OVERHEADS

OVERHEADSThe total cost of indirect materials, indirect labor and indirect expenses are called overheads. i.e Depreciation, Printing & Stationery , Factory exp. etc.Classification of OverheadsNature/Trace on productActivity or VolumeDirect OverheadIndirect OverheadFixed Variable Semi-Variable Direct Overhead :-Direct Overhead are the costs which are identifiable with the product unit or cost center. i.e Cost of wood for Furniture, Cost of Cloth for Shirt, Cost of Plastics R/M for Container.Indirect Overhead:- Indirect Overhead are not identifiable with the product unit or cost center and hence they are to be allocated, apportioned and then absorb in the production units.i.e. Salary of Management , Guard Sweeper Wages etc.Fixed Overhead :- In Fixed Overhead the total amount remain same (does not change even if production volume change)while per unit fixed cost is always variable. Examples of these costs are salaries, insurance, rent, etc.Variable Overhead :- Those Overhead that vary directly or proportionately with the output i.e D/M Cost, D/L Cost. Variable cost per unit is constant but the total is changes correspondingly level of output. Semi-Variable Overhead :- These Overhead are neither totally fixed nor totally variable. Maintenance costs, supervisory costs etc. These costs are also called as stepped costs.2Absorption of Overheads:- The process of absorbing all overhead costs allocated or apportioned over a particular cost center or production department by the units produced are called absorbing.Overhead Absorption Rate = Overhead Expenses/ Units of the base selected.Methods used for absorptionDirect Material Cost :- Budgeted or Actual Overhead Cost/ Percentage (%)of Direct Material Cost Direct Labor Cost Method :- Budgeted or Actual Overheads/ Percentage (%)of Direct Labor Cost Prime Cost Method :- Budgeted or Actual Overheads/ Percentage (%) of Prime Cost Production Unit Method :- Overhead absorption rate = Budgeted or Actual Overheads/Production UnitsDirect Labor Hour Method :- Budgeted or Actual Overhead Expenses/Direct Labor HoursMachine Hour RateMachine hour rate is the cost of operating a machine on per hour basis. The formula for calculating the machine hour rate is :-Budgeted or Actual Overhead Expenses/ Machine Hours

By CA JITENDRA MAHASETHCIPET HAJIPURIllustration :- A firm produces two products, A and B. Direct material costs for A are Rs. 2,50,000 and for B, Rs. 1,50,000. The overheads will be charged to these products as shown in the following statement, assuming the rate of absorption as 50% as shown above.Ans:-Particulars Product A Product BDirect Materials 2,50,000 1,50,000Overheads 50% of 1,25,000 75,000Direct Materials Total Overheads = 3,75,000 2,25,000Illustration :- A manufacturing firm produces two products, A and B. The direct material cost for A is Rs. 5,00,000 and for B Rs. 3,00,000, direct labor cost is Rs. 3,00,000 and Rs. 2,00,000 respectively for A and B, direct expenses are Rs. 1,00,000 and Rs. 2,00,000 respectively for A and B. The overhead expenses are Rs. 9,60,000. The statement of cost will appear as follows.

Ans:-Particulars Product A Product B TotalDirect Materials 5,00,000 3,00,000 8,00,000Direct Labor 3,00,000 2,00,000 5,00,000Direct Expenses 1,00,000 2,00,000 3,00,000Prime Cost 9,00,000 7,00,000 16,00,000Overheads 60% of Prime Cost 5,40,000 4,20,000 9,60,000Works Cost 14,40,000 11,20,000 25,60,000Note :- Overhead absorption rate is calculated as = 9,60,000/16,00,000 * 100 = 60%

The production department of a factory furnishes the following information for the month of March,2007.Materials used Rs. 54,000 Direct Wages Rs. 45,000 Overheads Rs. 36,000 Labor hours worked - 36,000 Hours of machine operation - 30,000 For an order executed by the department during the period, the relevant information was as under. Materials used Rs. 6,00,000 Direct Wages Rs. 3,20,000 Labor hours worked - 3,200 Machine hours worked - 2,400 Calculate the overhead charges chargeable to the job by the following methods, i. Direct materials cost percentage rate ii. Labor hour rate and iii. Machine hour rate.Solution :-i. Direct Material cost percentage rate :-Direct materials *100 / Overhead= (Rs. 36,000/Rs. 54,000) x 100 = 66.67%Materials used on the order Rs. 6,00,000, so overheads will be @66.67% = Rs. 4,00,000

ii. Labor Hour Rate :- Overheads/ Direct Labor Hours = 36,000/36,000 = Re.1Overheads will be @ Re. 1 = 3200 hrs * 1 = Rs. 3,200

iii. Machine Hour Rate :- Overhead/ Machine Hours = Rs. 36,000/30,000 = Rs. 1.2Overheads will be Rs.1.2 per hour *2,400 hours = Rs. 2,880

A machine was purchased on 1st January, 2007 for Rs. 5 lakhs. The total cost of all machinery inclusive of the new machine was Rs. 75 lakhs. The following further particulars were available. Expected life of the machine 10 years Scrap value at the end of the life Rs. 5,000 Repairs and maintenance for the machine during the year Rs. 2,000Expected number of working hours of the machine per year 4,000 Insurance premium annually for all machines Rs. 4,00 Power consumption for the machine per hour @ Rs. 5 @ per unit = 25 units Area occupied by the machine 100 sq feet Area occupied by other machines 1,500 sq. feet Rent per month of the department Rs. 800 Lighting charges for 20 points for the whole department out of which three points are for the new machine Rs.120 per month Compute the machine hour rate for the machine.Solution :-Computation of Machine Hour RateParticulars Rs. Per annum Rs. per hourStanding Charges Insurance Rs. 4,500 _ 5 lacs/ 75 lacs300Repairs and Maintenance 2,000Rent Rs. 800 per month _ 12 months_ 5 lacs/ 75 lacs640Lighting Charges Rs. 120 per month _12 months = Rs. 1,440 _ 3/20216Total Standing Charges 3,156 3,156/4,000 hours= 0.789Machine ExpensesDepreciation 5,00,000 5,000/10=49,500/4,000 hours12.375Electricity Consumption25 units per hour @ Rs. 5 per unit75Machine hour rate 88.16Note :- The total cost of the machinery in the workshop is Rs. 75 lacs out of which the cost of thismachine is Rs. 5 lacs and hence proportionate amount has been calculated in respect of expenses likeinsurance and rent.