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Payroll Procedures
THEINTACTFRONT14 FEB 2019 2 COMMENTS
1. Manual Method:
Under this method the attendance time of employees are recorded either by the time keeping
officer or by employees themselves.
Under this method, an attendance register is maintained for recording the attendance time. This
method is followed in small sized concerns. This method is more suitable for recording the
attendance time of clerical staff and other staff officers. Under this method two separate columns
are maintained corresponding the names of every employee.
One column is to record arrival time and second column for recording departure time. The
attendance time can be marked by the time keeping officer by calling out the name of every
employee or alternatively the attendance register may be signed by every employee.
Merits:
(1) It is simple to maintain attendance register.
Demerits:
(1) This method is not suitable for medium and large sized businesses.
(2) Where the attendance is marked by calling out the names of employees, there will be hold-
ups near the factory gate.
(4) Time keeping officer may show step motherly treatment to his friends and this will defect the
purpose of time keeping.
(5) It involves additional work for posting the entries into the individual working record.
1. Token or Disk Method:
Under this method, each worker is allotted an identification number and that number is suitably
painted on engraved on a round metal to ken (or disk) with the hole in it. All such token are hung
in a serial order on a board at the factory gate.
As the worker arrives he takes his token from the board and puts it in a box kept nearby, which is
specially kept for this purpose. After the fixed time the second board is removed. Those coming
late have to hand over their token personally at the time office so that exact time of their arrival
can be noted.
The time office records attendance on the basis of token in the box. The absentees are indicated
by the missing tokens. Similar procedure is followed at the departure time in the evening.
Merits:
Demerits:
(1) Dishonest practice of inserting a disc of an absentee worker by another employee may take
place.
(2) It involves more clerical work to prepare an attendance record with the help of disc, where
any mistake is committed in recording attendance time on the basis of disc and in case of any
disputes between an employee and time keeping officer, disc cannot offer any proof.
2. Mechanical Method:
In modern age, mechanical methods of time keeping are used to save time and ensure greater
accuracy. The machines record the exact time of the arrival and departure of employees. Thus,
they avoid possible disputes and difference of opinions between employees and time keeping
officers. Mechanical methods are used in medium and large sized industries as small sized
concerns cannot afford to invest more capital on such equipment.
The worker while entering into the gate turns the dial arm. He then presses the button
corresponding to his clock number. The time of his arrival is recorded on a sheet of paper kept
inside the machine.
The same procedure is followed before the employee leaves the factory gate.
Merits:
(2) Provision can also be made out not only to record time but also to calculate wages.
Demerits:
(2) Time of arrival and departure and separated out in two different sheets of paper which require
additional clerical work.
(3) A worker cannot see the time he has booked and disputes may arise afterwards.
This is a machine which is fitted with a clock on each side of which there is an ‘in’ and ‘out’
rack which contains the cards of the employees. The worker who enters the gate takes his and
from the ‘in’ rack, inserts it in the machine.
On pressing a lever the time of arrival is recorded on the card. Then the card is placed in the
‘out’ rack. At the time of departure from the factory the worker removes his card, inserts it in the
machine to record the time of departure and finally places it in the ‘in’ rack.
Merits:
(2) The absence of worker can be checked by a mere look at the ‘out’ rack.
This type of machine is most commonly used in small sized business enterprise where
supervision for time recording does not arise.
(1) It is a machine which is fitted with a clock and is connected to a printing mechanism on a roll
of paper.
(2) To operate the machine, the employee opens the shutter by pressing a lever which is at the
side of the machine. This enables to uncover a small signature window.
(3) The employee signs in this signature window and as he signs, the day and time is
automatically recorded.
(4) When the lever is released, the paper roll inside the machine is advanced, the shutter slides
back over the signature window, and the machine is ready for the signature of the next worker.
Merits:
Demerits:
(1) The worker’s name does not appear as per the pay roll order.
(2) Breakdown in the machine leads to stoppage in the recording of attendance time.
Payroll Procedures
Payroll is a list of employees who get paid by the company. Payroll also refers to the total
amount of money employer pays to the employees. As a business function, it involves:
1. Developing organization pay policy including flexible benefits, leave encashment policy,
etc.
2. Defining payslip components like basic, variable pay, HRA, and LTA
3. Gathering other payroll inputs (e.g., organization’s food vendor may supply information
about the amount to be recovered from the employees for meals consumed)
4. The actual calculation of gross salary, statutory as well as non-statutory deductions, and
arriving at the net pay
5. Releasing employee salary
6. Depositing dues like TDS,PF, etc. with appropriate authorities and filing returns
A payroll officer needs to do careful planning. There are always ongoing tasks that need
attention and a constant need to monitor changes to withholdings, contribution to social security
funds, etc. The entire process can be split into three stages, pre-payroll, actual payroll and post
payroll activities.
Pre-payroll activities
Defining payroll policy
The net amount to be paid is affected by multiple factors. The company’s various policies such
as pay policy, leave and benefits policy, attendance policy, etc. come into play at that time. As a
first step, such policies need to be well defined and get approved by the management to ensure
standard payroll processing.
Gathering inputs
Payroll process involves interacting with multiple departments and personnel. There can be
information like mid-year salary revision data, attendance data, etc.
In smaller organizations, these inputs are received from a consolidated source or fewer teams.
However, in a larger organization, the task of gathering data may look overwhelming. If you are
using a smart payroll software having integrated features like leave and attendance management,
employee self-service portal, etc. inputs collection process does not remain a problem.
Input validation
Once inputs are received, you need to check for validity of the data concerning adherence to
company policy, authorization/approval matrix, right formats, etc. You also need to ensure that
no active employee is missed out and that no inactive employee records are included for salary
payment
At this stage, the validated input data is fed into the payroll system for actual payroll processing.
The result is the net pay after adjusting necessary taxes and other deductions. Once payroll
process is over, it is always a good practice to reconcile the values and verify for accuracy to
avoid any errors.
Post-payroll process
Statutory compliance
All statutory deductions like EPF, TDS, ESI are deducted at the time of processing payroll. The
company then remits the amount to the respective government agencies. The frequency can vary
depending on the type of the dues. In most cases, payment of dues is made via challans. After all
dues are paid return/report are filed. E.g., for filing PF return, ECR is generated and filed.
Payroll accounting
Every organization keeps a record of all its financial transactions. Salary paid is one of the
significant operating costs which has to be reported in the books of accounts. As part of payroll
management, it is essential to check that all salary and reimbursement data is fed accurately into
accounting/ERP system.
Payout
You can pay salary by cash, cheque or bank transfer. Typically organizations provide employees
with salary bank account. Once you complete payroll, you need to ensure that company’s bank
account has sufficient funds to make the salary payment. Then you need to send a salary bank
advice statement to the concerned branch. This statement is issued with particulars like employee
id, bank account number, amount of wages, etc. If you are opting for a payroll software that has
employee self-service portal, you can easily publish the payslips and employees can log-in to
their account and access the payslips.
Reporting
Once you complete payroll run for a particular month, finance and high management team may
ask for reports such as department wise employee cost, location wise employee cost, etc. As a
payroll officer, it becomes your responsibility to dig into the data and extract required
information and share the reports.
While computing salary you need to consider all these deductions and contributions. Income tax
is one such deduction. At the beginning of the year, the employee is asked to make a declaration
about his additional incomes, tax saving investments, etc. called as ‘income tax declaration.’
Accordingly, employee’s tax liability is calculated, and TDS is deducted.
Overtime, idle time and incentives
THEINTACTFRONT14 FEB 2019 3 COMMENTS
Idle time means the amount of time the workers remain idle in a normal working day. The idle
time is usually caused by a sudden fault in machine or equipment, power failure, lack of orders
for the product, inefficient work scheduling, defective materials and shortage of raw materials
etc. The cost associated with idle time is treated as indirect labor cost and should, therefore, be
included in manufacturing overhead cost. For example, the normal weekly working hours of a
worker are 48 and he is paid @ $8 per hour. If he remains idle for 6 hours due to power failure,
then the cost of 42 hours would be treated as direct labor cost and the cost of 6 hours (idle time)
would be treated as indirect labor cost and included in manufacturing overhead cost.
The amount of $16 is overtime premium and is a part of manufacturing overhead cost.
A few firms treat direct labor related fringe benefits as addition to direct labor cost which is
considered a more superior practice.
Direct labor: This cost is charged to all units produced during the reporting period. The
basis for charging the cost is the number of hours of labor actually used in the production
process.
Indirect labor (factory): This cost is assigned to a cost pool, from which it is allocated
to the units produced during the reporting period. Depending on the level of allocation
sophistication, several cost pools may be used, each of which has a separate allocation
methodology. For example, a cost pool for real estate costs could accumulate factory rent, and
then be allocated out based on the amount of square footage used. Meanwhile, another cost pool
for maintenance costs could accumulate maintenance labor and equipment costs, and be
allocated based on machine hours used.
Indirect labor (administrative): This cost is charged to expense in the period incurred.
It never appears in the balance sheet as an asset.
The only type of labor that should be included in the direct labor classification is for those
employees directly involved in the manufacturing process, such as people working on an
assembly line or operating machinery. It does not include any support or supervisory staff, such
as the factory janitorial, maintenance, administrative, and management employees.
Direct labor should vary in concert with the amount and types of units produced, since this type
of labor is considered to be entirely variable. Indirect labor is much less likely to change with
production volume, since it represents the overhead of a business that is needed to support any
level of operations.
Under individual wage incentive plans three categories of personnel’s can be included. They are
Production workers or blue dollar workers, white collar workers such as salesman, and
managerial personnel’s. All these categories of employees have different needs, they differ in
qualification and type of work, and therefore separate plans are designed for them.
Under these plans, workers are rewarded individually when their performance exceeds pre
determined standard. Individual workers earn a bonus if they work more and produce more.
These plans are therefore known as premium plans. These plans are either time based or
production based.
A standard time is determined for doing a job. A standard time serves as the basis of giving
bonus to the workers if they meet or exceed the standard. The worker is said to be efficient if he
completes his job in less than the standard time. In order to reward him for his efficiency, he may
be given bonus under an appropriate incentive plan.
Incentive wage plan have following advantages:
(1) The standard output is determined on the basis of time and motion studies by the specialists
and the rates of wages are fixed for different jobs on the basis of job evaluation. This stimulates
workers to work more.
(2) Increase in output leads to lowering of per unit cost, hence a direct gain to the employer.
(3) Less supervision is required as the workers are motivated to work more. This saves
supervisor’s time for supervision. He can utilize this time for other more important work.
(4) No conflict between employees and employers as the needs of both are satisfied because
employees are rewarded for their efficient work and employers are happy with the increased
output.
Disadvantages:
(1) Even though output is increasing the quality is at the receiving end. Employees give more
stress on increase in output neglecting the quality. Employees become quantity conscious and not
quality conscious.
(2) Employees oppose the introduction of advanced and modern techniques of production
because of the fear that they may lose extra payment for extra output produced by them.
(5) Slow workers become jealous of fast workers because comparatively their earnings will be
less than their counterparts.
(6) This system increases their earnings. They may therefore put a demand for increased
minimum wages.
(7) Management faces difficulties in determining the rate of bonus to be paid. Fewer rates may
aggrieve the workers and high rates may reduce their efficiency.
This method is invented by Mr. Halsey. Under this payment of time wages to the worker is
assured. He is given an option to work on premium. A standard time for standard output is fixed
on the basis of past experience. If a worker finishes the work earlier than the prescribed time, he
is rewarded by paying him premium or bonus. The premium or bonus is calculated on the basis
of time saved in performing a job. The payment of premium is in addition to the time wages for
which he is entitled even though time is not saved. This plan is a combination of time and piece
wages. A care should be taken that premium rate be moderately fixed.
Earnings = Time Taken x Time rate + 50 percent of time saved x Time rate
= 6 x 1 + 50/ 100 x 2x 1
=7
Merits:
(1) It assures time wages to the average workers and offers extra payments to the efficient and
hard workers.
(3) It reduces labour cost due to increased production. Premium is shared by employer.
Demerits:
(1) The standard time for standard work is fixed on the basis of past performance and no new
standard are fixed.
(2) It creates dissatisfaction because employer also shares a part of incentive earned by the
worker.
(3) The management cannot force the worker to produce more after finishing the standard output.
(4) The standard time may not have been properly fixed.
Rowan Plan:
This system of wage incentive plan was invented by James Rowan of Scotland. It is a modified
form of Halsey plan. It is similar to Halsey plan except in the calculation of premium.
The premium is calculated as the ratio of the time saved to the standard time multiplied by the
time taken on the job.
Earnings = Time taken x Time rate + Time Saved / Time Allowed x Time Taken c Time Rate
= 6 x 1 + 2/8 x 6 1
=8.5
Merits:
(2) Employers are also benefitted when the efficient workers get bonus.
(3) The efficient workers get bonus at a diminishing rate if they save more than 50 percent of
standard time. This checks them to overstrain themselves and maintain quality.
Demerits:
(1) The worker is discouraged to achieve saving in time more than 50 percent of the standard
time.
(2) The calculation of premium is complex and hence cannot be easily understood by the
workers.
Under this plan minimum time wage is guaranteed to the workers. Conditions of work are
standardized and a standard output is fixed which is to be completed within a specified period of
time. A worker attaining 66.66 percent efficiency gets a minimum b6nus. The percentage of
bonus goes up with the increased efficiency up to 20 percent of the guaranteed wages.
Merits:
(1) The workers minimum wages are assured. If worker is unable to produce 66.66 of the
standard output, he is not deprived of his daily wage.
(2) There is enough scope for earning more and more for the efficient workers. The plan is
therefore very beneficial to extra ordinary workers.
Demerits:
(1) The drawback of this plan is that it offers bonus to the workers who have efficiency less than
100 percent.
Bedeaux Point Plan:
Like other wage incentive plans the time wage is guaranteed in this plan also. Under this plan the
amount of work done by a worker per minute is taken as standard work unit. This is known as
Bedeaux point ‘B’. The standard time for a job in the number of Bs allowed completing it. Let a
work gets completed in 60 Bs taken as a standard per hour. Now if a worker completes it earlier
or earns more than 60 Bs, gets a premium of 75 percent for the number of Bs i.e. time saved. The
standard work unit B includes the time of work as well as rest.
Standard time allowed to complete the job ‘St’ = 8 hours. Standard number of points for that job
‘Ns’= 8 x 60 = 480
Merits:
(1) Minimum wages are guaranteed to the workers even though they fail to complete the job
within the standard time.
(2) Since one fourth of wages for time saved goes to the foreman, he is induced to get higher
productivity from his workers.
(3) The plan is most suited to the industrial units where worker is expected to perform more than
one jobs because under this plan jobs can be reduced to standard unit B.
Demerits:
(1) Calculations under this plan is complex and therefore is difficult for workers to understand.
(2) Foreman is also entitled for one fourth share of bonus which workers do not like. They feel
cheated.
Under these plans, a standard of output is determined on scientific basis. The payment of wages
is made on the basis of number of units are produced. Efficient workers are benefitted because
they get wages at higher rates. The following are the production based incentive plans.
This plan is devised by F.W. Taylor. Under this system day wages are not guaranteed. Taylor
believed that the standard of performance can be accurately fixed by means of time and motion
studies. After fixing a standard task two different piece rates are prescribed for payment of
wages. Low piece rate to less efficient and high piece rate to more efficient workers. A high
piece rate is payable to the workers whose performance is equal to or more than the standard
prescribed.
A low rate is meant for those who do not achieve the set standard. This system of wage payment
rewards efficient workers and penalize the slow workers by paying at low rate. This plan suits to
those units where direct expenses are more than the cost of labour. The wage plans proposed by
H. L. Gantt and Merrick are improvement over the Taylor’s differential piece rate of wages.
Merits:
(1) This incentive plan provides more earnings to efficient and penalize less efficient workers.
This differential in wage may enthuse less efficient workers to work more.
(2) Total output goes up because every worker wants to improve his efficiency thereby
increasing their own earnings and output.
Demerits:
(2) The penalty for low efficiency is very high for those whose productivity in less than the set
standard.
(3) This may promote disunity among workers because of dual standards set for efficient and less
efficient workers. This will also lead to jealousy among workers.
Under this plan the workers are paid according to their efficiency in performance of jobs. Three
different piece rates are offered to the workers with different efficiencies thus dividing them into
three different categories.
The workers having efficiency less than 80 percent of the standard are paid as per basic piece
rate prescribed. The workers having efficiency more than 80 percent but less than 100 percent of
the standard gets wages at higher rate by 10 percent. The workers having 100 percent efficiency
get wages at the highest rate of 20 percent in addition. These systems enable the less efficient lot
to improve their efficiency to increase their earning.
Merits:
It is a liberal plan giving further chance for workers to increase their efficiency and to enhance
their earnings. It is a morale booster for hard working and efficient workers.
Demerits:
(1) This plan does not guarantee any minimum wages to the workers.
This plan is devised by H.L. Gantt, an associate of EW. Taylor. This plan guarantees the wages
as per fixed time rates to the workers. Standards for output and time for performance of each job
are fixed. If the workers complete the job within standard time or take less time receive wages
for the standard time. In addition to this he gets bonus at the rate ranging from 20 to 50 percent
of the time allowed.
The specialty of this system of wage payment is that the foreman also receives bonus for every
worker under him who receives bonus. So foreman of each department takes special interest to
see that every worker under him reach bonus standard.
Merits:
(2) The workers with less ability get minimum wages and with more ability benefit more.
Demerits:
(1) Every worker is assured of wages at the rate of time rate. So less efficient workers also get
wages at time rate. It discourages efficient workers.
(2) The workers unions are displeased with the scheme and they make demand for wages at high
rate of time wage. These are all short term plans meant for production workers. There is few
more incentive plans discussed below.
It is a modified version of Hasley premium plan introduced by G.J. Weir in England. The
modification is in the percentage of incentive or premium on time saved. This percentage is
33.33 while the rest is shared by the employer.
Under this plan the task standard are set on the basis of time study and work sampling. The rates
are expressed in terms of time rather than money e.g.:- 0.30 hour per piece. Workers are paid
according to hourly rate. The plan is similar to straight piece rate plan except for its higher
guaranteed hourly rate and the use of task time as a unit of payment instead price per piece. The
worker gets the full value of time saved. Incentive Plan for White Collar Workers.
Sales – pay plans featuring commissions or bonuses based on the number of items or rupee
volume sold can also be considered individual incentive plans. Most of the firms make payment
to their sales staff on the basis of salary cum commission.
Many stockbrokers and real estate agents are paid solely on a commission basis. Advantage of
commission payment is that they are tied to the revenues of the firm. Employees are motivated
towards increasing sales volume. During recession the firm reduces the commission.
According to which they receive monthly salary only. Here there is no linkage of incentive for
hard work.
Sales personnel receive only commission on sales volume. Here the salesman will sell those
items which are of high value.
Under this scheme sales personnel are paid a fixed salary and commission as an incentive based
on sales volume.
Performance bonuses of some kind are the most frequently used incentive plans for management
and exempt employees. The rates and other details vary greatly from company to company.
Bonuses are allocated on the basis of manager’s contribution at the year end, on the basis of the
extent to which the person attains the objectives agreed on at the beginning of the year under
M.B.O. scheme, spot bonuses and cash awards are given to the managers and professionals for
extra ordinary performance, stock option is yet another incentive given to them.
Under group incentive plan, bonus is calculated on the collective production of a group of
interdependent workers and distributed among members of group on some agreed terms and
conditions. As far as possible the bonus so earned is distributed equally among the members of
the group.
(1) Group bonus is distributed equally if all the members of the group possess similar skills.
(2) If the base wage of members is different than bonus may be distributed in proportion to the
basic rates.
(3) Bonus may be paid to the members on a specified percentage depending on the basis of skill,
experience, basic rate of pay of each individual employee.
Under this, the starting point is productivity of the group. Standard output is laid for the group.
Minimum wage is assured to a group. The group members are entitled for a bonus if their output
exceeds the set standard. The payment of bonus is made in proportion to the excess of actual
output over the standard output. This plan encourages the feelings of team spirit among the
members of the group. The employees behave as a group and work together to increase output.
This scheme does not consider the individual efficiency of worker. Thus the inefficient member
of the group also get bonus.
This plan was devised by Joseph Scanlon in 1937, a trade union leader. Under this plan workers
are involved in decision making. They are encouraged to make suggestions regarding cost
reduction and increasing productivity.
They are involved in the various screening committees in the plant to find out ways and means to
judge the cost reduction suggestions. In this way employees work with their supervisors,
managers and other fellow employees on various screening committees.
If the suggestions are successfully implemented, employees get share in the savings. To facilitate
workers’ participation, there are departmental committees consisting of representative of workers
and management.
Periodical meetings of these committees are held to discuss the problems faced by the workers.
They recommend measures to increase production. It promotes healthy labour relations,
minimizes supervision, increases efficiency and sense of partnership among workers.
This plan suffers from certain drawbacks such as the inefficient worker gets rewarded because of
better performance of the group. It is also true that the suggestions of the employees are not
given due consideration by the management.
Under the scheme of profit sharing a certain percentage of profit is distributed at fixed ratio
among some categories of employees annually. According to Henry R. Seager, “profit sharing is
an agreement freely entered into by which the employees receive a share, fixed in advance, of the
profits.”
The decision of sharing of profit to the employees is informed in advance. The basis of profit
sharing is decided on the length of service or the number of working days in a year or the wages
earned by a worker during a year.
It is direct incentive to a worker. The payment of profit can be made in cash or it can be
deposited in the account of provident fund of an employee. The advantage of this scheme is that
workers develop common concern for the development and progress of the undertaking.
It is the one which is not paid directly to the employee but credited in his provident fund account
or to pension account or sometimes paid in the form of bonus shares.
Merits:
(1) Creation of industrial peace because workers are satisfied as they are getting an additional
amount besides their wages.
(3) The bonus is paid only when the amount of profit exceeds the set target. It means bonus is not
part of cost of production.
(4) Profit sharing scheme is based on the basic pay of the employees.
(5) Workers have share in profit and not losses incurred by the employer.
(7) It brings about team spirit among the employees. They developed a sense of belonging to the
organization, reduces training time.
Demerits:
(1) Employees are entitled to bonus when company earns profit. They do not get bonus when
company recur losses.
(3) There is no distinction between efficient and inefficient employees of the company while
distribution of bonus.
(4) Bonus is paid to the employee once in a year. This does not motivate them for better
performance.
Overhead: Factory
Functional Analysis
THEINTACTFRONT14 FEB 2019 2 COMMENTS
Factory overhead is most commonly defined as “manufacturing costs that are not classifiable as
direct material or direct labor.”
Factory overhead costs include indirect materials, indirect labor, and factory expenses.
In standard costing, predetermined amounts are used to facilitate better control and faster
recording of costs. Standard costing allows management to determine areas that deviate from
established standards, to be able to investigate and take corrective actions.
Factory overhead costs are better analyzed when they are segregated into variable and fixed.
Variable Factory Overhead Variance
The computation and analysis of variable factory overhead (VFOH) is pretty much similar to that
of direct labor.
The only difference is the rate applied. Also, variable overhead rates may use direct labor hours
or machine hours as its base.
VFOH variance = Total actual VFOH cost – Total standard VFOH cost
The total actual variable overhead cost and total standard variable overhead cost may be
computed as follows:
Total actual VFOH cost = Actual hours used x Actual rate per hour
Total standard VFOH cost = Standard hours for actual production x Standard VFOH rate per
hour
Note that the “hour” used refers to direct labor hour or machine hour, depending upon which is
used by the company. Capital-intensive industries tend to use machine hours. Other bases may
also be used, especially when using activity-based costing.
Variable factory overhead may be split into: VFOH spending variance and VFOH efficiency
variance.
The computation for fixed factory overhead (FFOH) variance is similar to that of variable factory
overhead. Note, however, that fixed factory overhead amounts are almost always given in total
figures (thus, it may or may not require additional computations).
FFOH variance = Total actual FFOH cost – Total standard FFOH cost
The total actual fixed overhead cost is almost always given in total amount; hence no additional
computation is needed. The total standard fixed overhead cost (or applied fixed factory
overhead) may be computed as follows:
Total standard FFOH cost = Standard hours for actual production x Standard FFOH rate per
hour
Fixed factory overhead variance may be split into: FFOH spending variance (a.k.a. budget
variance) and FFOH volume variance (a.k.a. capacity variance).
The budgeted fixed factory overhead is also given in total amount – for a given level of
production. The total standard FFOH is computed as shown earlier, and is also known as
“applied fixed factory overhead”.
Administration Overhead
The term administration refers to the formulation of policy, direction, control and management
of affairs. The general functional expenses are included in the administration overhead. In other
words, administrative services are necessary for the effective operation of any business. Hence,
such service expenses are treated as administration overhead. The printing and stationary for
administration, rent, rates, insurance of general office, bank charges, telephone, postage, and the
like are the examples of administration overhead.
Selling Overhead
The selling overhead refers to the cost of selling function ie the cost of activities relating to
create and stimulate demand for company products and to secure orders. Salaries, Commission
and traveling expenses of sales representatives and executives, advertising and publicity
expenses, samples, printing of price lists, discounts, rebates, bad debts and the like are the
examples of selling overhead.
Distribution Overhead
The term distribution refers to the activities relating to the sequence of operation starts from
making the packed product available for dispatch and ends with making reconditioned returned
empty package available for reuse.
Distribution is also one of the functions like manufacturing, administration and selling. Running
expenses of delivery van, wages of packers, carriage and freight outwards, rent, rates and
insurance of warehouses and the like are some of the examples of distribution overhead.
Fixed cost: It mainly relates to time or period. It remains unchanged irrespective of volume of
production like factory rent, insurance, etc. The cost per unit fluctuates according to the
production. The cost per unit decreases if production increases and cost per unit increases if the
production decreases. That is, the cost per unit is inversely proportional to the production. For
example, if the factory rent is Rs 25,000 per month and the number of units produced in that
month is 25,000, then the cost of rent per unit will be Rs 1 per unit. In case the production
increases to 50,000 units, then the cost of rent per unit will be Rs 0.50 per unit.
Variable cost: Variable cost directly associates with unit. It increases or decreases according to
the volume of production. Direct material and direct labor are the most common examples of
variable cost. It means the variable cost per unit remains constant irrespective of production of
units.
Semi-variable cost: A specific portion of these costs remains fixed and the balance portion is
variable, depending on their use. For example, if the minimum electricity bill per month is Rs
5,000 for 1000 units and excess consumption, if any, is charged @ Rs 7.50 per unit. In this case,
fixed electricity cost is Rs 5,000 and the total cost depends on the consumption of units in excess
of 1000 units. Therefore, the cost per unit up to a certain level changes according to the volume
of production, and after that, the cost per unit remains constant @ Rs 7.50 per unit.
A step cost is a cost that does not change steadily with changes in activity volume, but rather at
discrete points. The concept is used when making investment decisions and deciding whether to
accept additional customer orders. A step cost is a fixed cost within certain boundaries, outside
of which it will change. When stated on a graph, step costs appear to be incurred in a stair step
pattern, with no change over a certain volume range, then a sudden increase, then no change over
the next (and higher) volume range, then another sudden increase, and so on. The same pattern
applies in reverse when the volume of activity declines.
For example, a facility cost will remain steady until additional floor space is constructed, at
which point the cost will increase to a new and higher level as the entity incurs new costs to
maintain the additional floor space, to heat and air condition it, insure it, and so forth.
Factory overheads,
Administration overheads
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Factory Overheads
Factory overhead is the costs incurred during the manufacturing process, not including the costs
of direct labor and direct materials. Factory overhead is normally aggregated into cost pools and
allocated to units produced during the period. It is charged to expense when the produced units
are later sold as finished goods or written off. The allocation of factory overhead to units
produced is avoided under the direct costing methodology, but is mandated under absorption
costing. The allocation of factory overhead is required when producing financial statements
under the dictates of the major accounting frameworks.
The range of possible factory overhead costs can be quite extensive, depending upon the size and
complexity of a factory operation and the level of detail at which costs are recorded.
After factory overhead is allocated to inventory, the amount actually allocated will vary from the
standard amount that had been budgeted to be allocated. This difference is caused by either a
spending variance or an efficiency variance. The spending variance occurs because the actual
amount of factory overhead expenditure incurred in the period was different from the standard
amount that had been budgeted at some point in the past. The efficiency variance occurs because
the the amount of units to which the factory overhead was allocated varied from the standard
amount of production that had been expected when the allocation rate was set up.
The use of factory overhead is mandated by accounting standards, but does not bring real value
to the understanding of overhead costs, so a best practice is to minimize the complexity of the
factory overhead allocation methodology. Ideally, there should be a small number of highly
aggregated factory overhead accounts that are pooled into a single cost pool, and then allocated
using a simple methodology. Also, the amount of factory overhead analysis and recordation
work can be mitigated by charging all immaterial factory costs to expense as incurred.
Administration Overheads
Administrative overhead is those costs not involved in the development or production of goods
or services. This is essentially all overhead that is not included in manufacturing overhead.
Examples of administrative overhead costs are the costs of:
Administrative overhead is considered a period cost; that is, the benefit of this type of cost does
not carry forward into future periods.
Selling and Distribution Overheads
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Commonly, selling expenses, publicity expenses & distribution expenses are known as
marketing cost.
Marketing Cost: Cost which is incurred for the purpose of publicizing & presenting the product
of the undertaking to the customers at an acceptable prices & suitably attractive forms, along
with all relevant research work’s costs, the securing of order, & usually, delivery of the goods to
the customers are represented by marketing cost. Cost of after-sale service & /or processing of
order, may also be included in certain cases.
Selling Cost: That portion of marketing cost is indicated by selling cost, which is incurred for the
purpose of securing orders.
Publicity Cost: That portion of marketing cost is indicated by publicity cost, which, as aids to the
sale of goods or services, is incurred for the purpose of advertising & sales promotion.
1. Nature of expenses wise analysis: We are able to find remuneration, packing expenses,
charges related to freight & duty, direct materials costs, fixed charges, sales promotion,
miscellaneous allowances & discounts etc.
4. Sales area or division wise analysis: On the basis of area of sales, analysis of selling &
distribution overhead may be done.
5. Salesmen wise analysis:On the basisof salesmen, analysis of selling & distribution overhead
may be done.
6. Distribution channel wise analysis: In this case, on the basis of whole-sellers, retailers &
customers, selling & distribution overhead is analyzed.
7. Type of customer wise analysis: In this case, according to foreign customer, domestic
customer, private customers, government customers, country retailers, country whole sellers etc.,
analysis of selling & distribution overhead is done.
On the basis of the above mentioned different ways, analysis of selling & distribution overhead
can be done. Only, so much of the elaboration is desirable as would be suitable for the product
type & the marketing method; as elaborate analysis is always expensive. In whatever way selling
& distribution overhead has been analyzed, it is to form a part of the total cost of sales.
Through the following processes, selling & distribution overhead are included in the total cost of
sales:
(a) As far as practicable, allocation of expenses which are considered direct should be done to
functions, products, salesmen, area etc.
(b) On some suitable basis, apportionment of other expenses which cannot be allocated directly
(i.e. the general selling & distribution expenses) need to be done. Commonly used bases for the
apportionment of selling & distribution overhead are given below:
1. Advertisement & sales promotion 1. Where there is uniform selling price, on the
basis of number of units sold, or else on the basis of sales value
4. Warehousing & shortage 4. On the basis of sales volume, area occupied etc.
(c) As a % of works cost: Under this method, for the purpose of absorption of selling &
distribution overhead, a certain % on works cost of the goods sold may be taken as a basis. By
analyzing the past result, the % of selling & distribution overhead on the works cost can be
worked out. Also, for absorption of selling & distribution overhead which are of fixed nature,
this method is used.
Rate per article method, of all the above discussed methods, is considered as best, particularly,
when the units of production are uniform in nature.
As per as accounting entries are concerned, to the selling & distribution account, all the selling &
distribution overhead incurred are debited. Similarly, debit is given to cost of sales account &
credit is given to the selling & distribution overhead account, for recovery of such overhead.
Due to the under mentioned reasons, control of selling & distribution overhead is a very tough
job:
(a) It is not possible to exercise control upon the customers & competitors.
(c) Fluctuations of market price does not always depends upon the cost factors.
(d) It is not possible to predetermine correctly the capacity of any sales organization.
However, for the purpose of control, the following methods should be adopted:
(a) It is possible to prepare selling & distribution cost control reports & compare the results with
the past records.
(b) It is possible to prepare flexible budgets to show the expenses at different levels of activities
& to compare actual figures with the budgeted figures.
(c) It is possible to set up standards & to compare the actual expenses with the predetermined
standards.