Chapter-5 ACCOUNTING OF OVERHEADS AND ITS CONTROL Meaning and Concept of Overheads Classification of Overheads Collection of Overheads Allocation, Apportionment and Absorption of Overheads Components of Overheads Factory Overheads Administrative Overheads Selling and Distribution Overheads Analysis of Overheads of the Textile Companies under Study Factory Overheads to Prime Cost Ratio Factory Overheads to Factory Cost Ratio Factory Overheads to Cost of Production Ratio Factory Overheads to Cost of Sales Ratio Administrative Overheads to Prime Cost Ratio Administrative Overheads to Factory Cost Ratio Administrative Overheads to Cost of Production Ratio Administrative Overheads to Cost of Sales Ratio Selling and Distribution Overheads to Prime Cost Ratio Selling and Distribution Overheads to Factory Cost Ratio Selling and Distribution Overheads to Cost of Production Ratio Selling and Distribution Overheads to Cost of Sales Ratio
214 Total cost of a product involves direct costs and indirect costs. Direct costs can be conveniently tract down to the product manufactured. It includes direct materials, direct wages, and direct expenses. On the other hand, indirect costs cannot be identified with the product manufactured. Indirect costs are referred as overheads. 1 Overhead costs are also termed as indirect or supplementary costs. These are costs which cannot be wholly debited directly to a particular job. They are neither direct material nor direct wages nor are they expenses of a direct nature and, therefore, they cannot enter in the cost of manufacture directly. But they constitute an element of costs as they have been incurred for manufacturing a commodity or making it ready for sale. 2 Besides direct expenses, there are also other expenses which cannot be identified with the articles produced or services rendered. Such expenses are termed as overheads. Overheds or indirect expenses are incurred for the output generally as a whole and not for a particular work order. Bloker and Weltmer have defined overhead as, Overhead costs are operating cost of a business firm which cannot be traced directly to a particular unit of output. The term overheads is used interchangeably with such terms as burden or supplement costs. 1. Paresh Shah, Management Accounting, Oxford University Press, New Delhi, 2009, p.136. 2. Maheshwari S.N., Cost and Management Accounting, Sultan Chand & Sons, New Delhi, 2008, p.236.
215 ICMA (London) in its terminology of cost accountancy defined it as the aggregate of indirect material cost, indirect wages, and indirect expenses. 3 It may therefore, be said that all items of expenses, be it material labour of other expenses which cannot be allocated directly to cost units, are termed as overheads. Overhead may be defined as the cost of indirect materials, indirect labour and other such expenses including services that cannot be conveniently charged to a specific unit. Alternatively, overheads are all expenses other than the direct expenses. In cost accounting, all indirect costs are termed as overheads. 4 MEANING AND CONCEPT OF OVERHEADS Overhead costs are the indirect and sometimes invisible costs associated with producing a product or service. Making sales is more exciting than conserving expenses, but both are essential functions of a manufacturing business. Overhead costs, just like sales levels and direct expenses, should be examined on a consistent, routine basis. Overhead costs are expenses which cannot be conveniently identified with a specific product or activity. Unlike materials and production labour, overhead is an invisible part of the finished product. Yet, overhead is a basic input into the production process just like raw materials. Understanding the nature of overhead costs can assist the managers in controlling these expenses. Proper allocation of overhead costs among products, or departments, permits the manager to understand their firm s production 3. Phophalia A.K., Cost Accounting, BBSA Publishers, Jaipur, 2004, p.17. 4. Paresh Shah, Management Accounting, Oxford University Press, New Delhi, 2009, p.136.]
216 costs. It also allows the manager to determine how much each product or segment of the firm is contributing to overall profitability. CLASSIFICATION OF OVERHEADS The classification or grouping of overheads is not a simple thing. It depends upon a number of factors, such as the type and size of the business, the nature of the product or the service rendered and managerial policies. Overheads are principally of the following types: 1. Function-wise Classification The classification of overhead expenses on a functional basis is done with reference to the various major activity of a concern. The main groups on the basis of the classification are: (a) (b) Manufacturing Overhead : It is the indirect expenses of operating the manufacturing division of a concern and includes all such expenses incurred by the factory from the receipt of the raw material unit production is completed and the finished product is kept for dispatch or disposed off otherwise. Manufacturing overhead is also known as factory overhead or work overhead or production overhead. Administrative Overhead : It is the indirect expenditure incurred while formulating the policy, directly the organization and controlling the operation of an undertaking, which is not related directly to a research, development, production, distribution or selling activity function. Thus, administration overhead expenses are those items of
217 expenditure which are incurred in the general and financial management of a business. (c) (d) Selling Overhead : It is the expenditure in promoting sales and retaining customers. Distribution Overhead : It is the expenditure incurred in the process which begins with making the pocket produced available for dispatch and ends with making the reconditioned returned empty package available for reissue. 2. Element-wise Classification The expenses are broken up into the following three elements: (a) (b) (c) Indirect material such as stores consumed for repair and maintenance work, sending stores of small value, small tools for general use, fuel, lubricating oil, loss and deterioration of stores. Indirect labour such as general indirect labour, idle time, wages for maintenance workers, workmen s compensation, overnight and shift night extra premium, holiday pay, leave pay, employers contribution to funds etc. Indirect expenses such as salary of factory staff, hospital and dispensary expenses, canteen, training expenses, depreciation of plant, machines and building, insurance, taxes, rates and rents. 3. Behavioural Classification This classification of overheads is based on the behaviour of costs in relation to the volume of output.
218 According to this grouping, the expenditure may be as follows: (i) (ii) (iii) Fixed Costs : The cost which remains constant for all volumes of production is referred to a fixed cost. Some examples of fixed overhead expenses are: Rent of buildings, storage, space etc, depreciation of plant and machinery, depreciation of buildings, pay and allowances of director, managers and accountants etc. Office expenses like stationary, postage etc, bank charges, legal charges, salaries of works manager, interest on capital if included in costs, supervisors insurance, canteen expenses, hospital and dispensary expenses etc. Variable Costs : Variable costs are those which are directly related to production. They vary according to the level of production. Some examples of variable overheads are given as: indirect labour, indirect material, power and fuel, lighting, heating and cooling, repairs and maintenance, spoilage, tools and spares, store handling, defective work loss, overtime pay, idle time. Semi-variable Costs : Constant as well as variable up to a certain range of activity, they are fixed costs but after that range is crossed, they become variable. Examples of semi-variable expenses are: normal maintenance of building and plants, administration wages and salaries, postage and stationary, supervising, service department wages. 4. On the basis of Controllability Costs are divided into two parts:
219 (a) Controllable costs are those costs which can be controlled if proper managerial influence is exercised. Variable costs are controllable costs. (b) Uncontrollable costs are those which are beyond the control of managerial influence. Fixed costs are generally said to be uncontrollable since the amount concerned has to be sent on time basis irrespective of the volume of output. 5 5. Nature-wise Classification Nature-wise overheads classification can be: (i) Normal or (ii) Abnormal. Normal Overheads : These are the expenses which are expected to be incurred in producing a given output. They cannot be avoided. They are included in production cost. Abnormal Overheads : These are the expenses which are not expected to occur in producing a given output. For example, abnormal idle time, abnormal wastage, etc. These expenses are transferred to costing P&L account. Collection of Overheads As has been already pointed out, it is necessary to find out the cost of a job or product even before the actual production begins. This involves making an estimate of indirect expenses before hand. This is because a firm cannot afford to wail till actual information is available. An estimate will be made naturally on the basis of figures of some 5. Phophalia A.K., op.cit., p.20.
220 previous period. There are separate methods for estimating the factory overheads, administration overheads and selling overheads etc. But the best method is the estimation on the basis of corresponding previous period figure. For example, the factory overheads for the year of 1978 can be estimated on the basis of the figures of the year 1977. To make such an estimate, fixed expenses will be taken as in the base period adjusted for known changes and variable expenses will be change by the same margin by which output has changed. 6 All overheads should be entered in the cost records, as and when incurred in a specified document or form in which the appropriate standing order. Numbers to which the costs are to be charged, should also be indicated. The primary documents used for this purpose are: (a) (b) (c) (d) (e) Store requisitions Time cards or wages analysis book Invoice or purchase vouchers Cash book Subsidiary records for recording items like, depreciation or notional rent or interest. Indirect Materials: Drawn from stores or direct purchases are obtained from store requisitions /invoices and their total (of stores) are ported to the debit of production and credited to stores ledger control account. Indirect Labour: Indirect wages are booked against each standing order number and for each department on the basis of time cards or job cards. Time cards are used to prepare monthly wages analysis sheet. The 6. Phophalia A.K., op.cit., p.29.
221 total production indirect wages thus obtained are debited to the production overhead control account and credited to the wages control account. Indirect Expenses: All indirect expenses are recorded in the purchases journal /cash book. Item of non-current nature like depreciation or (notional) rent or interest, are entered in the subsidiary records like plant ledger in case of depreciation etc. At the end of the period, the total of indirect expenses are depicted to the factory overhead control account and credited to cost ledger control account. 7 Allocation, Apportionment and Absorption of Overheads After having collected the overhead under proper standing order numbers, the next step is to allocate the expenses and the overheads which cannot be directly allocated. They will be apportioned on a suitable basis. I.S.M.A. London has defined the term allocation and apportionment as the allotment of proportions of items of cost to cost centers or units. American writers use the word distribution in place of the word allocation. The distribution according to them, is of the following two types: Primary distribution and secondary distribution. Primary distribution of overhead consists of assigning, allocating or apportioning the cost or certain suitable basis to all the departments, division or cost centers. While making the primary distribution, the distinction between a producing department and service department need not be made it is of little use. 7. Sharma N.K., Costing Methods, Arihant Publishing House, Jaipur, 2008, p.67.
222 Secondary distribution consists of a redistribution of the total cost of each service department to producing departments and other service departments. Basis of allocation of overheads over various departments: The criteria on which the allocation of overheads among various departments can be made, is as follows: 1. Service or Use Method: Under this method, the service or benefit received is the basis for the distribution or assigning of overheads. The service or benefit received by a department, the larger the share of the overheads to be borne by it. Since this method is based upon the extent of the benefit received by a department, the expenses are equitably apportioned. This method is considered to be fair as it takes into account the time element and gives consistent results. 2. Analysis or Survey of Existing Conditions: This method is for more useful to distribute such expenses as are not closely related to divisions or units of a product. Sometimes, the relationship of certain expenses is so small that it necessitates arbitrary distribution. While making an arbitrary distribution, survey of all those factors must be made which is likely to effect this kind of distribution. Such a survey need to be done only at irregular intervals just to watch importance of the situation. A new cost analysis is necessary. 3. Ability to Pay: The ability to pay principle has been based upon the taxation principle of Adam Smit. Under this method, the department which has a higher income bears the bigger proportion of the overheads. The allocation is made on the proportional basis. Undoubtedly, this method is simple to apply but it is generally considered inequitable because it penalizes the efficient an profitable units of a business to the
223 advantage of the efficient and profitable units of a business to the advantage of the inefficient ones. The principle is suitable only in case where the expenses are to be divided among old divisions of the factory and newly added lines. Newly added lines cannot bear the burden of overheads and should bear the lowest charge. 4. Efficiency of Incentive Method: This method is scientific one and is of recent origin. Under this method, production is budgeted and efficiency is measured by such managerial devices as making comparison of the actual result with the budgeted ones. If the budgeted figures are excluded, the incidence of overhead costs is lowered and the unit cost is lowered and if the targets are not achieved, the unit cost goes up revealing the inefficiency of the department. Apportionment of the Overheads There are some items of expenditure which cannot be easily allocated to a specific department and it needs equitable apportionment over those departments which have received the benefits of expenditure. The apportionment is to be done on certain basis such as: a. Floor area occupied b. Labour hours c. Machine hours d. Kilowatt hours e. Capital values f. Technical estimate Here is an example of some expenses which will have to be distributed among the various departments as follows:
224 Expense Salary works manager Rent, insurance, depreciation and repairs of factory premises Lighting Power Insurance premium Time keeping, pay roll, employment and labour Buying and store keeping expenses Basis of Apportionment The time he devotes to various departments Area occupied by each department Number of points in each department Either actual meter-reading or have power machines Value of machines Number of workers employed Material consumed in each department Overhead Allocation There are two types of overhead, which are administrative overhead and manufacturing overhead. Administrative overhead includes those costs not involved in the development or production of goods or services, such as the costs of front office administration and sales; these are essentially all overheads that are not included in manufacturing overhead. Manufacturing overhead is all of the costs that a factory incurs, other than direct costs. One needs to allocate the costs of manufacturing overhead to any inventory items that are classified as work-in-process or finished goods. Overhead is not allocated to raw materials inventory, since the operations giving rise to overhead costs only impact work-in-process and finished goods inventory. Depreciation of factory equipment quality control and inspection factory administration expenses rent, facility and equipment, indirect labor and production supervisory wages repair expenses indirect materials and supplies rework labor, scrap and spoilage maintenance, factory and production equipment taxes related to production assets.
225 The typical procedure for allocating overhead is to accumulate all manufacturing overhead costs into one or more cost pools, and to then use an activity measure to apportion the overhead costs in the cost pools to inventory. Thus, the overhead allocation formula is: Cost pool / Total activity measure = Overhead allocation per unit One can allocates overhead costs by any reasonable measure, as long as it is consistently applied across reporting periods. Common bases of allocation are direct labor hours charged against a product, or the amount of machine hours used during the production of a product. The amount of allocation charged per unit is known as the overhead rate. Absorption of Overheads The next step in the process of overhead control is to recover it while ascertaining the cost of production. Charging overheads to individual products or jobs is known as overhead absorption. The overhead expenses pertaining to a cost center are ultimately to be charged to the products, jobs etc, which pass through that cost center. The method apportionment of overheads of an individual cost center is known as absorption. The terms overhead absorption, recovery change, application of overhead are used interchangeably. Basis of Absorption For the purpose of absorption of overhead to individual jobs, processes or products overheads absorption rates are applied. The overhead rates of expenses for apportioning them to production may be estimated on the following three bases.
226 1. On the basis of the figure of the previous year or period overhead rate may be ascertained and applied to production in the current year. 2. The overhead rate for the year may be determined on the basis if the estimated expenses and anticipated volume of production or activity. 3. The overhead rate for the year be determined on the basis of the normal volume of output or capacity of the business. Blanket and Departmental Overhead Rate: Blanket overhead rate refers to use of one single or general overhead rate for the whole factory. Departmental overhead rates refers to a separate rate for each individual cost center or department. The blanket rate is used in those factories: 1. where only one major product in continuous process is being produced. 2. and where several products are produced, it can be applied only if (a) all products pass through all departments, and (b) all products are processed for the same length of time in each department. If the above conditions do not prevail, departmental rates should be used. These are several methods in use for determining overhead rates. The overhead rate is calculated as under: Overhead Rate = Overhead Expenses Base
227 Overhead absorbed in a product or job = Overhead rate No. of units produced Methods of Absorption of Factory Overheads The methods generally applied for the absorption of factory overheads are: 1. Percentage on Direct Material: The actual or predetermined rate of overhead absorption is calculated by dividing the manufacturing overheads by the material cost incurred or expected to be incurred and expressing the result as a percentage. The formula is given below: Percentage of Works Overhead to Direct material = Factory Overheads 100 Direct Material Cost 2. Percentage on Direct Wages: An actual or predetermined rate of overhead absorption is calculated by dividing the cost to be apportioned absorption by the wages paid or expected to be paid and expressing the result as a percentage. The formula for computing the percentage rate for a period is given below: Percentage of works overheads to direct wages = Factory Overheads Direct Wages 100 3. Percentage in Prime Cost: An actual or predetermined rate of overhead absorption is calculated by dividing the overheads to be absorbed by the prime cost in incurred or expected to be incurred and expressing the result as a percentage. The formula for computing the percentage rate for a period is given below:
228 Percentage of Work Overheads of Prime Cost = Factory Overheads Prime Cost 100 4. Direct Labour Hour Rate: An actual or predetermined rate of overhead absorption which is calculated by dividing the cost to be absorbed by the labour hours worked or expected to be worked. The labour hour rate for a period is given below: Direct Labour Hour Rate = Factory Overhead [ Direct Labour Hours during a given Period] The effective working hours for which the factory works during a particular period is ascertained as shown below: Effective Working Hours = [Number of average workers employed during a given period for which the factory works] * [No. of hours for which the factory works during each day] 5. Machine Hour Method: This is a method of allocating factory overheads to different job or products by first calculating the amount spent to run a machine for one hour and then calculating the amount chargeable to a job or products by first calculating the amount spent to run a machine for one hour and then calculating the amount chargeable to a job or product by multiplying the rate and the number of hours, the machine is used on that job. Machine hour rate = Factory Overheads Machine Hours
229 6. Cost Unit Rate Method: For actual or predetermined rate of overhead absorbed by the number of cost units produced or expected to be produced. The formula for computing the cost unit rate is given below: Factory overheads per unit = Factory Overheads [ No. of Units Produced in the Base Period] ABSORPTION OF OFFICE AND ADMINISTRATIVE OVERHEADS These overheads can be absorbed in one of the following ways: (1) These expenses are constant because they are period costs. So some people suggest that these expenses should be fully charged to profit and loss account directly. If this view is taken, the value put on the closing stock will be less than if these expenses are included in cost of production. (2) On the ground that administration overheads are generally concerned with both production and sales, the office and administration expenses should first be apportioned over the production and sales departments. The part that is apportioned to production should be added to factory overheads and the other to selling expenses. (3) The third approach to observe these overheads is to add them as a serrate item to the cost on a suitable basis and then to determine the total cost of production.
230 Although there is not much logical connection between works cost and office expenses, the traditional method of charging office expenses is that of a percentage on work cost or works overheads. Percentage of Office and Administration Overheads = Office and Administration Expenses [ Works Cost] 100 Absorption of Selling and Distribution Overheads Selling and distribution expenses are sometimes called after production costs also. These are those expenses which are incurred for the purpose of promoting the marketing and sales of different products. Distribution expenses are concerned with the delivery and dispatch of goods sold. Some people try to distinguish these both types of expenses, while other group together these tow types of overheads expenses in to one composite class. In concerns where selling and distribution overheads are small, they may prefer to exclude such expenditure entirely from cost accounts. But when the quantum of expenditure and selling and distribution is sizable, it has to be charged in the cost accounts. Methods of Absorption (i) Rate per Article : Under this method, the total fixed selling costs are divided by the number of units of a product sold. The rate per article is arrived at by the following formula: Rate per Article = [ Total Selling and Distribution Costs ( base period)] [ Number of Units Sold ( of base period)]
231 (ii) Percentage on the Selling Price of each Article : Under this method fixed selling costs may be charged by way of percentage on the selling price. The percentage is ascertained from the analysis of the past accounts and is arrived at as follows: Percentage on the Selling Price = [ Fixed Selling Expenses for the Base Period ] 100 [ TotalTurnover of the Base Period] This method works quite satisfactory, if the products of a business are sold at standard prices and the proposition of each type of product is constant. (iii) A Percentage on Work Cost : Under this method, a certain percentage on works cost is taken as a basis for the absorption of selling and distribution expenses. The percentage is ascertained in the same way as it is ascertained on the selling price under the second method. Percentage of selling and distributing overheads to the work cost = [ Selling and Distribution Expenses ] 100 [ Works Cost] Of all the three method, the rate per article is considered to be one of the best methods of absorption of selling and distribution expenses. The percentage on the work cost method is usually unsound unless a business produces one product only. In such a case, this method will have the advantage of simplicity. 8 8. Sharma N.K., Costing Methods, op.cit., p.86.
232 COMPONENTS OF OVERHEADS Factory Overheads Factory overhead costs are operating costs of a business enterprise which cannot be traced directly to a particular unit of output, product or jobs. Factory overhead is the aggregate of indirect materials, indirect wages and indirect expenses. Factory Overhead - Fixed, Semi-variable and Variable Factory overhead costs can be divided into fixed, semi-variable costs. Fixed overhead costs are commonly described as those that do not vary in total amount with increase or decrease in productive activity or volume of output for a given period of time, usually, an year. Fixed costs are constant in total amount, but vary per unit as production activity changes. Semi-variable or semi-fixed are those which remain fixed in total amount over a relatively short range of variation in output and then are abruptly changed to a new level, where they remain fixed in total amount for another short range of output. Variable costs include repairs, powers, workmen s compensation, supplies and indirect labour which are typical of cost varying in total amount, with changes in productive activity. Variable costs per unit remain relatively constant with changes in production. Thus, variable costs fluctuate in total amount but tend to remain constant per unit as production activity changes. Factory Overheads - Accounting and Distribution
233 Factory overheads by nature can not be identified or associated directly with specific products or jobs. However, they should be included in total cost of products or jobs. The following steps are important in distribution of overhead costs among products or jobs. Collection and Codification of Factory Overheads This first step in distribution of factory overhead cost is their collections and codification under proper headings. Similar overhead cost items should be grouped together. The grouping of overhead costs is done through a technique known as Codification. Codification is a method of identifying and describing various overhead expenses in numbers or letters or in a combination of both so that cost data can easily be collected. Codification of the entire items is done through a proper coding system. Allocation and Apportionment of Factory Overheads Departmentalisation of Overheads: Departmentalisation of factory overheads means dividing the company into segments called departments or cost centers where expenses are incurred. In a manufacturing concern, there are mainly two types of cost centers - producing departments and service departments. Primary Distribution: Some factory overheads can be directly identified with a particular department or cost center as having been incurred for that cost center. The apportionment should be done on some rational and equitable base. In cost accounting, this is known as primary distribution of factory overheads.
234 Absorption of Factory Overheads After all service departments overheads have been apportioned to producing departments, the next step is to spread factory overhead to different products or jobs produced. This is termed as overhead absorption in cost accounting. The Institute of Cost and Management Accountants (U.K.) defines overhead absorption as The allotment of overhead to cost units. As a result of absorption, the cost of each unit of product of the producing departments includes an equitable share of the total overhead of the department. Some method of overhead absorption has to be applied to absorb factory overhead to individual products or jobs, etc on some equitable basis. The rate, which is used to charge overhead cost to the products or jobs, is known as absorption rate. Administrative Overheads Administrative overheads are those expenses which are incurred for formulating the policy, directing the organization and controlling the operations of an undertaking. Distribution of Administrative Overheads The method of distributing administrative overheads is more or less the same as in the case of factory overheads. All items of administrative overheads are collected and grouped under proper classification heads. The overheads are then apportioned among the various administrative departments (cost centers).
235 Some examples of administrative departments are office department, accounts department, personnel department, recreation department, law department. Those administrative overheads which can be identified with specific departments are directly allotted to them. The remaining administrative overheads are apportioned among those administrative departments for which they have been incurred, on an equitable basis. Apportionment between Production and Selling Divisions Under this method administrative overheads are divided between production and selling divisions on some suitable basis. After such distribution, administrative overheads lose their identity. This method follows the logic that an organization has only two functions to perform, namely production and selling. Transfer to Costing Profit and Loss Account Under this method, administrative overheads are transferred to costing profit and loss account. This method is based on the assumption that administrative overheads are not directly concerned with the production function of the organization and therefore should not be included in the cost of production. This method reduces the cost of product or job. Selling and Distribution Overheads Selling overheads include the costs incurred in promoting sales and retaining customers. Distribution overheads includes the costs of the process which begins with making the packed product available for
236 dispatch and ends with making the reconditioned returned imply packages available for reuse. Distribution overheads strictly begin when an order has been obtained and generally ends when goods are to be dispatched. Broadly, selling overheads include the following items: (a) Indirect materials: They include cost of printing, and stationary, mailing literature, catalogue price lists etc. (b) Indirect labour: This include salaries, commission, allowances etc. of salesmen, representatives, sales manager, marketing managers etc. (c) Indirect expenses: Advertising, bad debts, rent of showroom, insurance of showroom, collection charges, traveling and entertainment expenses, expenses of branch establishment, sales office expenses, fees of directors who devote time to sales function, are some examples of indirect expenses. Broadly, distribution overheads include the following items: (a) (b) Indirect materials: Cost of packing cases, oil, grease, spare parts used in maintenance of delivery vehicles. Indirect labour: Wages of packers, van drivers, dispatch clerks, etc. (c) Indirect expenses: Godown expenses including rent, insurance, freight, carriage outwards and other transport charges, depreciation and running expenses of delivery vans.
237 Apportionment of Selling and Distribution Overheads Although, selling and distribution overheads differ in nature with each other, for the purpose of apportionment and absorption, both the overheads can be taken together. Selling and distribution overheads should be classified into two groups in order to charge them finally to products: (a) Direct overheads: Direct overheads are the overheads which can be directly identified with a particular product or products. (b) Indirect overheads: There are such selling and distribution overheads which cannot be identified with particular product or products. Such indirect overheads are apportioned using the following steps: (i) (ii) Collection and Classification of Overheads: All selling and distribution overheads should be collected and classified according to their nature into certain groups such as advertising exhibition, bad debts, depreciation of vehicles used for sale, discount freight, heating, insurance, lighting, packing, postage, commission, rent, repairs etc. Apportionment of Overheads: After collecting and classifying overheads, they should be further allocated to one or more cost centers or departments or functions to which they relate. If any item (or items) of overheads cannot be totally transferred to a particular department or function it should be apportioned among the departments or functions on an equitable basis for which they have been incurred.
238 (iii) Absorption of Overheads: After apportionment of overheads, selling and distribution overheads of each territory, or zone or area are charged to different products sold in that area or territory on a suitable basis. This may be done by one or more of the following methods: 1. Rate of Article: If this method is adopted, the overhead costs are divided by the number of products sold in that territory during a certain period. 2. A Percentage of Sales: This is suitable for apportionment of direct selling costs, general administration, finance costs, etc. 3. A Percentage of Work Cost: Where selling overheads are small, this method can be adopted, even though various articles are produced, as little advantage would be gained by using a more complicated system. 4. A Percentage of Cash Collected: This method may be used for apportionment of credit and collection costs such as bad debts, legal expenses, etc. 9 ANALYSIS OF OVERHEADS OF THE TEXTILE COMPANIES UNDER STUDY The analysis of various overheads of the textile companies under study has been done under the following heads: 1. Factory Overheads to Prime Cost Prime cost of a product is the sum of its direct material cost, direct labour cost and overheads. Under this method rate of absorption of 9. Jawahar Lal, Cost Accounting, 3 rd ed., 2005, p.190.
239 overheads is determined on the basis of prime cost using the following formula: Ratio of Factory Overheads to Prime Cost = Factory Overheads Prime Cost The ratio of factory overheads to prime cost of the textile companies under study has been shown in the following Table 5.1. Table 5.1 Factory Overhead to Prime Cost Ratio of the Textile Companies (From 2008-09 to 2012-13) (Ratio in Times) Years RSWM BSL MSUML STIL 2008-09 0.19 0.22 0.20 0.18 2009-10 0.19 0.22 0.21 0.17 2010-11 0.15 0.17 0.15 0.14 2011-12 0.13 0.16 0.14 0.13 2012-13 0.15 0.17 0.15 0.14 Average 0.16 0.19 0.17 0.15 S.D. 0.02 0.03 0.03 0.02 C.V. (%) 12.50 15.79 17.65 13.33 Source: Annual Reports & Accounts of the companies under study for the period from 2008-09 to 2012-13. RSWM: It can be observed from the above table that the ratio of factory overheads to prime cost in RSWM showed decreasing trend during the period of study except in the year 2012-13 despite an increasing trend of the factory overheads and prime cost. The decreasing trend was because of the reason that the rate of increase in factory overheads was less than the rate of increase in prime cost. The ratio of factory overheads to prime cost was 0.19 times in 2008-09 which remained same in the following year but then after it kept on decreasing
240 and decreased to 0.13 times in 2011-12 and finally increased to 0.15 times in 2012-13. The average of the ratio was 0.16 times which can be regarded satisfactory. The coefficient of variation was 12.50 percent showing a consistent trend which should be maintained in future also. However, it is suggested that the management of the company should try to keep the factory overheads under control. BSL: The table 5.1 shows that the factory overheads to prime cost ratio in BSL showed a decreasing trend during the whole period of study except in the year 2012-13. During the year 2008-09 the ratio of factory overheads to prime cost was 0.22 times which remained unchanged in the following year but decreased to 0.17 times in 2010-11 and to 0.16 times in 2011-12. The ratio marginally increased to 0.17 times in 2012-13. It is to be noted that the factory overheads as well as prime cost of the company showed an increasing trend during the period of study because of the increase in the production but the ratio showed a decreasing trend because the factory overheads increased in lower proportion than the prime cost. The average of the ratio was 0.19 times which can be regarded satisfactory and should be continued in future also. The coefficient of variation was 15.79 percent showing a consistent trend which should be maintained in future also. MSUML: From the table, it can be observed that the ratio of factory overhead to prime cost showed a fluctuating trend during the whole period of study. The highest proportion was in the year 2009-10 when it was 0.21 times and the lowest proportion was in the year 2011-12 when it was 0.14 times. The fluctuating trend was because of inconsistent increase in the amount of factory overheads and prime cost
241 though both the amounts showed an increasing trend except in the year 2011-12 and 2012-13 respectively. The average of the ratio was 0.17 times which can be regarded satisfactory. The coefficient of variation was 17.65 percent showing a consistent trend which should be maintained in future also. Further it can be suggested that the management of the company should continue with the same policy in future also. STIL: It is evident from the Table 5.1 that the ratio of factory overhead to prime cost in STIL showed a decreasing trend during the whole period of study except in the year 2012-13. The highest proportion was in the year 2008-09 when it was 0.18 times and the lowest proportion in the year 2011-12 when it was 0.13 times though the factory overheads and the prime cost of the company had shown an increasing trend during the period of study. The average of the ratio was 0.15 times which can be regarded satisfactory. The ratio also showed a consistent trend as the coefficient of variation was 13.33 percent that should be maintained in future also. An overall comparison of the ratio of factory overheads to prime cost reveals that the ratio in all the textile companies under study showed a consistent trend and remained under control. This ratio showed a decreasing trend for all the companies despite an increasing trend of the factory overheads and prime cost. The increase in the prime cost implies increase in the production but the decreasing trend of the ratio indicates that the management of the companies under study kept the factory overheads under control irrespective of increase in the production. It signifies an efficient management of the companies under study.
242 Analysis of Variance (F-Test) To test the significance of the ratio of factory overheads to prime cost of the textile companies under study F-test has been applied and following hypotheses have been tested. (i) Null Hypothesis (H 0 ) : There is no significant difference in the ratio of factory overheads to prime cost of textile companies under study. (ii) Null Hypothesis (H 0 ): There is no significant difference in the year-wise factory overheads to prime cost ratio of the textile companies under study. Table 5.2 ANOVA TABLE Source Sum Degree of Freedom (d.f.) Variance (Sum /d.f) F Ratio Between Companies (SSC) 0.003 (c-1)=(4-1)=3 0.00100 F= 33.33 (Between Companies) Within Companies (SSR) 0.012 (r-1)=(5-1)=4 0.00300 Error (SSE) 0.0004 (c-1)(r-1)=12 0.00003 F=100.00 (Within Companies) (i) F-Test Between the Companies F = HigherVariance SmallerVariance = 0. 00100 0. 00003 33.33 Critical value of F at 5 percent level of significance (V 1 = 3 and V 2 = 12) is 3.49 Decision: Since the calculated value of F is more than the critical value of F at 5 percent level of significance, therefore the Null Hypothesis is rejected and it is concluded that the difference in the
243 factory overheads to prime cost ratio of the companies under study is significant. (ii) F-Test within the Years F = HigherVariance SmallerVariance = 0. 00300 0. 00003 100.00 Critical value of F at 5 percent level of significance (V 1 = 4 and V 2 = 12) is 3.26 Decision: Since the calculated value of F is less than the critical value of F at 5 percent level of significance, therefore the Null Hypothesis is rejected and it is concluded that the year-wise difference in the factory overheads to prime cost ratio of the companies under study is significant. 2. Factory Overheads to Factory Cost Ratio The factory overhead to factory cost ratio is also used to ascertain the recovery rate of factory overheads. In the present study, the ratio of factory overheads to factory cost has been calculated by using the Years RSWM BSL MSUML STIL 2008-09 0.16 0.19 0.17 0.15 2009-10 0.16 0.18 0.17 0.14 2010-11 0.13 0.15 0.13 0.12 2011-12 0.12 0.13 0.12 0.11 2012-13 0.13 0.14 0.13 0.12 Average 0.14 0.16 0.14 0.13 S.D. 0.02 0.02 0.02 0.01 C.V. (%) 14.28 12.5 14.28 7.69 following formula:
244 Ratio of Factory Overheads to Factory Cost = Factory Overheads Factory Cost Following Table 5.3 shows the ratio of factory overheads to factory cost of the textile companies under study. Table 5.3 Factory Overhead to Factory Cost Ratio of the Textile Companies (From 2008-09 to 2012-13) (Ratio in Times) Source: Annual Reports & Accounts of the companies under study for the period from 2008-09 to 2012-13. RSWM: It can be noted from the above table that the ratio of overheads to factory cost showed a decreasing trend during the period of study except in the year 2012-13 despite an increasing trend of factory overheads and factory cost during the whole period of study. The ratio of factory overheads to factory cost was 0.16 times in 2008-09 which came down to 0.12 times in 2011-12 and marginally increased to 0.13 times in 2012-13. The increasing trend of factory cost shows an increase in the production but the decreasing trend of the ratio of factory overheads to factory cost shows that the management of the company kept the factory overheads under control which shows efficiency of the management. The average of the ratio was 0.14 times which can be regarded favourable and should be maintained in future also. The coefficient of variation was 14.28 percent showing a consistent trend which should be maintained in future also. BSL: It is evident from the above table that the ratio of factory overheads to factory cost in BSL showed a decreasing trend during the period of study except in the year 2012-13 and varied within the range of 0.19 times in 2008-09 to 0.13 times in 2011-12. The amount of factory
245 overheads and the factory cost of the company showed an increasing trend throughout the period of study. The average of the ratio 0.16 times which can be regarded satisfactory and signifies an efficient management to control the factory overheads because despite an increasing trend of the production the management of the company kept the factory overheads under control. The fluctuations were also under control as the coefficient of variation was 12.5 percent which should be maintained in future. MSUML: The ratio of factory overheads to factory as shown by above table reveals that like other companies this ratio showed a decreasing trend during the period of study except in the year 2012-13. The ratio of factory overheads to factory cost was 0.17 times which remained unchanged in the year 2009-10 and decreased to 0.13 times in 2010-11 and further to 0.12 times in 2011-12. This ratio slightly increased to 0.13 times in 2012-13. The average of the ratio was 0.14 times which can be regarded under control because the factory cost showed an increasing trend due to increasing level of production. The coefficient of variation was 14.28 percent which shows a consistent trend of the ratio. STIL: It can be observed from the above table that the ratio of factory overheads to factory cost of STIL showed a decreasing trend during the period of study except in the year 2012-13 and varied within the range of 0.15 times in 2008-09 to 0.11 times in 2011-12. During the year 2012-13 this ratio marginally increased to 0.12 times. Though, the factory overheads and factory cost of the company showed an increasing trend but increase in the factory overheads was less than the rate of
246 increase in factory cost which shows an efficient management for controlling the amount of factory overheads. The coefficient of variation was 7.69 percent showing a stability of the ratio which should be kept in future also. The inter firm comparison shows that the ratio of factory overheads to factory cost for all the textile companies under study showed a decreasing trend except in the year 2012-13 despite an increasing trend of the factory overheads and factory cost. The factory cost of the companies increased because of increasing level of production but the factory overheads did not increase in the same proportion denoting that the management of the companies under study kept the factory overheads under control. The average of the ratio of factory overheads to factory cost was highest for BSL at 0.16 times and lowest for STIL at 0.13 times. It shows that the average of the ratio was almost same for all the companies under study. The coefficient of variation was also under control for all the companies under study as it showed a consistent trend. It is, however, suggested that the management of these companies under study should try to maintain the same policy in future also. Analysis of Variance (F-Test) Source Sum Degree of Freedom (d.f.) Variance (Sum /d.f) Between Companies (SSC) 0.002 (c-1)=(4-1)=3 0.00067 Within Companies (SSR) 0.007 (r-1)=(5-1)=4 0.00175 Error (SSE) 0.0003 (c-1)(r-1)=12 0.00002 F Ratio F= 33.50 (Between Companies) F= 87.50 (Within Companies)
247 To test the significance of factory overheads to factory cost ratio of the companies under study F-test has been applied and following hypotheses have been tested (i) Null Hypothesis (H 0 ) : There is no significant difference in the factory overheads to factory cost ratio of the companies under study. (ii) Null Hypothesis (H 0 ): There is no significant difference in the year-wise factory overheads to factory cost ratio of the companies under study. Table 5.4 ANOVA TABLE (i) F-Test between the Companies F = HigherVariance SmallerVariance = 0. 00067 0. 00002 33.50 Critical value of F at 5 percent level of significance (V 1 = 3 and V 2 = 12) is 3.49 Decision: Since the calculated value of F is more than the critical value of F at 5 percent level of significance, therefore the null hypothesis is rejected and it is concluded that the difference in the factory overheads to factory cost ratio of the companies under study is significant. (ii) F-Test within the Years F = HigherVariance SmallerVariance = 0. 00175 0. 00002 87.5 Critical value of F at 5 percent level of significance (V 1 = 4 and V 2 = 12) is 3.26
248 Decision: Since the calculated value of F is more than the critical value of F at 5 percent level of significance, therefore the Null Hypothesis is rejected and it is concluded that the year-wise difference in the factory overheads to factory cost ratio of the companies under study is significant. 3. Factory Overheads to Cost of Production Ratio Factory overheads to cost of production play an important role to predict the estimated amount of factory overheads for the future Years RSWM BSL MSUML STIL 2008-09 0.15 0.18 0.17 0.15 2009-10 0.16 0.18 0.17 0.14 2010-11 0.13 0.15 0.13 0.12 2011-12 0.12 0.13 0.12 0.11 2012-13 0.13 0.14 0.13 0.12 Average 0.14 0.16 0.14 0.13 S.D. 0.02 0.02 0.02 0.01 C.V. (%) 14.28 12.50 14.28 7.69 production. For estimating the amount of factory overheads on the basis of factory cost the ratio of factory overheads to cost of production can be calculated by using the following formula: Ratio of Factory Overheads to Cost of Production = Factory Overheads Cost of Production The ratio of factory overheads to cost of production of the textile companies under study has been shown in the following table
249 Table 5.5 Factory Overhead to Cost of Production Ratio of the Textile Companies under Study (From 2008-09 to 2012-13) (Ratio in Times) Source: Annual Reports & Accounts of the companies under study for the period from 2008-09 to 2012-13. RSWM: The ratio of factory overhead to cost of production showed a fluctuating trend during the whole period of study. The highest proportion was in the year 2009-10 when it was 0.16 times and the lowest proportion was in the year 2011-12 when it was 0.12 times. The average of the ratio was 0.14 times which can be regarded satisfactory. Moreover it can be noted from the above that the proportion of factory overhead to cost of production showed almost a decreasing trend because the amount of factory overheads remained stable while the cost of production kept on increasing due to increasing level of production. The coefficient of variation was 11.63 percent showing a consistent trend which should be maintained in future also. Further it can be suggested that the management of the company should follow the same practice in future. BSL: From the table, it can be concluded that the factory overheads to cost of production ratio of BSL showed a decreasing trend except in the year 2012-13. This ratio was 0.18 times in 2008-09 which remained unchanged in the year 2009-10 but decreased to 0.15 times in 2010-11 and further to 0.13 times in 2011-12. The ratio marginally increased to 0.14 times in 2012-13. The average of the ratio for the period of study was 0.16 times which is quite satisfactory and shows the efficiency of the management to control the factory overheads despite an increasing level of the production. The fluctuation was also under control as the coefficient of variation was 12.5 percent.