ABSORPTION OF OVERHEAD

   ABSORPTION OF OVERHEAD
COST ACCOUNTING
MEANING OF ABSORPTION OF OVERHEAD

1.       ABSORPTION OF OVERHEADS IN SIMPLE WORDS MEANS RECOVERY OF OVERHEAD COSTS FROM THE COST OF PRODUCTION.

2.       ABSORPTION MEANS THE DISTRIBUTION OF THE OVERHEAD EXPENSES ALLOTTED TO PARTICULAR DEPARTMENT OVER THE UNITS PRODUCED IN THAT DEPARTMENT.

3.       PRIMARY DISTRIBUTION OF OVERHEAD ALLOCATED AND APPORTIONMENT THE OVERHEAD COSTS TO THE PRODUCING DEPARTMENTS AND SERVICE DEPARTMENTS

4.       SECONDARY DISTRIBUTION OF OVERHEAD REAPPORTIONS THE SERVICE COST TO THE PRODUCING DEPARTMENT. NECESSARY TO KNOW THE TOTAL COST OF EACH UNIT.

·         PROCESS OF DISTRIBUTION OF COSTS

   D

   DEFINITION OF ABSORPTION

   C.I.M.A LONDON,” ABSORPTION OF OVERHEAD IS THE PROCESS OF ABSORBING ALL OVERHEAD COSTS ALLOCATED OR APPORTIONED OVER PARTICULAR COST CENTRE OR PRODUCTION DEPARTMENT BY THE UNITS PRODUCED.

   COST ABSORPTION IS THE PROCESS OF ABSORBING ALL INDIRECT COSTS OR OVERHEAD COSTS ALLOCATED OR APPORTIONED OVER PARTICULAR COST CENTER OR PRODUCTION DEPARTMENT BY TH UNITS PRODUCED.

   ABSORPTION IS ALSO REFERRED TO AS LEVY,RECOVERY OR APPLICATION OF OVERHEAD.

   STEPS IN ABSORPTION OF OVERHEAD

·         COMPUTING OVERHEAD RATES:_SOME SUITABLE BASE MUST BE DETERMINED FOR THE DETERMINATION OF OVERHEAD RATE. OVERHEAD RATE IS CALCULATED OVERHEAD EXPENSES DIVIDED BY TOTAL NUMBER OF UNITS OF THE BASE

·         OVERHEAD RATE=OVERHEAD EXPENSES/TOTAL QUANTUM OF BASE( QUANTITY OR VALUE)

·         FOR EXAMPLE : THE TOTAL OVERHEAD OF A COST CENTER IS 1,80,000 PER MONTH. THE NUMBER OF LABOUR HOURS WORKED IN THE DEPARTMENT FOR THE SAME PERIOD IS 30,000 HRS

·         SO OVERHEAD RATE IS=1,80,000/30,000=RS 6 PER LABOUR HOUR

·         APPLYING OVERHEAD RATES TO COST UNITS:-THE OVERHEAD RATE IS MULTIPLIED WITH UNITS OF THE BASE CONTAINED IN EACH INDIVIDUAL PRODUCT,JOB OR PROCESS

   LIKE FOR PRODUCING A UNIT 10 LABOUR HOURS ARE REQUIRED THEN 6x10= RS 60

   OVERHEAD ABSORPTION RATES

   DETERMINATION OF OVERHEAD RATE FOR THE ABSORPTION OF OVERHEAD IN COSTS OF JOBS,PROCESS OR PRODUCT

   OVERHEAD RATE IS CALCULATED BY DIVIDING THE AMOUNT OF OVERHEAD EXPENSES BY THE TOTAL NUMBER OF UNITS OF THE BASE SELECTED AS UNITS OF PRODUCT,DIRECT LABOR HOURS,MACHINE HOURS ETC

   OVERHEAD RATE=OVERHEAD EXPENSES/TOTAL QUANTUM OF BASE( QUANTITY OR VALUE)

   OVERHEAD ABSORBED IN PRODUCT= OVERHEAD RATE X UNITS OF THE BASE CONTAINED IN THE PRODUCT

   MAIN OVERHEAD RATES

1. ACTUAL OVERHEAD RATE= ACTUAL EXPENDITURE DURING THE MONTH/ACTUAL QUANTITY OR VALUE OF THE BASE . NOT DESIRABLE TO ADOPT ACTUAL RATE IN PRACTICE DUE TO
1. DETERMINATION IS POSSIBLE WHEN THE ACCOUNTING PERIOD IS OVER
2. ACTUAL RATE IS LIABLE TO FLUCTUATE AND THIS MAKE THE COMPARISON DIFFICULT FROM PERIOD TO PERIOD
3. USEFUL ONLY WHEN COMPARED WITH THE ESTABLISHED NORMS
2. PREDETERMINED OVERHEAD RATE:-OVERHEAD RATE(PREDETERMINED)=BUDGETED OVERHEAD EXPENSES FOR THE PERIOD/BUDGETED BASE OF THE PERIOD
3. BLANKET OR SINGLE OVERHEAD RATE=OVERHEAD COSTS FOR THE ENTIRE FACTORY/TOTAL QUANTUM OF THE BASE.HERE SINGLE RATE IS CALCULATED FOR THE FACTORY AS WHOLE. APPLIED IN SMALL CONCERN WHERE ONLY ONE PRODUCT IS MANUFACTURES

4. MULTIPLE OVERHEAD RATE= COMPUTATION OF DIFFERENT RATES FOR EACH PRODUCING DEPARTMENT,SERVICE DEPARTMENT,COST CENTER,EACH PRODUCT OR PRODUCT LINE,EACH PRODUCT FACTOR AND FOR FIXED OVERHEADS AND VARIABLE OVERHEADS.
5. OVERHEAD RATE= OVERHEAD COST ALLOCATED AND APPORTIONED TO EACH COST CENTER/DEPARTMENT/CORRESPONDING BASE
6. NORMAL OVERHEAD RATE= NORMAL OVERHEAD/BASE AT NORMAL CAPACITY
7. SUPPLEMENTARY OVERHEAD RATE= (ACTUAL OVERHEAD INCURRED-ABSORBED OVERHEAD)/BASE( HOURS OR UNITS)

   MULTIPLE OVERHEAD RATE

1.       SEPARATE FOR EACH PRODUCTION DEPARTMENT HAVING SIMILAR MACHINE AND LABOUR OPERATION

2.       SEPARATE RATE FOR EACH SERVICE DEPARTMENT WHEN SECONDARY DISTRIBUTION IS NOT DONE

3.       SEPARATE RATE OF EACH COST CENTER IS CALCULATED IN ORDER TO HAVE COMPARISON

4.       SEPARTE OVERHEAD FOR FIXED AND VARIABLE OVERHEAD

5.       FOR EACH PRODUCT LINE IF THERE ARE DIFFERENCE AMONG PRODUCTS WITH REGARD TO TIME SPENT IN DIFFERENT PARTS OF THE FACTORY AND DIFFERENT TYPE OD WORK

6.       SEPARATE RATE FOR EACH ELEMENT OF THE COST WHEN THERE ARE SUBSTANTIAL DIFFERNEC IN MATERIAL CONTROL,LABOUR CONTENT AND FACTORY UTILIZATION