Overheads

Course: Commerce
Subject: Cost Accounting

Lesson: Accounting for Overheads
Author’s Name: Komal Singhal
College: Kalindi College
Reviewer: Dr. Gurmeet Kaur,
Fellow in Commerce
1
Institute of Lifelong Learning, University of Delhi.
Lesson: Accounting for Overheads
Table of Contents:
1: Learning Outcomes
2: Introduction
3: Definition of Overhead
4: Categorization of overheads
5: Stages of factory overheads distribution
5.1: Codification and collection of overheads
5.2: Departmentalization of overheads
5.3: Re apportionment or secondary distribution
5.4: Absorption of overheads
6: Distribution of Office and Administration overheads
7: Distribution of Selling and Distribution overheads
8: Under and Over Absorption of overheads
9: Treatment of Certain items
10: Comprehensive Illustrations
Summary
Exercises
Glossary
References
1. Learning Outcomes:
After you have read this lesson, you should be able to:
 Understand the meaning of the term ‘overheads’,
Classify the overheads into different categories,
Identify stages involved in overhead distribution,
Differentiate between allocation and apportionment of overheads,
Learn how to various overheads according to different stages,
Learn how to charge the factory overheads among different
products using different methods of absorption,
Differentiate between blanket overhead rate and multiple overhead
rate,
Understand the concept of over and under absorption and different
methods for their disposal,
Understand the treatment of some items in costing.
2. Introduction:
In a manufacturing company, two types of costs are incurred in the production of goods
– Direct Costs and Indirect Costs. Direct costs include cost of material and labour which
are used directly in the production of goods. Indirect costs are those costs that are not
incurred directly in the production of goods but are still necessary to be incurred for the
continuation of production process and producing income. These are the indirect costs
which are known as overhead expenses.
3. Definition of Overheads:
Overheads are the indirect costs that are incurred during the course of manufacturing an
item, rendering a service or running a department but cannot be debited directly or
wholly to an item, services or departments.
Suppose an organization produces three products: A, B and C. Material, labour and other
direct expenses which an organization used for each product individually are the direct
costs. Besides these, there are other expenses like rent, helper wages, salaries of office
staff, rent of showroom; salaries of salesman etc. which are incurred for the benefit of
the organization as a whole but cannot be charged separately for each product are
overheads.
Figure 1: Overheads
Indirect + Indirect + Indirect =

Material Labour Expense Overhead
Thus, overheads is the sum total of indirect material, indirect labour and indirect
expenses.
4. Categorization of Overheads
Overheads can be classified as follows:
Function wise:
1) Factory/Manufacturing overheads – Factory overheads are the expenses that
are common to all the products produced within the factory. It is that part of the
product which is invisible. E.g. adhesive in the furniture, glue in the book binding
etc.
2) Office and Administration overheads – Office and Administration overheads

are the expenses that are incurred for carrying on the general office activities of
the enterprise which includes policy formulation, controlling and maintenance of
accounts. Example of office administration can be printing charges, postage and
stationary used in administration department, director’s fees, insurance of office
building, office staff salaries etc.
3) Selling and Distribution overheads – Selling overheads are those expenses
which a company incurs on marketing activities in order to stimulate the demand
for goods or services and to secure the orders. E.g. Sales manager’s salary, sales’
director’s salary, printing and stationary cost used in sales department.
Distribution overheads are the costs which are incurred to move a product from
the producer or manufacturer to the consumer. E.g. Delivery expenses, carriage
outward, godown charges, packaging charges, insurance of delivery vans etc.
Figure 2: Categorization of Overheads
Factory / Manufacturing Overheads

Function wise Office & Administration Overheads
Selling & Distribution Overheads
Fixed Overheads
Variable Overheads
Variability wise
Semi-variable Overheads
Indirect Material
Nature wise Indirect Labour
Indirect Expenses
Controllable Overheads
Control wise
Uncontrollable Overheads
Variability wise:
a. Fixed overheads – If the volume of production or level of activity increases or
decreases but expenses do not change within a given range such expenses are
known as fixed overheads. E.g. Manager’s salary, building rent, legal expenses
etc. Fixed cost per unit changes as the volume of production changes i.e., it
decreases when the production increases and vice-versa.
b. Variable overheads – If the volume of production increases and decreases and

expenses fluctuates in total amount in direct proportion to the volume of
production are known as variable overheads. E.g. Stores, salesmen’s commission,
indirect material, indirect labour etc. Variable cost per unit remains static as the
level of activity fluctuates.
c. Semi-variable overheads – It is mixture of both fixed and variable overheads.

It does not change up to a set level of production and beyond that production
level, increases in direct proportion to output. E.g. Salesman gets a fixed salary
plus commission when sales beyond a certain level is achieved.
Value Addition 1: Activity
Classification of costs
Following is the list of expenses incurred by an organization. Read
them carefully and classify them into fixed, variable and semi
variable costs.
Rent and insurance of building, Depreciation, Salary of a manager,

Power, Telephone expenses, Carriage inward, Selling commission
and Repairs and maintenance.
Discuss the list classified by you in your peer group.
Nature wise:
a. Indirect material – Those materials which are used in manufacturing a product
but cannot be recognized and directly charged to a specific department are called
indirect materials. E.g. oil, rags, cons. stores etc.
b. Indirect labour – The labour that is not directly involved in producing a product
but helps those labours who are engaged in manufacturing a product is known as
indirect labour. E.g. Supervisor, foreman, watchman etc.
c. Indirect expenses – Those expenses which are not incurred for a specific
product and cannot be charged directly to cost centers are known as indirect
expenses. E.g. rent of building, repairs etc.
Control wise:
a. Controllable overheads – Those overheads which can be controlled by the
action of the management are known as controllable overheads. E.g. direct
material, direct labour etc.
b. Uncontrollable overheads – Those overheads which cannot be controlled by

the action of the management are known as uncontrollable overheads. E.g., Rent,
Insurance, Salary etc.
5. Stages of Factory Overhead Distribution:
The following stages are involved in distribution of overheads:
Figure 3: Stages of Overheads Distribution
Codification & Collection of Overheads
Departmentalization of Overheads
Reapportionment of Overheads
Absorption of overheads
Codification and Collection of Overheads:

Codification of overheads:
In codification, codes or symbols are allotted to each item of overhead. Code numbers
are termed as Standing order number.
Different methods are used for codification:
a) Numerical Method: A fixed number is assigned to each type of expense.
E.g.
Depreciation of plant 100
Labour 200
b) Mnemonic Method: An alphabet is assigned to identify the expenses. E.g.
Repair RE
Maintenance MN
Depreciation DE
c) Decimal Method: For the main expenditure, the whole number is assigned
and for its sub-division, decimals are assigned. E.g.
Factory office 1
Indirect labour 1.1
Salaries 1.1.2
Bonus 1.1.3
d) Alphabetical cum Numerical Method: Under this method, mixture of
alphabet and number are used to assign codes. E.g.
Depreciation D
Depreciation of plant D1
Depreciation of building D2
Collection of overheads:
Collection of overheads means compilation of different items of overheads under proper
heading and a unique standing order number and cost account number.
There are different documents from which overheads are collected:
i) Cash Memo
ii) Invoice
iii) Material Requisition
iv) Cost Journal
v) Subsidiary Records
vi) Wage Analysis Book
Departmentalization of Overheads:
After codification and collection, next step is to distribute the overheads to different cost
centres on a suitable basis. This process is called Primary distribution.
Figure 4: Departmentalization of Overheads
Overheads Allocation Cost Centres
Apportionment
Two stages are involved in departmentalization of overheads:

i) Allocation of overheads
ii) Apportionment of overheads
5.2.1 Allocation of Overheads:

When the precise amount of overhead is known and a particular cost centre have
incurred the overhead, in that case whole amount of overhead is charged to that cost
centre, this process is known as allocation. E.g. If a machine is located in department A
then repair cost of machine is charged to only department A.
5.2.1 Apportionment of Overheads:

When an overhead expense cannot be charged fully to a particular department because
it is incurred for a factory as a whole, in that case expenses are distributed among the
number of departments on some equitable basis, this process is known as
apportionment. E.g. Building or factory is used by all the departments, thus rent cannot
be charged only to a specific department, it is to be apportioned to different departments
on the basis of floor area occupied by various departments.
Figure 5: Difference between Allocation and Apportionment
Allocation Apportionment
Deals with whole Deals with proportion

items of overheads of items of overheads
Thus we can say that there is a difference between allocation and apportionment.
5.2.3 Basis of Apportionment:
Overheads Items Basis
Power H.P of machinery or no. of

machine hours
Lighting expenses No. of light points or floor area
Depreciation, insurance and repairs of Capital value

plant and machinery
Stock insurance Capital value
Rent ,rates and taxes, insurance, Floor area

depreciation and repairs of building
Group insurance, canteen expenses, E.S.I No. of employees or wages of
contribution, welfare expenses, fringe each department
benefits and supervision
Factory manager salary and overtime Direct labour hours
wages
Delivery expenses Value or weight of materials
Stores overheads No. of requisition or value of

materials
Value Addition 2: Activity

Apportionment of Expenses
Following items of expenses were incurred by several departments of
a factory. Read them carefully and suggest the bases for
apportioning the expenses to its departments.
Rent and rates, Electric Power, Repairs of plant, Depreciation of
plant, Charges of material handling, Salaries, Insurance of plant,
Advertisement, Sales commission, Delivery expenses.
Discuss the basis suggested by you in your peer group.
Illustration 1:
Actual cost for a period incurred by three producing departments P, Q, R respectively
and service department T of XYZ Ltd are given below:
₹
Rent and Rates 2000
Insurance of plant 1200
Depreciation of plant 900
Staff welfare expenses 300
Supervision 3000
Insurance of stock 1000
Power consumption 1800
Light and Heating 240
Additional information:
Production Department Service

Department
P Q R T
Area (sq. metres) 3000 2200 1800 1000
No of workers 40 30 20 10
Total wages (₹) 12000 8000 6000 4000
Plant value (₹) 48000 36000 24000 12000
Stock value (₹) 30000 18000 12000 -
HP of plant 48 36 24 12
Prepare a statement showing apportionment of cost to various departments.
Solution:
Overhead Distribution Summary
Items Basis Total Production Service

Departments Deptt.
P Q R T
Rent and Rates Floor Area 2000 750 550 450 250
Insurance of plant Plant value 1200 480 360 240 120
Depreciation of plant Plant value 900 360 270 180 90
Staff welfare exp. No of workers 300 120 90 60 30
Supervision No of workers 3000 1200 900 600 300
Insurance of stock Stock value 1000 500 300 200 -
Power consumption HP of plant 1800 720 540 360 180
Light and Heating Floor Area 240 90 66 54 30
Total 10440 4220 3076 2144 1000
5.3 Reapportionment or Secondary Distribution:

Redistribution of cost from services to production department is known as
Reapportionment or secondary distribution.
Generally, cost centres are not engaged in manufacturing of goods but they assist
production department in the production process. Because of this reason, production
department bears all the cost of service department. Thus the process of charging the
overhead cost of service department to production department is known as
reapportionment or secondary distribution of overheads.
Figure 6: Distribution of Service Department Cost to Production Department
Production Cost
Centre 1
Service Cost Centre

Production Cost
Centre 2
Production Cost
Centre 3
Basis of Reapportionment:
Service Department Basis
Purchase No. of purchases or material value
purchased
Accounts, canteen and medical No. of workers
Stores Issued value of stores, issued quantity of
stores and number of requisition
Repairs and maintenance No. of hours worked
Tools room Direct labour hours or machine hours or
wages
Inspection Inspection hours spent
Fire protection service Capital values
Internal transport No. of requisition, weight or cost of
materials
Methods of Secondary Distribution:

There are different methods through which cost of service department is apportioned
to production department.
Figure 7: Methods of Reapportionment
Reapportionment
Direct Step Distribution Reciprocal Services

Redistribution Method Method
Method
Simultaneous Equation Method

Repeated Distribution Method
Trial & Error Method
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Direct Redistribution Method:
Under this method, service department cost is assigned only to production department
and there is no interaction between the service departments.
Figure 8: Apportionment of Service Department Cost to Production Department
Service Department Service Department

(Canteen) (Accounting)
Production Department Production Department

(Finishing) (Assembling)
Illustration 2:
A manufacturing company has three production departments X, Y and Z and four service
departments- Stores, Time keeping, Power and Canteen. Their departmental expenses
according to primary distribution are given below:
Production department
X ₹30000
Y ₹26000
Z ₹24000
Service departments
Stores ₹4000
Time keeping ₹3000
Power ₹1600
Canteen ₹1000
Other information relating to departments:
X Y Z
Horse power 150 150 100
No. of employees 20 15 15
Value of stores requisition(₹) 1250 750 500
Required: Distribute the cost of service department to production departments.
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Solution:
Statement showing Apportionment of Service Department Cost to
Production Department
Item Basis of Total(₹) X(₹) Y(₹) Z(₹)

Apportionment
Cost as per primary 80000 30000 26000 24000
distribution
Time keeping No. of workers 3000 1200 900 900
Stores Value of store 4000 2000 1200 800

requisition
Power H.P. of machines 1600 600 600 400
Canteen No. of workers 1000 400 300 300
Total 89600 34200 29000 26400
5.3.2.2 Step Distribution Method/Non Reciprocal basis:

In this method, cost of the service department which provide services to a larger number
of departments is assigned first to all the other service departments and production
departments but the cost of other service departments are not assigned back to it, then
the cost of next service department is apportioned and this sequence goes on till the last
service department cost is apportioned to production department only.
Figure 9: Non Reciprocal Basis
Service Department A Service Department B
Production Department X Production Department Y
Illustration 3:
A Ltd. has two production departments A and B and three service departments X, Y and
Z. Actual expenses for a period for each department are as follows:
A – ₹106000, B-₹ 14000, X- ₹ 34000, Y-₹ 60000, Z-₹ 26000
Apportionment of service department cost to production department is given below:
12
A B X Y Z
X 50% 30% - - 20%
Y 30% 50% 10% - 10%
Z 40% 60% - - -
Prepare overhead distribution summary.

Solution:
Statement Showing Distribution of Overheads
Particulars A(₹) B(₹) X(₹) Y(₹) Z(₹)
Overheads as given 106000 14000 34000 60000 26000
Cost of service deptt. Y

18000 30000 6000 (60000) 6000
reapportioned (3:5:1:1)
40000
Cost of service deptt. X

20000 12000 (40000) - 8000
reapportioned (5:3:2)
40000
Cost of service deptt. Z

16000 24000 - - (40000)
reapportioned (2:3)
Total 160000 80000 - - -
Reciprocal Services Method:

This method is used when different services cost centres provide services to each other.
Figure 10: Reciprocal Basis Method
Service Department A Service Department B
Production Department Production Department

X Y
In reciprocal basis, following methods are used to assign the costs:
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i) Repeated Distribution Method – This method involves the following steps:
 Apportion the cost of first service department to production department and
other service departments using agreed percentage.
 Distribute cost of second service department (including the proportion of first
department) to other departments.
 This process goes on till the service department cost become insignificant.
Illustration 4:
K Ltd. has two production departments A and B and two service departments X and Y.
Their departmental expenses are as follows:
A- ₹ 103674, B- ₹ 24326, X- ₹ 80000, Y-₹ 32000
Apportionment of service departments expenses are as follows:
A B X Y
X 50% 40% - 10%
Y 30% 50% 20% -
Required: Apportion the service department cost using repeated distribution method.
Solution:
Statement of Overhead Distribution
Item Production Departments Service Departments
A(₹) B(₹) X(₹) Y(₹)
Primary Overhead 103674 24326 80000 32000

Distribution
X cost apportioned(5:4:1) 40000 32000 (80000) 8000
Y cost apportioned (3:5:2) 12000 20000 8000 (40000)
Y cost apportioned (3:5:2) 240 400 160 (800)
Y cost apportioned(3:5) 6 10 - (16)
Total overheads 160000 80000 - -

ii) Simultaneous Equation Method – Under this method, algebraic equations
are formulated and solved to find the total cost of service department and
then service department costs are assigned to production department.
Illustration 5:
C Ltd. has two service departments A and B and three production departments X, Y and
Z and their expenses as per primary distribution are given below:
X- ₹1600, Y –₹ 1400, Z-₹ 1000, A-₹ 468, B – ₹ 600
Apportionment of service department expenses to production departments and other
service departments are as follows:
14
X Y Z A B
A 20% 40% 30% - 10%
B 40% 20% 20% 20% -
Required: Apportion the expenses of service departments to production departments

using simultaneous method.
Solution:
Let the total overhead of department A be x
Let the total overhead of department B be y
x= 468 + 0.2 y (i)
y= 600 + 0.10x (ii)
Put the value of x in equation (ii)
y= 600 + 0.10(468+ 0.2y)
y=600 + 46.8 + 0.02y
0.98 y = 646.8
y=646.8/0.98= ₹ 660
Put the value of y in equation (i)
x=468 + 0.2(660)
=₹ 600
Distribution of Overheads
Total X(₹) Y(₹) Z(₹)
As per 4000 1600 1400 1000

Primary
distribution
Cost of Service Deptt. 540 120 240 180
X apportioned (2:4:3)
Cost of Service 528 264 132 132
Deptt. Y apportioned
(4:2:2)
Total 5068 1984 1772 1312
iii) Trial and Error Method –

 Cost of first service department is assigned to another service
department.
 Then total cost (including that of first service department) of second
service department is assigned to first service department.
 This process goes on till the figure become too small.
 Last, service department total cost is apportioned to production cost
centres.
Illustration 6:
Using same illustration given above, distribute the service department expenses using
Trial and Error method.
15
Solution: Statement of Overhead Distribution
Items Production Departments Service Deptt.

A (₹) B(₹) X(₹) Y(₹)
Total overhead expenses 103674 24326 80000 32000
X cost apportioned to Y(10% 8000
of 80000)
Y cost apportioned to X 8000
(20% of 32000+8000)
Additional cost of X 800
apportioned to y(10% of
8000)
Additional cost of Y apportioned 160
to X(20% of 800)
Additional cost of X apportioned 16

to y(10% of 160)
Total 103674 24326 88160 40816
90%cost of X apportioned to A 44080 35264
and B(5:4)
80%cost of Y apportioned to A 12245 20408
and B(3:5)
Total overheads 159999 79998
5.4 Absorption of Overheads:

After allocation and apportionment of expenses to production department, the next step
is recovering of overhead or levy or absorption of overhead.
Absorption overhead means allotting the overhead expenses of a particular production
department among the various products manufactured by it on basis of absorption
overhead absorption rate.
Figure 11: Absorption of Overheads
Overhead Absorption Rate= Total Overheads
Units of base
Production Department X Production Department Y
Product Product Product Product Product Product

A B C A B C
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Rates of Overhead Absorption:
Overhead absorption rate may be of the following types
Figure 12: Rates of Absorption of Overheads
Actual Blanket
Overhead Rate Overhead Rate
Rates of
Absorption
Predetermined Multiple
Overhead Rate Overhead Rate
a. Actual Overhead Rate:

This rate is determined when the expenses have incurred during a particular period.
Actual expenses for a period

Actual Overhead Rate =
Actual quantum of the base for a period
However, this method is not desirable because of the certain limitations:

 This rate can be calculated only when the data of actual expenses are available
which is possible only after the end of a particular period. Thus it results in delay
ascertaining the cost of products.
 There are certain costs like repairs, maintenance etc. which is not uniform
throughout the year, this result in difference in actual overhead from period to
period. This makes comparison between two overhead rates impossible.
 It does not help in controlling of cost.
b. Predetermined Overhead Rate:

This rate is calculated before the actual expenses are incurred during a particular period
Budgeted overheads for a period

Predetermined Overhead Rate =
Budgeted base for a period
17
This method has the following merits:
 Because this rate is calculated in advance, it results in prompt determination of
cost.
 This rate helps in controlling of cost because of comparison of actual overhead
with the predetermined overhead absorbed.
 This rate facilitates comparison between costs of two periods because same rate
is used for the full period.
 This rate is used in taking various managerial decisions like fixation and
quotations.
c. Blanket Overhead Rate:
It is a single rate which is determined for the whole factory. This rate is used in those
firms which manufactures only one product or where two or more goods are
manufactured but they pass through all departments.
Total overheads of the factory

Blanket Overhead Rate =
Total quantum of the base
Merits of blanket overhead rate:

 It is easy to calculate.
 It involves less clerical work.
Demerits of blanket overhead rate:
 When several products are produced and they do not go through all the
departments then in that case this rate gives ambiguous results.
 It does not help in managerial control because the performance appraisal of
the individual department is not possible with this rule.
 It results in over value work in progress.
d. Multiple Overhead Rates:
This rate is determined separately for each department/cost centres.
Overheads of each department

Multiple Overhead Rate =
Base
Advantages of multiple overhead rates:

 Comparison of cost behaviour between different departments is possible.
 This rate helps in assessment of different departments.
 When separate rate is calculated for fixed and variable overheads, it helps the
firm in many ways.
18
Overhead Absorption Methods:
There are different methods of method of absorption of overheads
Figure 13: Methods of Absorption of Overheads
Methods
Percentage Hourly Rate Rate per unit

Methods Methods of Output
Method
Direct Material Cost Labour Hour Rate

Method Method
Direct Labour Cost Machine Hour Rate
Method Method
Prime Cost Method Dual Hour Rate Method
a. Direct Material Cost Method:

This method uses direct material cost used in producing a product as a base for
calculation of production overhead absorption rate.
Total Production Overheads

Factory Overhead Rate = x 100
Direct Material Cost
If in a factory, direct material cost is 50,000 and production overhead is 1200, thus
overhead absorption rate is 24% of direct material cost.
This material is applied in the following cases:
 Where the overheads amount is not significant in relation to material cost.
 Where only one product is manufactured.
 When material prices are not fluctuating.
Demerits of Direct Material Cost method
 Time factor is ignored in this method.
 When the prices of material are not stable, this stable is not suitable.
 It does not make any distinction between skilled workers and unskilled workers
performance.
 It does not make any distinction between work done by labour and machines.
19
b. Direct Labour Cost Method:
This method uses direct labour cost used in manufacturing a product as a base for
computing production overhead absorption rate.

Cost of Direct Labour
This method is followed in following cases:

1) Where the larger proportion of total production cost is direct labour.
2) Where rates of labour are stable.
3) Where labour employed and performed work is uniform.
Merits of direct labour cost method:
1) It is easy to understand and use.
2) It does not ignore the time factor.
3) Normally, wages rates are stable than prices of material.
4) Cost of extra labour is not involved because data is easily available from the
statement of wage analysis.
Demerits of direct labour cost method:

1) When a firm uses piece rate system, this method gives unsatisfactory results.
2) This method does not make any distinction between work done by skilled worker
and unskilled workers.
3) It does not make any distinction between machine work and labour work.
c. Prime Cost Percentage Method:
This method uses direct material cost and direct labour cost used in manufacturing a
product as a base for calculating the production overhead rate.

Prime Cost
This method is used when constant material quantity and labour hours are required in
producing a standard item in a factory.
Demerits of Prime cost percentage method:
 It does not make any distinction between labour work and machine work.
 It does not make any distinction between fixed and variable expenses.
 When time factor is not taken into account and cost of material is major
proportion of prime cost.
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Illustration 7:
The following information of a production department for a certain period is given below :
Direct materials ₹ 60000
Direct wages ₹ 40000
Overheads ₹ 24000
Data for Job No.101 executed by the department during the period are as follows:
Direct materials ₹ 8000 Direct wages ₹ 6000
Prepare a comparative statement of cost if factory overheads are recovered on
the basis of (i) Direct material cost (ii) Direct wages (iii) Prime cost.
Solution:
Factory Overhead Absorption Rate (on the basis of direct material)
= Factory Overheads/Direct Material Cost x 100
=24000/60000 x 100
= 40%
Factory Overhead Absorption Rate (on the basis of direct wages)
= Factory Overheads/Direct Wages x 100
= 24000/ 40000 x 100
=60%
Factory Overhead Absorption Rate (on the basis of prime cost)
= Factory Overheads/ Prime Cost x 100
= 24000/ (60000+40000) x 100
= 24%
Comparative Statement of Cost of Job No. 101
Particulars On the basis of On the basis of On the basis of
material cost(₹) labour cost (₹) prime cost (₹)
Direct Materials 8000 8000 8000
Direct Wages 6000 6000 6000
Prime Cost 14000 14000 14000
Factory Overhead 3200(40% of 8000) 3600(60% of 6000) 3360(24%of14000)
Works Cost 17200 17600 17360
d. Direct Labour Hour Rate Method:

This method uses number of labour hours spent on a job to compute production
overhead rate.

Factory Overhead Rate = X 100
Direct Labour Hours
g. Total production overheads = ₹ 20000
Direct labour hours = 8000 hrs
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Production overhead rate = 20000/8000 = ₹ 2.5
If 20 hours are spent on a job, factory overheads charged to that job will be ₹ 50.
This method is suitable where production is done by manual labour.
Merits of direct Labour Hour Rate method:

 Time factor is considered in calculation of this rate.
 Data on labour hours are easily accessible from job card, timesheet etc.
Demerits of Direct Labour Hour rate method:
 This method gives lot of consideration to labour only and not any other factor.
This leads to wrongful overhead distinction.
 When the concern uses piece rate system, then data is not available to
calculate this rate as no record of time is retained.
 This method does not take into account of the expenses which are not
dependent on labour hours such as power, fuel etc.
e. Machine Hour Rate Method:
This method uses total number of machine hours used in production as a basis for
computation of overhead absorption rate.

Total Machine Hours
This method is followed in those factories where major portion of work is done by
machines rather than labour. It is not advantageous to compute machine hours
rate for a factory as a whole because all the machines are not same in every
respect. Because of this reason, for each machine or for a group of identical
machines, machine hour rate is calculated separately. If there are 15 machines in
a factory, 15 machine hour rates would be calculated.
Computation of Machine Hour Rate:
To calculate machine hour rate, following steps are followed :

 Treat every machine or a group of identical machines as a separate cost
centre to apportioned overhead cost.
 Machine related overheads are divided into two types such as fixed or
standing charges and running or machine expenses.
 Calculate effective machine hours for a given period for each machine. While
calculating effective working hours, hours required for maintenance or setting
up time should be reduced.
 Estimate total standing charges for each machine for a given period and then
it is divided by total number of effective working hours to calculate standing
charges per hour.
 Calculate running charges per hour for each expense separately. It is
calculated by dividing the running expenses by normal working hours.
 By adding fixed charges per hour and variable charges per hour, we get
machine hour rate.
22
Figure 14: Types of Charges
• Those expenses which do not change

Standing with utilization of the machine such as
Charges Rent , Insurance etc.
• Those expenses which changes with the

Running utilization of the machine such as
Charges Depreciation, power , repairs etc.
Value Addition 3: Did You Know?
Treatment of Setting up Time

If setting up time is treated as unproductive, then it should be deducted from
estimated machine hours.
If setting up time is treated as productive then it will not be considered.
Value Addition 4: Illustration

Calculation of Effective Working Hours
From the following information, calculate effective machine hours when

a) Setting up time is treated as unproductive
b) Setting up time is treated as productive
i) Estimated working time per year = 2200 hours
ii) Hours of repairs and maintenance = 200 hours
iii) Setting up time = 100 hours
Solution:
a) When treated as unproductive
Annual working hours 2200 hrs
Less: Maintenance hours 200 hrs
2000 hr
Less: Set-up time 100 hrs
Effective working hours 1900 hrs
b) When treated as productive
Annual working hours 2200 hrs
Less: Maintenance hours 200 hrs
Effective working hours 2000 hrs
23
Cost of Power per Hour

If power is taken during setting up time, then power is calculated for total
machine hours (including setting-up time) and divided by effective machine
hours to calculate power per hour.
If no power is taken during setting up time, then power is calculated for
effective machine hour (excluding setting up time) and divided by effective
machine hours to calculate power per hour.
Comprehensive Machine Hour Rate

When wages of machine operator are added to machine hour rate, in that
case it becomes comprehensive machine hour rate. It is the cost of running
the machine including operator.
Comprehensive machine hour rate = Simple machine hour rate + wages of
machine operator.
To apportion the overhead expenses to a number of machines while calculating machine

hour rate, some basis of apportionment is used, that are as follows:
Basis of Apportionment of Overheads to Machines
Fixed or Standing Charges Basis
Rent and rates Floor area occupied
Heating and lighting No. of light points or floor area
Supervision Time devoted by supervisor
Insurance Machine value
Lubricating oil and consumable machine hours or past experience

stores
Labour welfare No. of workers
Miscellaneous expenses Equally or past experience
Running expenses
Depreciation Cost + installation expenses-scrap value

effective life in hours
Repairs Machine hours or past experience
Power H.P. of machines or working hours or
H.P X working hours
24
Merits of Machine hour rate:
 It helps in comparing the efficiencies and operating cost of different machines.
 This method is more practical, scientific and accurate.
 This rate helps in preparing dependable cost reports and helps the management
in taking various types of decisions.
 This method helps in estimation of production cost setting of standards and
fixation of selling price for quotations.
 This method helps in determining the cost of idle machines in case individual
rates are fixed and variable overhead rates are computed.
Demerits of Machine hour rate:
 This method is very costly because extra work is involved in determining the
working hours of machines.
 Expenses that are not proportional to machine working hours are not considered.
 In case program of production is not available in advance, it is not easy to
calculate machine hours.
 When manual labour is equally involved, it does not give accurate results.
Value Addition 7: Exercise
Factory Overhead Absorption Rate
You are given the following information related to a cost centre in a factory:
i) Working hours per week = 30 hrs
ii) Number of identical machines used in the centre = 10
iii) Budgeted production overheads for a 4-week period for the cost
centre = ₹ 12000
iv) Direct labour cost for a 4-week period for the cost centre= ₹ 30000
After studying the above problem, calculate factory overhead absorption

rate based on
a) Machine hours
b) Direct labour cost
Answer: a) Based on machine hour = ₹ 10/hour

b) Based on direct labour cost = ₹ 40/hour
Illustration 8:
Calculate machine hour rate from the following data:
Directly allocated factory overheads to machines ₹ 45000
Not directly allocated factory overheads to machines ₹ 60000
25
Area occupied by the machines 3000 sq. ft
Total area of the factory 36000 sq. ft
There are 5 machines of similar size and specifications and each machine operate 20
hours in a week and have remained idle for 40 hours in the year for repairs.
Solution:
Directly allocated factory overheads ₹ 45000
Other (apportioned on the basis of area)
(60000/36000x3000) ₹
5000
Total factory overheads ₹ 50000
Factory overheads per machine = 50000/5 = 10000
Machine Hour Rate = Factory Overheads per Machine
Working Hours in a year
= 10000/ 1000 = ₹ 10 per hour
Working Notes:
Calculation of working hours
Working hours per machine in a year= 20x52=1040(assume 52 week)
Less: Idle Hours = 40
Effective working hours in a year = 1000 hours
Illustration 9:
A factory has 8 machines of similar nature. The following annual expenses were incurred
as followed:
Factory lighting ₹ 1600
Supervision ₹ 1800
Factory rent ₹ 8000
Attendants: Two persons looking after eight machines paid @ ₹ 120 per
month each
Repairs ₹ 4800
Interest on loan ₹ 4000
Power consumption for the shop @ ₹ 20 paisa per unit ₹ 76800
Depreciation per machine ₹ 600
Sundry supplies for the factory ₹ 480
Each machine consumes 20 units of power in an hour.
26
If a machine runs for 2400 hours in a year calculate Machine Hour Rate.
27
Solution:
Computation of Machine Hour Rate
Particulars Per annum Per hour

(₹) (₹)
Standing charges:
Lighting 1600
Supervision 1800
Rent 8000
Attendant wages (120x12x2) 2880
Sundry supplies 480
Total 14760
Standing charges per machine= 14760/8= 1845

Standing charges per hour= 1845/ 2400 0.768
Running charges:
Repair per hour 4800 0.25
(8x2400)
Depreciation per hour(600/2400) 0.25
Power(20x0.20) 4
Machine hour rate 5.268
Illustration 10: Calculate machine hour rate from the following information:
(1) Cost of the machine ₹ 88000

(2) Scrap value ₹ 8000
(3) Estimated life of machine 20 years
(4) Rent for the shop ₹ 50000 p.a.
(5) Lighting for the shop ₹ 320 per month
(6) Power consumption 10 units per hour @ ₹ 10 for every 100 units
(7) General expenses allocated to machine ₹ 8000 p.a
(8) Repairs 50% of depreciation
(9) Workshop supervisor salary ₹ 6000 per month
(10) Estimated time per year 50 weeks of 40 hrs each
(11) Setting up time which is treated as productive 400 hrs per year
The machine occupies 1/5th area of the shop. Supervisor devotes 1/4th of his time in
supervising the machine.
28
Solution:
Calculation of Machine Hour Rate
Particulars Per annum (₹) Per
hour(₹)
Standing charges:
Rent for the shop(50000/5) 10000

Lighting for the shop(320x12/5) 768
General expenses 8000
Supervisor salary(6000x12/4) 18000
Total standing charges 36768
Standing charges per

hour(36768/2000)
18.384
Running charges:
Depreciation (88000-8000)/(20x2000)
2.00
Repairs(50% of depreciation)
1.00
Power(10x10x1600)/(100x2000)
0.8
Machine Hour Rate
22.184
Calculation of Machine Hours:

Machine hours=no. of weeks x machine hours per week
=50x40=2000 hours
Note: It is assumed that no power is consumed during setting up time. Thus power has
calculated for 1600(2000-400) hours. However if it is assumed that power is consumed
during setting up time power per hour would be ₹1 [(10x10x2000)/ (100x2000)]. As a
result machine hour rate would be ₹22.384
Illustration 11: Calculate machine hour rate from the following data:
(1) Machine cost ₹ 200000
(2) Estimated life 20 years
(3) Salvage value ₹20000
(4) Estimated working time 52 weeks of 40 hours each which includes 80 hrs for
maintenance and 100 hrs for setting up time. However setting up time is
treated as productive time.
29
(5) Electricity used during production is 8 units per hour@ 18 paisa per unit. No
current is taken during setting up or maintenance time.
(6) A chemical solution is required for machine which is replaced at the end of
each week @₹ 40 each time.
(7) Maintenance cost ₹ 2400 P.a
(8) Operation of this machine is controlled by two attendants together with five
other identical machines. Their combined weekly wages are ₹ 240
(9) Allocated general work overheads to this machine for the year is ₹ 4000.
Solution:
Particulars Per Per hour
annum(₹) (₹)
Standing Charges:
Attendants wages 2080

(240x52)/6 General works 4000
overheads Total standing 6080
charges
3.04
Standing charges per hour(6080/2000)
Machine Expenses:
4.50
Depreciation (200000- 1.37
20000)/(20x2000) Power (2736/2000) 1.04
Chemical (40x52)/2000 1.2
Maintenance 11.15
(2400/2000)
Machine Hour
Rate
f. Dual Hour Rate Method:
Those factories where both manual and machine manual and machine work are involved,
dual hour rate method are used. This method uses both direct labour hour rate and
machine hour rate. In departments where manual work is being carried out, overhead
are recovered by using direct labour hour rate and there machine work is being carried
out, machine hour rate is used.
h. Rate per unit of output method
This method is used in those cost centres where single article is manufactured.
Factory Overheads
Factory Overhead Rate =
Units of Production
30
6. Distribution of Office and Administration Overheads:
Administration overheads are those expenses which are incurred for directing, policy
formulation and controlling of the business activities. These expenses are not directly
involved in the production of goods and services. E.g. directory salary, rent of office
building, office telephone expenses, lighting, heating of office, insurance of office
building etc.
Stages involved in office and Administration overhead distribution

The following stages are involved in the distinction of office and administration
overheads:
Figure 15: Office and Administration Overhead Distribution Stages
Classification & Departmentalisation Absorption of

Collection of overheads of overheads overheads
a. Classification and Collection of Overheads:

Under this stage, all items of expenses incurred are classified into suitable sections.
E.g. rent, rates and taxes, repairs and maintenance, insurance, depreciation, lighting,
heating and cleaning. These are then grouped under account heading and then cost
account number is given to each head of expenses.
b. Departmentalization of Overheads:
After classification and collection, next stage is departmentalization which includes
allocation and apportionment of different administrative overhead of various
departments / cost centres i.e. personnel department, account department etc. Those
expenses which are able to be recognized with a particular department can be
allocated to that department. Those expenses which are common for all the
departments can be apportioned to different administrative departments on suitable
basis.
c. Absorption of Overheads:
There are different approaches regarding absorption of administrative overheads:
i) When administration overhead is treated as a separate item of cost:
In this method, administration overhead is considered to be a distinct item of
cost and accordingly charged to products and job by using blanket overhead
game which is calculated by any of the given methods:
i. Work Cost Percentage Method:
Total Administration Overhead

Administration Overhead Rate = x 100
Total Work Cost
30
ii. Conversion Cost Percentage Method:

Total Conversion Cost
Sales Value Percentage Method

Total Sales value
Gross Profit Percentage Method

Gross profit
Per Unit Production Method

Administration Overhead Rate =
Number of units produced
Value Addition 8: Illustration

Calculation of Administrative Overhead Rate
A company estimated its administrative overhead for a period as ₹ 20000
and sales value as ₹ 100000. Sales value for the goods sold during a period
is ₹ 4000. Calculate overhead absorption rate and administrative overhead
amount that is to be added to units sold.
Solution:
Overhead absorption rate = Administration overheads / Sales value * 100
= 20000/100000 * 100 = 20%
Administrative overhead added to units sold = 20% of 40000

= ₹ 8000
31
ii) When administration overhead is excluded from production:
Under this method, it is assumed that administrative overhead has no direct
relationship with the product manufactured and sold. It is not considered to
be included as a part of cost of production. Thus it should be treated as a
period cost and transferred to the debit side of costing profit and loss account.
Demerits:
a. Because administrative overhead are not considered in the cost of
production thus production cost would be understated.
b. It is also against the sound accounting principles.
iii) When administrative overheads are apportioned to production and
selling divisions:
Under this method, overheads of administrative department are distributed
between manufacturing and selling departments because of the assumption
that manufacturing and selling are the two important functions of an
organization.
When administrative overhead gets combined with the overhead of production
and selling department, it loses its identity.
Demerits:
a. Selecting a base for apportionment of administration overhead is very
difficult.
b. Apportionment of overhead involves lots of clerical work.
Illustration 12:
A company estimated its expenses for the year which are as follows:
Direct Material ₹ 18000
Direct wages @ ₹ 10 per hour ₹ 40000
Direct Expenses ₹ 2000
Work overheads ₹ 10000
Administration overheads ₹ 7000
Work overheads are absorbed on the basis of labour hour rate and administrative
overhead on the basis of percentage of work cost. A job 102 is carried out during the
year, details of which are given below:
Calculate administration overhead absorption rate and amount of administration
overhead charged to job number 102.
Solution: Calculation of administration overhead absorption rate
Work overhead ₹ 10000
Work cost ₹ 70000
32
Administrative overhead rate = Administrative overhead / work cost * 100
= 7000 / 70000 * 100
= 10%
Calculation of amount of overhead change to order:
Direct Material 4500
Direct wages 10000
Direct Expenses 500
Prime cost 15000
Work overhead = 2.5 * 1000 = 2500
Work cost 17500
Administration overheads = 10% of 17500
= ₹ 1750
7. Distribution of Selling and Distribution Overheads:

Selling overhead are those expenses which are incurred for promotion of company
goods and services and to retain the customers. e.g. Advertisement, bad debt,
telephone expenses of sales office, sales commission, costs of catalogues etc.
Distribution overheads are those expenses which are incurred for moving final product
from producer to storage and then to the consumer, and from customer, in case goods
are sold on sale return basis. E.g. expenses of warehouse, freight and carriage outward,
secondary packing cost, insurance of finished stock in godown, depreciation of delivery
vans etc.
7.1 Stages involved in Selling and Distribution overheads

The following stages are involved in the selling and distribution overhead:
Figure 15: Office and Administration Overhead Distribution Stages
Classification & Departmentalization Absorption of

Collection of Overheads Overheads
a. Classification and Collection:
In this stage, expenses incurred are classified into various sections such as warehouse
expenses, showroom expenses, advertisement, storage cost, credit collection costs
etc. and then suitable cost account number is given to each head of expenses.
b. Departmentalization of Overheads:
In this stage, those items which can be recognized with a particular selling and
distribution department can be allocated to that department and those which cannot
be recognized that should be apportioned to different selling and distribution overhead
on some basis. The following basis can be used for some common items:
33
Items Basis of Apportionment
Advertisement and sales Value of sales
promotion
Showroom expenses, godown rent Area occupied
Insurance of finished goods Finished goods value
Credit collection expenses Credit sales or number of sales
orders
Royalty Sales value
General Administration expenses Number of orders or Number of
invoices
Then cost of each cost centres would be apportioned to various areas or territories on
equitable basis.
c. Absorption Overheads:
This stage involves charging of selling and distribution overheads of each area to the
different products sold in that area. This can be done by the following methods:
A. For Variable Overhead
i. Rate per unit sold
Total Selling and Distribution Overheads

Overhead Absorption Rate =
Number of Units Sold
ii. As a percentage of sales

Overhead Absorption Rate = x 100
Total sales value
B. For Fixed overheads

i. As percentage of works cost

Overhead Absorption Rate = x 100
Total Work cost
34
Illustration 13:
The data related to direct selling and distribution expenses are given below:
Freight ₹ 80
Insurance ₹ 20
Commission ₹ 120
Packing cases ₹ 20
For the year, estimated fixed selling and distribution expenses were ₹ 60000 and value
of sales was ₹ 300000.
Work cost of an item is ₹ 800 and selling price is ₹ 1600.
Determine final cost of an item given fixed selling and distribution expenses are
absorbed on the basis of percentage of sales.
Solution:
Final cost of an item
Items ₹ ₹
Work cost 800
Add: Selling and distribution

expenses
Variable: Freight 80
Insurance 20
Commission 120
Packing cases 20
240
+ fixed : 20% of sales value 320 560

(20% of 1600)
Total cost 1360
Profit 240
Selling price 1600
Working Notes:
Fixed selling and distribution overhead absorption rate = 60000 * 100
300000
= 20%
35
8. Under and Over Absorption of Overheads:
When a department uses predetermined overhead rate for charging overheads to
different products manufactured by it, then in that case, actual overhead may differ from
absorbed overhead. Two possibilities arise:
Figure 16: Absorption of Overheads
Under absorption Over absorption of

of overheads overheads
Under absorption of overhead

When the amount of overhead absorbed is less than the actual overhead incurred, it is
said to be under absorption of overheads.
Under Absorption = Actual Overheads – Absorbed Overheads
Over absorption of overhead

When the amount of overhead absorbed is more than the actual overhead incurred, it is
said to be over absorption of overheads.
Over Absorption = Absorbed Overheads – Actual Overheads
Causes of Under and Over Absorption

When overhead amount is estimated wrongly.
When the production level and hours to be worked estimated wrongly.
When method of production changes.
When productive capacity if over/under utilized.
Seasonal fluctuations in the overhead expenses.
Treatment:
1) Use of supplementary rate – When the difference between actual overhead
and absorbed overhead is significant and difference is due to normal reasons, in
that case, supplementary rate method is used.
It is calculated as
Supplementary Rate = Under/Over absorption of overhead
Actual Base
In case of under absorption, use positive rate to increase the cost of sales, stock
of finished goods and work in progress.
In case of over absorption, use negative rate to decrease the cost of sales, stock
36
of finished goods and work in progress.
2) Transfer to costing profit and loss account – when the difference between
actual and absorption overhead are insignificant and small and due to abnormal
reasons which are not within the control of management, in that case amount is
transferred to costing profit and loss account.
Under absorption -- Transfer to debit side
Over absorption -- Transfer to credit side
3) Carry over to the next year – This method is used
 When demand and production in an industry is not stable.
 When normal business cycle period is more than one year.
 When new projects involve more output in coming years that in initial
period.
Illustration 14:
In a factory overheads are absorbed at a predetermined rate of ₹20 per man- day. Man
days actually worked and total production overheads incurred were 300000 days and ₹
8300000 respectively.
60000 units were sold out of 80000 units produced.
After examining the reasons, it was found that 60% of the unabsorbed overheads were
due to abnormal reasons and the rest were due to increase in overhead cost. How would
you treat unabsorbed in cost accounts?
Solution: Actual overhead incurred= ₹ 8300000
Absorbed overheads= 20x 300000
= 6000000
Under absorbed overheads= actual overheads-absorbed overheads
= 8300000-6000000=₹ 2300000
Reasons for under absorption:
(1) Abnormal reasons=60% x 2300000=₹ 1380000
(2) Increase in overheads cost=40%x 2300000= ₹920000
Total units produced=80000 units
Supplementary overhead absorption rate=920000/80000
=₹11.5 per unit
Treatment
(1) ₹ 1380000 should be charged to costing profit and loss account because
under absorption is due to abnormal reasons.
(2) Under absorption of ₹ 920000 which is due to increase in cost will be charged
to production i.e. 80000 units at the supplementary rate of ₹ 11.5 p/u. Amount is
charged to:
Cost of sales = 60000x11.5 = ₹ 690000
Closing stock of finished goods= 20000 x 11.5 = ₹ 230000
Total = ₹ 920000
37
9. Treatment of certain items in Cost Accounts:
Interest on Capital:
There is an argument about the treatment of interest on capital in cost. Some
accountants have an opinion that interest on capital should be included in cost and some
accountant has an opinion that it should not be included in cost account.
Argument in favour of inclusion:
1. Wages are reward for labour and interest is reward on capital therefore like
wages, interest should also be included in the total cost.
2. Comparison of two jobs which requires different amount of capital or which are
completed in different time period, is not possible unless interest is considered.
3. If labour is replaced by machine or if less expensive machine is replaced by more

expensive machine, in that case cost under two methods is incomparable unless
interest is considered.
4. If interest is not included in accounts, true profit cannot be determined.
5. Calculation of total cost is not possible without interest, in case raw material is
used in different stages.
Arguments in favour of exclusion:
1. Interest payment is a pure finance internal matter which is not related with the
manufacturing cost and thus it should be excluded.
2. Total amount of capital on which interest is allowed is difficult to calculate.
3. The rate of interest that is to be charged is difficult to determine because of

market fluctuations.
4. If interest on capital is excluded, it would increase the cost of production and fair
interest rate which would create complications.
Conclusion: On the basis of above arguments, it can be concluded that interest should
not be included in the cost accounts but it should be considered for taking various
managerial decisions.
Depreciation:
Depreciation refers to decrease in the book value of fixed assets due to normal usage,
physical wear and tear, passage of time or any other cause. In order to find the true cost
of production it should be properly determined. The following methods are used to
calculate depreciation:
(i) Fixed Installment Method
(ii) Diminishing Balance Method
(iii) Machine Hour Rate Method
(iv) Revaluation Method
(v) Replacement Cost Method
38
Treatment of Depreciation:
Figure 17: Treatment of Depreciation
Factory Fixed Office Fixed Selling Distribution

Assets Assets Office Fixed Office Fixed
Assets Assets
Part of Part of Part of Part of

Production Administration Selling Distribution
Overheads Overheads Overheads Overheads
9.3 Packaging Expenses:

Depending on the situations the packaging expenses treatment are as follows:
Figure 18: Treatment of Packaging Expenses
If Primary Packing is required to protect the Part of Prime Cost

product
If Packing is required for transportation of Part of Distribution

goods overheads
If Packing is required to attract the customer Part of Selling

Overheads
If Special Packing is required at the customer Charged to

request specific order.
Bad Debts:
There is an argument about the treatment of bad debts. According to one opinion, it
should not be included in cost accounts because bad debts are financial losses. According
to another opinion, it should be included in cost accounts.
39
Figure 19: Treatment of Bad Debts
Included in
If emerge during the normal course of business. Selling
Overheads
Extraordinary or Abnormal Bad Debts Excluded from

cost accounts
Research and Development Costs:

Research expenses are those expenses which are incurred for searching and testing
the new techniques of production, new products, new use of materials etc. The
treatment of research cost is as follows:
 If associated with existing products then it is included in manufacturing
overheads.
 If it is related to a particular product then is directly charged to those Products.
 If it is an unsuccessful research it would be treated as deferred revenue
expenditure and charged to costing profit and loss account.
Development expenses are those expenses which are incurred on the production of
new or improved product, use of new or improve method etc.
 If development cost is related to a specific product it would be charged directly to
that product.
 If amount is considerable it should be charged to costing profit and loss account
as deferred revenue expenditure.
Idle Facilities:
It is that portion of total facilities which is not utilized because of many reasons such as
non availability of materials, power etc. The treatment of idle facilities is as follows:
Figure 20: Treatment of Idle Facilities
Due to Unpreventable reasons Included in Production

Overheads
Due to Avoidable reasons such as Charged to Costing

faulty planning, power failure etc Profit and Loss account
Training Expenses:
Training expenses are incurred for providing wages to trainees, running the training
department, training facilities, spoilage etc. If training expenses are incurred to provide
training to the factory workers then it should be included in production overheads. If it is
related to office, sales or distribution employees it should be included in administration,
selling or distribution overheads respectively. If labour turnover is high then training
expenses should be charged to costing profit and loss account.
Fringe Benefits:
Fringe benefits are extra benefits which are given to workers in addition to basic salary
40
in order to enhance moral and loyalty of the workers for e.g.: housing allowance, holiday
pay, leave pay, medical facilities etc. If the value of fringe benefits is substantial it
should be charged to production as direct wage by means of supplementary rate. If
value is not substantial it is included in production overheads.
Bonus:
If minimum bonus is paid to
 Factory direct workers Included in Direct labour cost
 Factory indirect workers Included in Production overheads
 Administration workers Included in Administration overheads
 Sales workers Included in Selling overheads
 Distribution workers Included in Distribution overheads
Night Shift Allowance:
When in a factory employee works during night hours he gets an extra amount which is
known as night shift allowance. The treatment of night shift allowance is as follow:
 If it is paid to fulfill demand beyond normal capacity it should be included in
production overheads.
 If paid to meet some customer order then it should be charged to specific order.
 Due to abnormal circumstances then it should be transfer to costing profit and
loss account.
Insurance:
 If insurance premium is paid for direct materials it would be included in direct
material cost.
 If insurance premium is paid for the plant and equipment then such cost would be
apportioned to different production departments on the basis of machine values.
 If it is paid for the fixed assets of administration department it would be included
in administration overheads.
 If it is paid for finished goods, fixed assets of distribution department it would be
included in distribution overheads.
Carriage and Cartage Expenses:

These expenses are incurred for moving the goods and materials from one place to
another.
Treatment of such expenses is as follows:
Carriage and Cartage Expenses Treatment
For the movement of direct materials It would be included in direct material cost.
For the movement of indirect It would be included in production overheads.

materials
For the movement of finished goods It would be included in distribution overheads
For the movement of direct/indirect Transfer to costing profit and loss account
materials/ finished goods due to
abnormal reasons
41
Repair and Maintenance Expenses:
The treatment of repairs and maintenance are as follows:
Figure 21: Treatment of Repairs and Maintenance
Related to Related to Related to Related to

Factory Administration Sales Distribution
Office Office Office
Production Administration Selling Distribution

Overheads Overheads Overheads Overheads
After Sales Service:

After sales service are provided during the guarantee period for e.g.: free repairs, free
replacement of parts etc.
 If after sale service includes free repair and replacement of inoperative parts and
components then it should be included in production overheads.
 If during transit some parts and components get damaged then cost of
replacement should be included in distribution overheads.
10. Comprehensive Illustrations:
Illustration 1:
The following details are available related to three Production departments A, B and C
and two service departments R and S of T ltd.
Particulars A B C R S
Area (sq m ) 2000 2500 3000 2000 500
No. of light points 80 120 160 80 40
Direct wages (₹) 24000 16000 24000 12000 4000
H.P of machines 120 60 100 20 -
Value of machines(₹) 96000 128000 160000 8000 8000
Working hours 4670 3020 3050
The following expenses were incurred during the year:

Rent – ₹40000, Electricity – ₹ 4800, indirect wages- ₹ 12000, Power- ₹ 12000,
Depreciation – ₹80000, canteen expenses- ₹ 80000
The service department cost is to be apportioned in the following manner:
42
A B C R S
R 20% 30% 40% - 10%
S 40% 20% 40% - -
Calculate overhead absorption rate per hour.

Solution: Overhead Distribution
Items Basis Total A(₹) B(₹) C(₹) R(₹) S(₹)
Rent Area 40000 8000 10000 12000 8000 2000
Electricity Light 4800 800 1200 1600 800 400

points
Indirect wages Direct 12000 3600 2400 3600 1800 600
wages
Power H.P of 12000 4800 2400 4000 800 -
machines
Depreciation Machine 80000 19200 25600 32000 1600 1600
value
Canteen exp. Direct 80000 24000 16000 24000 12000 4000
wages
Direct wages Actual 16000 - - - 12000 4000
Total 60400 57600 77200 37000 12600
Service deptt. 7400 11100 14800 (37000) 3700

R apportioned
Total 67800 68700 92000 - 16300
Service deptt. 6520 3260 6520 - (16300)

S apportioned
Total 74320 71960 98520 - -
overhead
Working hours 4670 3020 3050
Rate per hour 15.91 23.83 32.30

(₹)
Illustration 2.
From the data given below compute direct Labour hour overhead rate:
Total number of workers 200
Working days in a year 300
No. of hours per day worked 8
43
Idle time 10%
Factory overheads ₹2280000
Gifts to office staff ₹ 20000
Solution:
Total number of hours= No. of workers x working days in a year x hours per day
= 200 x300 x8 = 480000
Less: idle time (10%) = 48000
Direct labour hours worked = 432000
Direct labour hour overhead rate = Factory overheads

Direct labour hours worked
= 2280000/432000
= ₹ 5.27 per labour hour
Note: gifts to an office staff are not a part of factory overheads.

Illustration 3:
In a factory, the following data are given related to production department for a month:
Direct material consumed ₹ 90000
Factory overheads chargeable to deptt. ₹63000
Labour hours worked 6000 hours
Machine hours worked 5000 hours
The data related to job no 301 executed in the department during the period are as
follows:
Material consumed ₹ 15000
Labour hours 825 hours
Machine hours 600 hours
Calculate the production overhead absorption rates and overhead charged to job no 301
by the following methods:
(i) Direct material cost method
(ii) Direct labour cost method
(iii) Prime cost method
(iv) Labour hour rate
(v) Machine hour rate
44
Solution: Computation of Production Overhead Rates
Overhead Absorption Rate Production Overhead
charged to job no 301
Direct material =factory overheadsx100
cost method direct material cost = 70% 0f 15000
=63000/90000*100 =₹ 10500
=70%
Direct labour cost = factory overheadsx100
method direct wages =12375 x 84%
= 63000/75000*100 = ₹ 10395
= 84%
Prime cost method factory overheadsx100

prime cost =(15000+12375)x38.18%
=63000/(90000+75000)*100 =₹ 10452
=38.18%
Labour hour rate Factory overheads/labour hours

=63000/6000 =825 x 10.50
= ₹ 10.50 = 8662.5
Machine hour rate Factory overheads/machine hours

=63000/5000 =600x 12.60
= ₹ 12.60 =₹ 7560
Illustration 4:
The following data given below are related to B ltd which has three production
departments and service department for one month (25 working days of 8 hours each).
Each department works all days with full attendance.
Expenses Total Production Departments Service

Department
(₹)
P(₹) Q(₹) R(₹) A(₹)
Lighting 2200 400 600 720 480

Salary of supervisor 4000
Rent 1000
Welfare 1200
Others 2400 400 800 800 400
Supervisor salary 30% 30% 20% 20%
No. of workers 60 80 40 20
Floor area ( sq m ) 1200 1600 1200 1000
Service deptt. Renders 50% 30% 20%

services to production
deptt.
Calculate labour hour rate of each production department.
45
Solution: Calculation of Labour Hour Rate
Expenses Basis of Production Departments Service

Apportionment Department
P(₹) Q(₹) R(₹) A(₹)
Lighting Actual 400 600 720 480
Salary of supervisor % given 1200 1200 800 800
Rent Area Occupied 240 320 240 200
Welfare No. of workers 360 480 240 120
Others actual 400 800 800 400
Total 2600 3400 2800 2000
Service deptt. A 1000 600 400 (2000)

apportioned (5:3:2)
Total(a) 3600 4000 3200
No. of working hours(b) 12000 16000 8000
Labour hour rate (a/b) 0.3 0.25 0.4
Working Notes:
No. of working hours = No. of workers x working days x hours each day
Deptt. P = 60 x 25 x 8= 12000 hours
Deptt. Q = 80 x 25 x 8 =16000 hours
Deptt. R = 40 X 25 X 8= 8000 hours
Illustration 5:
A machine is installed in a factory. From the following information related to a machine
calculate comprehensive machine hour rate.
Cost of machine ₹ 380000
Charges of installation ₹20000
Working life of machine 5 years
Repairs 50% of depreciation
Power expenses @ 20 paisa per unit ₹ 12000
Following charges were incurred related to eight hourly days:
Power ₹ 48
Lubricating oil ₹ 40
Consumable stores ₹ 56
Wages ₹ 160
46
Solution:
Computation of Comprehensive Hour Rate
Particulars Per hour (₹)
Standing charges:
Lubricating oil(40/8) 5
Consumable stores(56/8) 7
Wages(160/8) 20
Running charges:
Depreciation (380000+20000)/(5x2000) 40
Repairs ( 50% of depreciation) 20
Power ( 48/8) 6
Machine hour rate 98
Illustration 6:
A company purchased a new machine for ₹ 10 lakhs. Total cost of all machines including
new machine are ₹ 150 lakhs. The following details are also given:
Expected life of the machine 10 years

Scrap value ₹ 10000
Repairs for the machine ₹ 4000 p.a
Expected no. of working hours of the machine 4000 p.a
Insurance premium for all the machines ₹ 9000 p.a
Power consumed for the machine per hour (@ 80 paisa per unit) 50 units
Area occupied by the machine 200 sq ft.
Area occupied by other machine 3000 sq ft.
Rent of the department ₹ 19200 p.a
Lighting charges for 40 points for the department. Out of which 6 points are for the
machine ₹ 240 per month. For the new machine calculate machine hour rate.
47
Solution:
Particulars Per Per hour

annum(₹) (₹)
Standing charges:
Insurance premium(9000x1000000)/15000000 600
Rent (19200x 200)/3200 1200
Lighting(240x12x6)/40 432
Total standing charges 2232
Standing charges per hour (2232/4000) 0.558
Running charges:
Depreciation (1000000- 24.75
10000)/(10x4000) Repairs(4000/4000) 1
Power(50x0.8) 40
Machine hour rate 66.308
Illustration 7:
The following data related to a production departments A and B and service department
P of a manufacturing company for 2007 at standard capacity:
Departments
A B P
Direct labour cost ₹200000 ₹ 100000 -
Floor area (in sq m ) 60 30 10
Factory overheads identifiable to ₹184000 ₹106000 ₹82000

department
Factory overheads not identifiable to ₹ 20000
department: Factory rent , rates
and taxes
Service department cost would be equitably apportioned to other production
departments on direct labour cost basis.
Department A operates 40 hours in a week. There are 6 machines in the department and
each machine has remained idle for 200 hours in 20o7 for repairs, holidays etc.
48
Calculate overhead absorption rate:
(i) For Department A based on machine hours
(ii) For Department B based on direct labour cost.
Solution: Calculation of Overhead Absorption Rate
Departments
A(₹) B(₹) P(₹)
Factory overhead 184000 106000 82000

Factory rent, rates and taxes(6:3:1) 12000 6000 2000
20000
Total 196000 112000 84000
Service Deptt. P apportioned to production 56000 28000 (84000)
deptt (2:1)
Total cost 252000 140000 -

No. of machine hours 11280
Machine hour rate (252000/11280) ₹22.34
per m.h
Direct labour cost 100000

Direct labored cost percentage 140000/100000*
100
=140%
Working Notes:
Total machine hours= 40x6x52= 12480
(-) for repairs= 200x6 = 1200
Effective machine hours = 11280
Illustration 8:
The following information is given related to a production department for a period.
Budgeted Data Actual
Data
Direct material ₹ 50000 ₹ 70000
Direct labour ₹ 100000 ₹ 125000
Production overheads ₹ 100000 ₹ 115000

Direct labour hours 25000 31250
Machine hours 20000 25000
The actual data related to a job XYZ carried out by this department during the period are
as follows:
Direct material- ₹ 3000, direct labour –₹ 1500, direct labour hours- 375
Machine hours-375
Calculate:
49
(i) Predetermined production overhead absorption rate for a period based on
percentage of direct material cost and machine hours
(ii) Based on rates calculated above calculate production overheads to be charged
to job XYZ
(iii) Assuming absorption based on machine hour to be used calculate under/over
absorption of overheads for the period.
Solution: (i) Direct material cost (percentage method)
= production overheads/material cost* 100
= 100000/50000 * 100= 200%
Machine hour rate = production overheads/machine hours
= 100000/20000= ₹ 5 per hour
(ii) Production Overheads Charged to Job XYZ
Direct material Machine hour rate

cost % method(₹) method(₹)
Direct material 3000 3000
Direct labour 1500 1500
Prime cost 4500 4500
Production overheads:
Direct material % method 200% of 3000
=6000
Machine hour rate method 5x375=1875
Cost of production 10500 6375
(iii) Absorbed overheads= machine hours x machine hour rate

= 25000 x 5= ₹ 125000
Over absorption= absorbed overheads-actual overheads
= 125000-115000= ₹ 10000
Illustration 9:
The information related to a cost centre in a factory is as follows:
Normal working week 35 hours
Number of machines 10
Weekly loss of hours due to maintenance 5 hours per machine
Estimated annual overheads ₹ 75000
Estimated direct wage rate ₹ 4 per hour
No. of weeks worked per year 50
Actual data for 4 week period are as follows:
Overheads incurred ₹ 7500
Wages incurred ₹ 3500
Machine hours worked 1100 hours
50
Calculate: (a) overhead absorption rate based on machine hour rate
(b) Amount of over or under absorption of both wages and overheads
Solution:
(a) Effective working hours per year
= No. of machines x effective hours per week x no. of weeks p.a
=10 X (35-5) X 50
= 15000
Annual overheads= ₹ 75000
Overhead absorption rate= Annual overheads/Effective working hours p.a
= 75000/15000
= ₹ 5 per hour
(b) Absorbed overheads= 1100 x 5= 5500
Actual overheads= ₹ 7500
Under absorption of overheads= 7500-5500
Wages absorbed= 10 x 35 x 4 x 4= ₹ 5600
Actual wages = ₹ 3500
Over absorption of wages = ₹ 2100
Summary:
 Overheads are the indirect costs that are incurred during the course of manufacturing
an item, rendering a service or running a department but cannot be debited directly
or wholly to an item, service or department.
 Overheads can be classified according to function wise, variability wise, nature wise
and control wise.
 Four stages are involved in the distribution of overheads which includes codification
and collection, primary distribution, secondary distribution and absorption of
overheads.
 Codification means assigning codes or symbols to each items of overheads.
 Overheads are collected from different sources such as cash memo, invoice, material
requisition, cost journal, subsidiary records and wage analysis book.
 Primary distribution involves allocation and apportionment of overheads among
different production and service departments
 Secondary distribution involves charging of overheads of service department among
production departments.
 Absorption of overheads means allotting the overhead expenses of a particular
production department among the products manufactured by it.
 Different methods are used for absorbing the overheads such as direct material cost
method, direct labour cost method, prime cost method, machine hour rate, labour
hour rate, dual hour rate and per unit of output method.
 When actual overheads are different from absorbed overheads the difference is
known as under/over absorption of overheads.
51
 Three methods are used for disposal of under/over absorption of overheads:
(i) Transfer to costing profit and loss account
(ii) Carry forward to the next year
(iii) Use of supplementary rate
Exercises:
A) Short Answer Questions
1. What do you mean by overheads? Give the functional classification of overheads.
2. Differentiate between fixed and variable overheads with examples.
3. Write the stages that are involved in accounting for overheads.
4. Distinguish between allocation and apportionment of overheads.
5. What do you mean by absorption of overheads?
6. Distinguish between machine hour rate and comprehensive machine hour rate.
7. Differentiate between blanket overhead rate and multiple overhead absorption
rates.
8. What is machine hour rate?
9. What do you mean by under/over absorption of overheads?
B) Long Answer Questions
1. Describe the stages that are required in overheads accounting.
2. Explain the methods of secondary distribution of overheads.
3. Explain the different methods of absorption of production overheads.
4. Describe the steps involved in computation of machine hour rate.
5. Explain the causes of under/over absorption of overheads and how it is treated
in cost accounts.
6. Differentiate between machine hour rate and labour hour rate.
7. Describe the treatment of following items in cost accounts.
(i) Interest on Capital
(ii) Bad Debts
(iii) Research Expenses
C) Numerical Questions
1. The following data are related to a production company which has three
production departments X,Y and Z and two service departments A and B. Total
overheads as per primary distribution are:
X-₹12600, Y-₹14800, Z-₹5600, A-₹ 9000, B –₹4000
Company Apportion the overheads of the service departments cost to
Production department on the basis of given percentages:
X Y Z A B
A 40% 30% 20% - 10%
B 30% 30% 20% 20% -
52
Required: calculate production department overheads by apportioning service
department overheads to production department using simultaneous method.
[Total of X-₹18100. Y-₹19300, Z-₹8600]
2. The following particulars are given below related to a factory. You are required
to prepare a statement showing distribution of overheads.
Item Production departments Service
departments
P(₹) Q(₹) R(₹) A(₹) B(₹)
Direct wages(₹) 4000 6000 8000 2000 4000

Direct 2000 4000 4000 3000 3000
materials(₹)
No. of workers 200 300 300 100 100
Electricity 8000 6000 4000 2000 2000
(Kwh.)
Light points 20 32 8 12 8
(Nos.)
Value of 120000 80000 60000 20000 20000
assets(₹)
Area(Sq. m ) 300 500 100 100 100
The following expenses were incurred during the period:

Power-₹1100, lighting-₹200, Stores overheads-₹ 800, Fringe benefits- ₹ 3000,
Depreciation- ₹36000, General overheads- ₹ 12000, Rent- ₹ 550
Distribute the expenses of service department B in the ratio of 2:3:4 and those of
A in the ratio of 5:3:2 to department P, Q and R respectively.
[P-₹ 24886, Q-₹ 21046, R- ₹ 19718]
3. From the following information calculate machine hour rate for a new machine .
Cost of machine ₹184000
Working life of the machine 36000 hours
Scrap value at the end of life ₹ 4000
Machine will work annually for 3600 hours
Repairs charges for the whole period of life ₹21600
Rent of department (area occupied by this machine
is ¼ of total space) ₹ 15600 p.a
Power consumption 10 units per hour @ ₹4 per unit
Light (24 points for the deptt. Out of which 4 point used
In this machine) ₹ 5760 p.a
Supervisor salary (devote 1/5th time in new machine) ₹120000 p.a
Insurance for machine ₹720 p.a
Cotton waste ₹ 1200 p.a
[Machine hour rate-₹54.15 per hour]
53
4. Calculate machine hour rate
Installation cost ₹600
Expected life of machine 10 years
Scrap value ₹ 1000
Rent (5% area is occupied by this machine) ₹ 8000 p.a
Insurance for this machine ₹ 300 p.a
Repair for the factory (12% related to this machine) ₹ 2000 p.a
Consumable stores related to this machine ₹ 550
Total production services (20% related to this machine) ₹ 8000
Power cost 50 paisa per working hour. The year consists 250 working days of 8
hours each and machine will remain idle 40% of this time.
[Machine hour rate-₹7.825]
5. A company has two departments X and Y. Manual work is done in department X
and machine work is done in department Y. following annual data is given below:
Direct wages ₹50000
Factory overheads directly allocated to department X ₹30000
Factory overheads directly allocated to department Y ₹45000
Factory overheads not allocated directly to both departments amount to ₹ 10000
which is to be apportioned in the ratio 1:1.
In department Y there are 10 machines of similar size. Every machine work 45 hours
in a week and remain idle on account of holidays and maintenance etc. for 160 hours
annually. Compute overhead absorption rate using
(i) Direct labour cost percentage method
(ii) Machine hour rate method
[(i) 70% (ii) ₹2.293 per hour]
6. The following data are related to production department for the month of January
2011:
Direct materials ₹ 27000
Labour hours worked 18000
Machine hours 15000
Overheads chargeable to the department ₹ 18000
The additional information related to one order carried out by the department is as
follows:
Material used ₹ 3000
Labour hours worked 1600
Machine hours 1200
Calculate overhead absorption rate and overheads charged to the order by:
54
(i) Percentage to direct material cost method
(ii) Labour hour rate method
(iii) Machine hour rate method
[(i) 66.66%, ₹2000 (ii) ₹ 1 p/h, ₹ 1600
(iii) ₹1.20 p/h, ₹1440]
7. From the following data calculate machine hour rate related to a machine for the
month of July 2010:
Estimated scrap value ₹ 40000
Working life in hours 20000 hours
Repairs over the life of machine ₹ 500000
Standing charges related to this machine for July 2010 ₹8000
Power consumed by the machine @ ₹6 per unit ₹ 12000
The machine consumes 10 units of power per hour.

[Machine hour rate-₹155]
8. The following data related to a new machine are given below :

Purchase price ₹ 200000
Installation charges ₹ 50000
Rent per Quarter (25% of area is occupied) ₹1875
Lighting for total area ₹500 per month
Supervisor salary (devotes 1/6 of his time for this machine) ₹ 15000 p.a
Insurance premium for the machine ₹ 1500 p.a
Repairs for the machine ₹ 2500 p.a
Consumable stores for the machine ₹2000 p.a
Power consumed 4 units per hour @ ₹100 per 100 units
Estimated life of machine 10 years
Scrap value at end of 10 years ₹ 50000
Machine is expected to run 10000 hours in its life. Calculate machine hour rate.
[Machine hour rate-₹35.875]
9. The following data are related to the factory overheads of four production
departments of a company for the year 2009-2010:
55
Department P ₹39000
Department Q ₹ 9000
Department R ₹ 8000
Department S ₹ 5000
Overheads are recovered according to the following methods for different
departments.
Department P @₹ 3 per machine hour for 28000 hours
Department Q @ ₹ 2.60 per labour hour for 6000 hours
Department R @ 80% of direct labour cost of ₹12000
Department S @ ₹2 per item for 1900 items.
Find out the amount of over or under absorbed overheads for each department.
[P=+ ₹45000, Q=+₹6600, R=+ ₹1600, S=-₹1200]
Glossary:
 Cost centre: It is a unit of an organization for which cost is determined for cost
controlling purposes.
 Standing Order Number: It is a code that is given to items of factory
overheads.
 Cost Account Number: It is a code that is given to the items of office and
administration or selling and distribution overheads.
 Material Requisition- It is a document used to require the issue of specified
material from store.
 Invoices: It is a non negotiable instrument which is issued by a seller to a buyer
which specifies the quantities, date, mode of transport, price, delivery and
payment terms.
 Primary Distribution: It is an apportionment of production overheads to
production and service departments.
 Apportionment of Overheads: It is splitting up an item of overhead and
charged to the department on some suitable basis.
References:
Work Cited and Suggested Readings
 Tulsian , P.C., “ Introduction to cost accounting”, S.Chand and Co., New Delhi
 Agarwal,N.K and Deepali Jain, “ Cost Accounting Fundamentals”, second edition,
Asian Books Private Ltd., New Delhi
 Maiya, Umesh, “Cost Accounting”, Kitab Mahal
 Maheshwari, S.N., S.K. Maheshwari and S.N Mittal , “ Elements of Cost
Accounting”, Shree Mahavir Book Depot, New Delhi
 Jain, S.P. and K.L. Narang, “ Cost Accounting Principles and Practice”, Kalyani
Publishers, New Delhi
 Arora, M.N., “ Cost Accounting”, Himalaya Publishing House, New Delhi
 Gupta, Nirmal and Chhavi Sharma, “ Cost Accounting Theory and Practice”, Ane
Books Pvt. Ltd, New Delhi.
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Course: Commerce

Subject: Cost Accounting

Indirect + Indirect + Indirect =

2) Office and Administration overheads – Office and Administration overheads

Figure 2: Categorization of Overheads

Factory / Manufacturing Overheads

b. Variable overheads – If the volume of production increases and decreases and

c. Semi-variable overheads – It is mixture of both fixed and variable overheads.

Value Addition 1: Activity

Rent and insurance of building, Depreciation, Salary of a manager,

Discuss the list classified by you in your peer group.

b. Uncontrollable overheads – Those overheads which cannot be controlled by

Codification & Collection of Overheads

Codification and Collection of Overheads:

Overheads Allocation Cost Centres

Two stages are involved in departmentalization of overheads:

5.2.1 Allocation of Overheads:

5.2.1 Apportionment of Overheads:

Deals with whole Deals with proportion

Overheads Items Basis

Power H.P of machinery or no. of

Depreciation, insurance and repairs of Capital value

Rent ,rates and taxes, insurance, Floor area

Delivery expenses Value or weight of materials

Stores overheads No. of requisition or value of

Value Addition 2: Activity

Production Department Service

Items Basis Total Production Service

5.3 Reapportionment or Secondary Distribution:

Service Cost Centre

Methods of Secondary Distribution:

Direct Step Distribution Reciprocal Services

Simultaneous Equation Method

Figure 8: Apportionment of Service Department Cost to Production Department

Service Department Service Department

Production Department Production Department

Other information relating to departments:

Horse power 150 150 100

Value of stores requisition(₹) 1250 750 500

Required: Distribute the cost of service department to production departments.

Item Basis of Total(₹) X(₹) Y(₹) Z(₹)

Stores Value of store 4000 2000 1200 800

Canteen No. of workers 1000 400 300 300

Total 89600 34200 29000 26400

5.3.2.2 Step Distribution Method/Non Reciprocal basis:

Service Department A Service Department B

Production Department X Production Department Y

X 50% 30% - - 20%

Y 30% 50% 10% - 10%

Prepare overhead distribution summary.

Particulars A(₹) B(₹) X(₹) Y(₹) Z(₹)

Overheads as given 106000 14000 34000 60000 26000

Cost of service deptt. Y

Cost of service deptt. X

Cost of service deptt. Z

Total 160000 80000 - - -

Reciprocal Services Method:

Service Department A Service Department B

Production Department Production Department

In reciprocal basis, following methods are used to assign the costs:

X 50% 40% - 10%

Y 30% 50% 20% -

A(₹) B(₹) X(₹) Y(₹)