c) Describe the steps involved in calculating overhead absorption rates d) Calculate and explain under and over absorbed overheads. 1.1Overheads and absorption costing Overhead is the cost incurred in the course of making a product, providing a service or running a department , but which cannot be traced directly and in full to the product, service or department .Overheads comprise indirect materials , indirect labour and indirect expenses. Overheads can be classified as production, administration, selling and distribution . Absorption costing method is generally used in dealing with overheads.The objective of absorption costing is to include in the total cost of a product an appropriate share of the organisation’s total overhead Unlike marginal costing , absorption costing recognises both fixed and variable production overheads as important elements of production.The theoretical justification for using absorption costing is that all production overheads are incurred in the production of the organisation’s output and so each unitof the product receives some benefit from these costs. Each unit of output should therefore be charged with some of the overhead costs. The main reasons for using absorption costing are inventory valuations , pricing decisions and establishing the profitability of different products. The three main stages in absorption costing (sometimes referred to as allotment ) are allocation, apportionment and absorption. 1.2Procedures for dealing with production (factory )overhead costs The following are the guiding steps in dealing with manufacturing or factory overheads: a.The factory is divided into cost centres: those departments concerned with actually making the product to be sold ( production cost centres) and those departments which to not actually make the products but contribute to the efficient working of the production cost centres ( service cost centres). b.Wherever possible, a direct charge or allocation is made to the cost centres. c.Each cost incurred jointly by a number of cost centres is apportioned to them on some equitable or fair basis. d.The service costs are transferred to the production cost centres. e.All products made in a particular cost centre are charged with a fair share of the overhead costs 1.3Overhead allocation Allocation is the allotment of whole items of costs to cost centres and this method should be used whenever possible .It is the process by which the whole cost items are charged to a cost unit or as a cost centre eg salary of a service department manager. A Cost centre may be a production department,a production area service department, an administrative department, a selling or a distribution department, or an overhead cost centre.For instance, direct labour would be charged to a production cost centre whereas costs such as canteens are charged direct to the various overhead cost centres.When allocating overheads one must ensure that a cost centre necessitated the overhead to be incurred and the exact amount of overhead is known.
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- Fall '18
- Paul Ndavi
- Test, Shs