Overhead Part2

ACCA F2 - Management Accounting

Recording overhead demands understanding of capital expenditure (cap-ex) and revenue expenditure (rev-ex). Capital expenditure (up grading cost, installation cost) is a one-off kind and its benefit is derived over several accounting periods. Revenue expenses (repair and maintenance) on the other hand are scheduled cost and are incurred to maintain earning capacity of the facility.

Overhead cost can be controlled in many different ways. Decreasing working capital reduces production overhead, implementing total quality management decreases cost of non-conformance, monitoring and studying cost and adopting cost-reducing measures (e.g. redesigning).

Now we concentrate on some mathematics involved in managing overhead. Segregation of semi-variable overhead into variable and fixed overhead is done using total cost equation. Segregated overhead are allocated using a proportion basic. Under different costing system, overhead is allocated using different drivers of cost. Traditionally, machine hour and labour hour were used as driving forces for overhead. For mathematical illustrations, please check the article below on allocating overhead. "Re-apportionment of service cost centre costs"

Interdivisional transfer is dealt with transfer pricing. The price agreed in transfer pricing may or may not be the open market price. Overhead costs play an important role in determining transfer price of products form one unit to other. Cost centers face challenges defining the value of product if there is no open market for their product. All these issues will be checked in later post related to transfer pricing.

Ratios are analytical tools used by accountants and managers to access the position of specific account and the performance of responsible managers. Significant overhead are studied in isolation whereas more general and minor overheads are grouped in a class and analysed. Overhead ratio explains the different between gross profit and operating profit.

Overhead ratio= Operating Expenses/(Taxable net interest income + Operating income)

Lower overhead ration as compared to past or competitor indicates better control over overhead costs.

Understanding, Allocating and Controlling overhead costs

ACCA Article: Re-apportionment of service cost centre costs