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Overheads & Job Costing - Lecture

Overheads & Job Costing - Lecture - 1 OVERHEADS...

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OVERHEADS LECTURE The Classification of Overhead Costs Overhead costs fall into two broad categories: (a) production overhead costs; (b) non-production overhead costs Production overheads consists of: (a) indirect material costs, such as lubricants and supplies of materials needed for factory repairs and maintenance (b) indirect labour costs, such as the wages and salaries of work-men who do not work on specific product lines, foremen, inspectors, factory management staff, cost of idle time, overtime and shift premium etc. (c) indirect expenses such as factory heat, light, power, insurance and rates, as well as the depreciation of factory buildings, plant and machinery. Non-Productive overhead costs consist of: (a) selling and distribution expenses relating to the activities of sales department; (b) administrative expenses relating to the management activies of the head office; (c) financial activities relating to acquiring the funds necessary to finance operations. The Purpose of Production Overhead Cost Allocation Production overhead is allocated to products for the following reasons: (1) Determining the cost of production This is required for the purpose of establishing the cost of goods sold and the closing stock of work-in-progress and finished goods, in the course of preparing periodic profit and loss accounts and balance sheets. Note that IAS2 requires that production overhead costs are to be included with prime costs when valuing stocks which are included in published accounts. (2) Making pricing decisions Product costs are needed for making pricing decisions. Such pricing decisions may relate to setting unit product prices or preparing bids or quotes for jobs. This cost information allows the firm to make competitive pricing decisions based upon its own experience of production costs. (3) Determining the profitability of different products Firms making different products seek to use limited resources to the most profitable end. When producing several different products, a firm will wish to make product mix decisions that combine the most profitable set of products. Hence, it will require information that relates to the cost of each product in order to evaluate profit margins and make decisions relating to products that are relatively unprofitable. Allocating and Apportioning Production Overheads The first task is to identify production overheads costs with cost centers. ( A cost center is an area of the business where costs is chargeable to.) Those costs relating solely to a single production department, such as a specific part of the factory, are allocated directly to that part of the factory. 1
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Those overhead costs that relates to a number of different areas of the business (cost centers) must be shared between them. This is done by apportioning any joint overheads amongst the cost centers that incur them.
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Overheads & Job Costing - Lecture - 1 OVERHEADS...

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