity 5,000 12,000 6,000
labour hrs. machine hrs. labour hrs.
Overhead cost per hour
Rs. 10.91 Rs. 11.35 Rs. 10.22
(b) Six sources from which overhead expenses are collected are as follows : i) Stores requisition
ii) Invoices iii) Cash Book
iv) Wages analysis sheet v) Other registers and reports vi) Journal.
Stores requisition is used for indirect materials issued from stores : The total of stores drawn are debited to production Overhead Control Account and credited to Stores Ledger Control Account.
Invoices received for stores received or services rendered are entered in the Purchase Journal maintained for the purpose of cost collection.
Cash Book should be scrutinised and payment for indirect expenses should be properly collected against standing order number and for each department.
Wages analysis sheet is used for indirect wages payable for each standing order number and for each department.
Other registers and reports are for the items which do not result in cash outlay e.g. depreciation (Plant Register) scrap, waste, idle facilities etc. (relevant reports/records). Journal entries – accrual for unpaid salaries, rent or wages, notional charges for rent or interest etc. are all collected from journal entries.
(c) Standing Order Numbers and Cost Account Numbers :
For systematising the control of overhead and to ensure proper grouping of like items it is necessary to derive a system of accounting headings suitably coded. The headings should be selected in such a way that they should be clear and should not be confused with one another.
It should be clearly remembered that Standing Order Numbers are conventionally applied to factory expenses headings.
Cost Account Numbers are customarily applied to administrative and distribution expense headings. Letters, symbols or decimal arrangement or mixture of the two may be used for the coding purpose.
Question 8 :
Atlas Engineering Ltd. accepts a variety of jobs which require both manual and machine operations. The budgeted Profit and Loss Account for the period 1996-97 is as follows :
(In lakhs of rupees) Sales 75 Cost : Direct materials 10 Direct labour 5 Prime Cost 15 Production Overhead 30 Production Cost 45
Administrative, Selling and Distrn. Ovd. 15 60 Profit 15 Other budgeted data :
Labour hours for, the period 2,500 Machine hours for the period 1,500 No. of jobs for the period 300
An enquiry has been received recently from a customer and the production department has prepared the following estimate of the prime cost required for the job :
Direct material Rs. 2,500
Direct labour 2,000 Prime Cost 4,500 Labour hours required = 80
Rs. 10,000
Overheads
You are required to :–
(a) Calculate by different methods, six overhead absorption rates for absorption of production overhead and comment on the suitability of each.
(b) Calculate the production overhead cost of the order based on each of the above rates. (c) Give your recommendation to the company. 9+3+4
Answer :
(a) ATLAS ENGINEERING LTD.
Statement showing computation of overhead absorption rates for absorption of production on overhead under different methods.
Sl. No. Absorption rates (Rs. in lakhs) Overhead
absorption rate.
A
1. Direct Labour Hour :
LH Rs. 120
2. Machine Hour Rate : Rs. 200 3. Percentage of direct material cost :
A RAs. 30 Rs. 30 × 100 10 Rs. 30 300 % 4. Percentage of direct wages cost :
A
× 100 × 100 DL MD1235MH0000 5
Rs. 30
× 100 600 %
5. Percentage of Prime Cost : × 100
PP Rs. 15 × 100 200%
A
6. Production Unit (JOB) :
J Note :
Production overhead to be absorbed = A Labour hours required for production = LH Number of machine hour for the period = MH Direct material cost incurred = DM Direct labour cost incurred = DL Prime cost of production = PP No. of jobs for the period = J
(b) Statement showing the production overhead cost of the order (for the job) under different methods.
Methods Production overhead cost for the job (Rs.)
1. Direct Labour hour rate 80 Hrs.×120 9600 2. Machine hour rate 50 Hrs.×200 10000 3. Percentage of direct material cost 300% of Rs. 2500 7500 4. Percentage of Direct Labour Cost 600% of Rs. 2000 12000 5. Percentage of Prime cost 200% of Rs. 4500 9000 6. Production Unit/Job 1 × Rs. 10000 10000
Comments :
(a) For labour hour rate and Machine hour rate, the rates are based on time and hence generally considered equitable as most overheads vary with time. (b) In case of percentage of Direct material Cost, it may be suitable only if all the
jobs use the same materials and labour, and machine time does not significantly. (c) If wage rates vary, percentage of direct wages cost may cause distortion. (d) Percentage of prime cost is simple but has the disadvantages of percentage of
Direct Material Cost and percentage of Direct Labour Cost.
(e) In case of production unit (job) method, it is very simple and acceptable if all the jobs are same. If they are different, this method is not appropriate for charging overhead.
(c) Recommendation to the Company. Separate overhead rates based on Labour hours and Machine hours for absorption of labour related overhead and Machine related overheads respectively, is the ideal solution. However, if the degree of mechanisation is very high in the factory, the Management wants a single rate for simplicity, the machine hour rate may be used for absorption of production overheads.