4. Overheads & Expenses

Question 1

Overheads are ?

Answer 1

Indirect materials
Indirect labour
Indirect expenses
= Total indirect costs (or ‘Overheads)

Question 2

Prime cost is ?

Answer 2

Direct materials
Direct Labour
Direct expenses

= Total direct costs (or ‘Prime cost’)

Question 3

What to note about direct costs?

Answer 3

They can be identified directly with each unit of output.

In contrast to indirect costs which are “period” costs which cannot be identified directly with each unit of output

Question 4

What to note about overheads

Answer 4

Overheads do not relate to particular units of output but must instead be shared amongst all the cost units (units of output to which cost can be charged) to which they relate.

Question 5

In larger businesses overheads are usually …

Answer 5

Classed by function eg..

Factory or production.
Selling and distribution
Administration
Finance

Each function is likely to be a cost centre

Question 6

Define a cost centre

Answer 6

Segments of a business or organisation to which costs can be charged.

Question 7

Name some responsibility centres

Answer 7

Profit centres
Revenue centres
Investment centres
Cost centres

Question 8

What do we need to know about a business to deal with overheads

Answer 8

We need to know the responsibility centres of the organisation.

Question 9

Costs can be either allocated to a cost (or profit?) centre or apportioned …. what is the difference ?

Answer 9

Allocated if whole cost was incurred by / belongs to one centre.
Apportioned if cost incurred should be shared.

Remember both allocation and apportionment should be reviewed at regular intervals .

Question 10

There are 2 methods of charging overheads of service departments to production cost centres … ‘ Re-Apportionment ‘

Answer 10

Direct apportionment - when service departments provide services to production centres only.

Step down method - where service departments provide services to production departments and other service departments.

(Do the apportionment in steps … deal with any service dept that costs go to another service dept first…. then apportion the new amount to the production departments)

Question 11

In the language of cost accounting what is Absorption (or Recovery)

Answer 11

After allocation or apportionment of overheads to profit centres or production cost centres, this is the final step..

Ie the cost of the overhead is charged to the cost units which pass through that particular production department.

Question 12

Steps to absorb (or recover) the overheads…

Answer 12

1. Calculate the ‘Overhead Absorption Rate’ - OAR.

2. Application of this rate to actual work done.

Question 13

OAR = ?

Answer 13

Overhead absorption rate.

OAR = total budgeted CC overheads
______________________________
total planned work in CC

Amount of work would be eg. Direct labour hours or machine hours.

Question 14

Methods of overhead absorption or recovery:

Direct labour HOUR method…

Answer 14

Commonly used where production is labour intensive.

Cost per direct labour hour (OAR) = £ Total CC Overheads
____________________________
Total Direct Labour HRs in CC

Question 15

Methods of overhead absorption (or recovery)

Machine Hour Method…

Answer 15

Commonly used where production is machine intensive.

Cost per direct labour hour (OAR) = £ Total CC Overheads
____________________________
Total Machine HRs in CC

Question 16

Methods of overhead absorption or recovery

Direct labour percentage…

Answer 16

Basically same as Direct labour hour method but using labour cost instead of labour hours

OAR = £ total CC overheads
____________________________
£ expected labour cost (NB: £s instead of hours)

Comes out as a fraction but can multiply by 100 to get a %

Question 17

Other methods of overhead absorption (service sector) ?

Answer 17

Accountants and solicitors - chargeable hours.

Bus or taxi company - miles travelled.

Question 18

What to remember about absorption methods…

Answer 18

…they need reviewed and any changes to method agreed with senior management and discussed/communicated to personnel such as managers

Question 19

OAR

Most businesses caudate a pre-determined OAR for each dept.

It’s done in advance using estimates . Avoids having to calculate the rate regularly . Instead the rate is smoothed out over fluctuations over a longer accounting period.

Answer 19

. Needs appropriate consultation with personnel from the operating departments before a rate is established for a particular department.

Question 20

Over/under absorption (recovery) of overheads…

Answer 20

At EOY the SPL is credited or debited with the over or under absorbed amount.

Under absorption is a cost … so reduces profit…

Selling price maybe too low.
Production maybe less than expected.
Overheads might be higher than budgeted.

Question 21

Overhead ‘under-absorption’ is the same as ‘under-recovery’

Answer 21

Overhead ‘over-absorption’ is the same as ‘over-recovery’

Question 22

When bookkeeping for production overheads just think like inventory to get it right.
Cr Bank | Dr Production OHs (Buy OHs)
Cr Production OHs | Dr Production (Charge OHs to cost units via OAR)
Dr or Cr Production OHs | Dr or Cr PandL (Transfer over/under recovered)

Answer 22

.