Overhead is basically the cost pertaining towards a specific cost unit or a accost center which may be divided into two equivalent parts, which is indirect and direct. The indirect part of the total cost which is constituting the main overhead cost is actually the aggregate of the material cost which is indirect. It is also in relation to the indirect expenses as well as the indirect wages. The CIMA has a definition for the overhead, which is, indirect cost is as similar as the expenditure on the labor, services and on the materials. They cannot be particularly identified as per a specific saleable cost of the product per single unit. The indirect costs refers to the costs incurred for the simplification of a large number of cost units or the cost centers. As seen before, these indirect costs can never be correlated with a particular cost unit or a cost center but due to its dynamic nature, it can be portioned off by the various cost units and cost centers as per the requirements. In simpler words, overhead is basically the expenditure which went over and above the expected prime cost of any good or service produced. Overhead is a vast term which comprises all of the main expenditures incurred by the business firms for the operations an also of the part of the undertaking that is the cost of operating supplies which is redeemed by the undertaking as per the needs. It is used by the undertaking for the purpose of maintaining the major capital assets. Overhead is a larger term than its sense, hence it can also be called as the indirect expenses, supplementary costs, on costs and point costs.
Absorption or the incidence of overheads simply means the process which elaborates the overheads into the overall total cost of producing a product. In the words of Cost accountancy terminology, incidence costs means, “the charging overheads to cost units by means of rates separately calculated for each cost center. In most cases the rates are pre-determined”. When some products are made which are not similar from each other, then the different production processes are also indulged into those extent. The overhead of costs is to be absorbed, hence named also absorption of overhead. And it is done mainly by two factors, which are: 1) The total number of units which are absorbed on its base which is the machine hours and the labor hours. 2) The overheads attribute against the given cost unit and cost center.
The bases of absorption have the main objective process to include the total cost in which a product or a service is produced. It is basically the appropriate share of a company’s overheads’ total. There are various bases on which the absorption of the overheads are counted. These are:
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There are certain factors which are considered helpful for choosing the most appropriate and particular base for the absorption of the overheads. The overall final verdict is only a matter of judgment and an arid common sense. These are:
Machine hour rate is a very efficient and also the most appropriate method which is in itself mechanized into the cost center. It means that the production is largely carried on with the process of mechanical induced. In these type of cost centers, most of the overheads which are present are directly related to the machinery and hence this method of the absorption of the overheads also reflects a much more accurate incidence of the overheads in the total cost.
This method of absorption of the overhead is basically the most convenient and in the labor intensive cost center. Although it is considered one of the easiest forms these days. Nowadays, the most productive method which involve the substantial usage of the machinery and resources and also the labor hour method have become more inappropriate.
This method means the total overhead absorption which is not commendable with the operations of the production process of the firm and since it is mainly used with leads to the most absurd anomalies. Even though this method of selecting the base is very simple and also easy to understand and apply as well, but it also have some suffers of its own.
This method is one of the most frequently used methods of absorption. It is used extensively in the practice run. The method is also not so very complicated and is very easy to understand. It takes consideration of time factor and then makes it rational method for the absorption of each and every factory overheads. As per this method, the total labor cost is very much computed by the multiplication of the numbers of hours which is spent on the work by one hour labor rate. This also mentions that the more of the hours which is being worked is higher the labor cost as they are directly relational. If there is only one rate of wage per hour paid throughout a cost center and no form of incentive scheme exists then the direct wages system would be more appropriate to use. But such a situation is a distant possibility.
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