Overhead Expenses

Allocation of Overhead Expenses

[Submitted by Mr. Anshul Rastogi,
CA(Final) Student]

Overhead is expenses incurred for carrying out the production process and sale of finished goods. On the other hand overhead is an indirect cost i.e. cost does not directly attributable to any department. All overhead expenses must have identification for department or product except in cases where this is not possible. Various approach are used for allocate and apportionate overhead to the department.

There is little difference between allocation and apportionment of overhead. The dictionary meaning of allocation is ‘To Place’ and dictionary meaning of apportionment is ‘To Share’. According to ICMA Terminology “The allotment of whole item of cost to cost centers or cost unit is know as allocation.” The term apportionment is defined as allotment to two or more cost center or cost unit of a proportion of common item of cost on estimated basis of benefit received. The service department expenses have to be further apportioning to the department on some equitable basis depending up on the nature and extent of service rendered. The process of allocation or apportionment of overhead to the department is called as departmentalization of overhead. These department or product is called as cost center to which all cost is charged through allocation and apportionment.

In perspective of India two approach is famous to allocate and apportionate overhead viz. traditional approach and modern approach (Activity Based Costing).

I. Traditional Approach:
This approach is very famous approach to allocate and apportionate overhead up to 1950’s in India. In this approach indirect cost that directly identifiable to the department is allocate and expense incurred for various department jointly have to be apportionate over each department on proportionate basis. Proportion can be differing from expense to expense. For examples:

It is necessary to take best suitable proportion to apportionate overhead for ascertain cost. In this approach every customer pay equal amount for product irrespective of facility enjoyed.

II. Modern Approach (Activity Based Costing):

With the rapid advancement in industrialization with all its complexities a new approach is introduced to allocate and apportionate overhead named Activity Based Costing. Under this approach all indirect cost are traced to departments on the basis of activity carried for production. The great advantage of this approach is that customer who enjoyed more facility pay more and who enjoyed less facility pay fewer amounts.

In both approach profit of the company is same department-wise profit can be changed. Activity Based Costing (ABC Technique) is world wide acceptable costing technique. Big manufacturing concern can adopt ABC Technique because it evaluates correct performance of each department.

In the perspective of India small-scale industry can not adopt ABC Technique because it is very technical system and require a person who has technical knowledge of ABC Technique. This system is very expensive system because it require more cost records and cost books. Small-scale industry can adopt a new technique named Hybrid Technique easily. Under this approach some indirect expense who play relevant role in ascertainment of cost apportionate on the basis of activities and other expense apportionate on proportionate basis depending up on the nature of expense. Hybrid technique is less expensive, less technical and requires less costing records in compare to Activity Based Costing.

Illustration:

A small-scale industry manufactures three products A, B and C. Product A is manufacture in department X, product B is manufacture in department Y and product C is manufacture in department Z. there is two service department viz. canteen and maintenance. Information relating to direct cost to these departments is given below:

Information relating to indirect cost:

Product C requires cooling facility.

You are required to calculate cost of each product.

Solution:

Calculation of cost of products

Note:

  Indirect costs are apportionate as follows:

   Re-distribution of cost of service departments are as follows: