Accounting Of Administration Overhead

There are three distinct methods of accounting administrative overheads, viz,

• Apportioning between production and selling and distribution function:

  According to this method, total administration overhead are apportioned between the production and sales departments on some equitable basis, on the premise that manufacturing and selling are the two main functions of the organisation and administrative expenses are incurred mainly for these two functions. Hence, all expenses pertaining to administrative function should be proportionately charged to production and selling departments, and absorbed by the products as part of production and selling and distribution overheads. Identity of administration overheads, thereby, is lost.

• Transfer to profit and loss account

  This method recognises the fact that the items of administration expenses are of fixed nature, having no direct relationship with production and sales activities. They should therefore, be treated as period cost and be written off to costing profit and loss account in the period in which they are incurred.

• Treating administration overhead as separate addition to cost of productions sales

  In this method, administration overhead is treated as a separate function, and administrative overhead appears as a separate element of cost of goods sold. However, the most difficult problem arises in selecting an equitable base for recovery or absorption. The following bases are normally used for determining the rate of application:

  • Factory cost
  • Gross profit
  • Net sales value
  • Number of units sold or manufactured

  Each one of the above basis has relative merits and demerits, but generally factory cost is adopted for product cost oriented products, while one of the last three bases is used where selling and distribution cost is predominant. However, it should be emphasised that although administration overhead will be added to cost of sales, the same should not be loaded with inventory of finished goods or work-in-process.

Control of Administrative Overhead

Administrative overhead expenses are of fixed nature, arising out of management policies. Control of such expenses requires collection under correct cost account numbers for each administrative department. For the purpose of control, overheads collected for an accounting period are compared with similar figures of the previous period. Such a comparison will reveal efficiency or inefficiency of the concerned department. However, this method gives a limited degree of control, if the level of activity is not constant during the two periods under comparison. Again, past year’s data may not provide the right evaluation criteria, because it incorporates inefficiencies of the past year and fails to consider intervening changes.  A better method of control is the preparation and use of budget for each item of expenses classified department wise. The budget figures based on anticipated activity level are compared against actual performance, and the variances are analysed and responsibility is assigned to the department concerned for control purposes.