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Overheads Budget

Index
Introduction
What is a Budget?

Process of Budgeting

What is overhead?

What is Manufacturing Overhead Budget?

10

Components of Manufacturing Overhead

11

Example of the Manufacturing Overhead

12

Budget
What is Selling and Administrative overhead

14

Budget?
Example of the Selling and Administrative

15

Overhead Budget
Bibliography

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Overheads Budget

Introduction
What is a budget?
A budget forecasts the financial results and financial position of a
company for one or more future periods. A budget is used for
planning and performance measurement purposes, which can
involve spending for fixed assets, rolling out new products, training
employees, setting up bonus plans, controlling operations, and so
forth.
At the most minimal level, a budget contains an estimated income
statement for future periods. A more complex budget contains a
sales forecast, the cost of goods sold and expenditures needed to
support the projected sales, estimates of working capital
requirements, fixed asset purchases, a cash flow forecast, and an
estimate of financing needs. This should be constructed in a topdown format, so a master budget contains a summary of the entire
budget document, while separate documents containing
supporting budgets roll up into the master budget, and provide
additional detail to users.
Many budgets are prepared on electronic spreadsheets, though
larger businesses prefer to use budget-specific software that is
more structured and so is less liable to contain computational
errors.
A prime use of the budget is as a performance baseline for the
measurement of actual results. It can be misleading to do so, since
budgets typically become increasingly inaccurate over time,

Overheads Budget

resulting in large variances that have no basis in actual results. To

reduce this problem, some companies periodically revise their
budgets to keep them closer to reality, or only budget for a few
periods into the future, which gives the same result.
Another option that sidesteps budgeting problems is to operate
without a budget. Doing so requires an ongoing short-term forecast
from which business decisions can be made, as well as
performance measurements based on what a peer group is
achieving. Though operating without a budget can at first appear to
be too slipshod to be effective, the systems that replace a budget
can be remarkably effective.
Purpose
Budget helps to aid the planning of actual operations by forcing
managers to consider how the conditions might change and what
steps should be taken now and by encouraging managers to
consider problems before they arise. It also helps co-ordinate the
activities of the organization by compelling managers to examine
relationships between their own operation and those of other
departments. Other essentials of budget include:
To control resources
To communicate plans to various responsibility center managers.
To motivate managers to strive to achieve budget goals.
To evaluate the performance of managers
To provide visibility into the company's performance

Overheads Budget

For accountability

In summary, the purpose of budgeting tools:

1. Tools provide a forecast of revenues and expenditures, that is,
construct a model of how a business might perform financially if
certain strategies, events and plans are carried out.
2. Tools enable the actual financial operation of the business to be
measured against the forecast.
3. Lastly, tools establish the cost constraint for a project, program, or
operation.

Advantages of Budgets
The major strength of budgeting is that it coordinates
activities across departments. Budgets translate strategic
plans into action.
They specify the resources, revenues, and activities
required to carry out the strategic plan for the coming year.
Budgets provide an excellent record of organizational
activities.
Budgets improve communication with employees.
Budgets improve resources allocation, because all requests
are clarified and justified.
Budgets provide a tool for corrective action through
reallocations.

Overheads Budget

Disadvantages of Budgets
The major problem occurs when budgets are applied
mechanically and rigidly.
Budgets can demotivate employees because of lack of
participation.
If the budgets are arbitrarily imposed top down, employees
will not understand the reason for budgeted expenditures,
and will not be committed to them.
Budgets can cause perceptions of unfairness.
Budgets can create competition for resources and politics.
A rigid budget structure reduces initiative and innovation at
lower levels, making it impossible to obtain money for new
ideas.

Overheads Budget

Process of Budgeting
The following exhibit shows the relationship among the income
statement budgets. The budget process begins by estimating sales. The
sales information is then provided to the different units to estimate the
production and selling and administrative budgets. The production
budgets are used to prepare the direct materials purchases, direct labor
cost, and factory overhead cost budget. These three budgets are used to
develop the cost of goods sold budget. Once these budgets together
with the budget for administrative and selling expenses have been
developed, the budget income statement can be prepared.

What is overhead?

Overheads Budget

Overhead is those administrative expenses of a business that are

required to operate general corporate functions, and which cannot be
definitively attributed to any revenue-generating activities or units of
output (such as products to be sold). Overhead is a necessary part of a
business, and must be paid for even when sales levels are low or nonexistent. The cost of overhead can be substantial, which is why
managers tend to closely monitor it.
Examples of overhead expenses are as follows:
Accounting
Administrative salaries
Insurance
Legal
Rent
Utilities
Thus, overhead costs do not directly lead to the generation of profits.
Overhead is still necessary, since it provides critical support for the
generation of profit-making activities. For example, a high-end clothier
must pay a substantial amount for rent (a type of overhead) in order to
be located in an adequate facility for the sale of clothes. The clothier
must pay overhead to create the proper retail environment for its
customers.
Overhead costs tend to be fixed, which means that they do not change
from period to period. Examples of fixed overhead costs are depreciation

Overheads Budget

and rent. Less frequently, overhead varies directly with the sales level, or
varies somewhat as the activity level changes.
The other type of expense is direct costs, which are those costs required
to create products and services, such as direct materials and direct
labour. Overhead and direct costs, when combined, equal all of the
expenses incurred by a company.
Collection of Overheads
Collection of overheads means the pooling of indirect items of expenses
from books of account and supportive/ corroborative records in logical
groups having regards to their nature and purpose.
Overheads are collected on the basis of pre-planned groupings, called
cost pools.
Homogeneity of the cost components in respect of their behaviour and
character is to be considered in developing the cost pool. Variable and
fixed overheads should be collected in separate cost pools under a cost
centre. A great degree of homogeneity in the cost pools are to be
maintained to make the apportionment of overheads more rational and
scientific. A cost pool for maintenance expenses will help in apportioning
them to different cost centres which use the maintenance service.
Allocation of overheads
Allocation of overheads is assigning a whole item of cost directly to a
cost centre. An item of expense which can be directly related toa cost
centre is to be allocated to the cost centre. For example, depreciation of
a particular machine should be allocated to a particular cost centre if the
machine is directly attached to the cost centre.

Overheads Budget

Apportionment of overhead
Apportionment of overhead is distribution of overheads to more than one
cost centre on some equitable basis. When the indirect costs are
common to different cost centres, these are to be apportioned to the cost
centres on an equitable basis. For example, the expenditure on general
repair and maintenance pertaining to a department can be allocated to
that department but has to be apportioned to various machines (Cost
Centres) in the department. If the department is involved in the
production of a single product, the whole repair & maintenance of the
department may be allocated to the product.
Similar Terms
Overhead is also known as burden or indirect costs.
A subset of overhead is manufacturing overhead, which are all overhead
costs incurred in the manufacturing process. If overhead can be traced
to the factory area, it is designated as factory/manufacturing overhead
and is allocated to the units produced in the period in which the
overhead cost is incurred.
Another subset of overhead is selling and administrative overhead,
which are all overhead costs incurred in the general and administrative
side of a business. If the overhead is associated with any other part of
the business other than manufacturing, it is designated as administrative
overhead and is charged to expense as incurred; there is no allocation.

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Overheads Budget

What is Manufacturing Overhead Budget?

The manufacturing overhead budget contains all manufacturing costs

other than the costs of direct materials and direct labour. The information
in the manufacturing overhead budget becomes part of the cost of goods
sold line item in the master budget.
Also, the total of all costs in this overhead budget are converted into a
per-unit overhead allocation, which is used to derive the cost of ending
finished goods inventory, and which in turn is listed on the budgeted
balance sheet. The information in this budget is among the most
important of the various departmental budget models, since it may
contain a large proportion of the total amount of a company's
expenditures.
This budget is typically presented in either a monthly or quarterly format.
The budget could also include a calculation of the overhead rate. For
example, direct labour hours could be included at the bottom of the
budget, which are divided into the total manufacturing overhead cost per
quarter to arrive at the allocation rate per direct labour hour.
Much of the information in this budget can be estimated from historical
results, if the types of products manufactured and production volumes
do not vary significantly from prior periods.

Components of Manufacturing Overhead

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Overheads Budget

Indirect material + Indirect labour + other indirect costs = Manufacturing

overhead

Indirect Material: Indirect materials are those not directly used as

raw materials for the production of goods and services. The use of
indirect material makes the production process possible, more
efficient and safer. Indirect materials include lubricants, fuels,
cleaning chemicals and protective gear.
Indirect labour: Indirect labour refers to the cost of those
employees who are associated with the production process, but
not on specific units or products; they indirectly produce goods
and services by supporting the production facility. Indirect labour
costs include the cost of factory supervision, inspection teams,
superintendents, factory managers and clerks.
Other Indirect Costs: Other indirect costs include rent, property tax
on the factory premises, fire insurance, depreciation of the plant
and machinery, repairs and maintenance of machinery, utilities,
and taxes. These costs are further classified as either fixed or
variable factory overhead.

Example of the Manufacturing Overhead Budget

Manufacturing Overhead Budget

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Overheads Budget

Quarter >

Year

Units to be produced

40,800

49,200

59,200

51,200

200,400

Indirect Material

6,120

7,380

8,880

7,680

30,060

Indirect Labour

4,080

4,920

5,920

5,120

20,040

Other

10,200

12,300

14,800

12,800

50,100

20,400

24,600

29,600

25,600

100,200

Salaries

15,000

15,000

15,000

15,000

65,000

Rent

10,000

10,000

10,000

10,000

40,000

Depreciation

10,070

10,070

10,070

10,070

40,280

Total fixed overhead costs

35,070

35,070

35,070

35,070

140,280

Total overhead costs

55,470

59,670

64,670

60,670

240,480

(10,070)

(10,070)

(10,070)

(10,070)

(40,280)

45,400

49,600

54,600

50,600

200,200

Variable overhead costs:

Total Variable overhead cost

Fixed overhead costs

Less: Depreciation
Cash Payments for overhead
Manufacturing overhead per
unit*

Year ending December 31

*1.20 = 240,480 total overhead cost 200,400 units to be produced for the
year.

By definition, total variable overhead costs change with changes in

production and are calculated by multiplying units to be produced by
the cost per unit. For example, indirect materials cost for the first
quarter of 6,120 is calculated by taking 40,800 units to be produced
0.15 cost per unit.

1.20

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Overheads Budget

Fixed costs generally do not change with changes in production and

therefore remain the same each quarter.
Depreciation is deducted at the bottom of the manufacturing overhead
budget to determine cash payments for overhead because depreciation
is not a cash transaction.

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Overheads Budget

What is Selling and Administrative overhead Budget?

The selling and administrative expense budget is comprised of the
budgets of all non-manufacturing departments, such as the sales,
marketing, accounting, engineering, and facilities departments. In
aggregate, this budget can rival the size of the production budget, and
so is worthy of considerable attention. The selling and administrative
expense budget is typically presented in either a monthly or quarterly
format. It may also be split up into segments for separate sales and
marketing budget and a separate administration budget.
The information in this budget is not directly derived from any other
budgets. Instead, managers use the general level of corporate activity
to determine the appropriate level of expenditure. This can involve
activity-based costing analysis to determine which activities are likely to
be needed more or less as sales levels and capital spending change.
When creating this budget, it is useful to determine the activity levels at
which step costs may be incurred, and to incorporate them into the
budget.
It is very common to derive the amounts in the sales and administrative
expense budget with incremental budgeting, which means that the
amounts budgeted are based on the most recent budget or the most
recent actual results. This is not the best way to create budgets, since it
tends to perpetuate existing spending patterns, and allows managers to
retain excess funding. However, since it is a simple way to create a
budget, it is the most common method for doing so, especially in
companies that are not under significant competitive pressure to cut
costs.

Example of the Selling and Administrative Overhead

Budget

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Overheads Budget

Administrative & Selling Overhead Budget

Year ending December 31

Quarter

Year

Salaries

1,500

1,500

1,500

1,500

6,000

Insurance

110

110

110

110

440

Telephone

200

200

200

200

800

Supplies

200

200

200

200

200

Bad Debts Expense

60

80

90

100

330

Other

100

100

100

100

400

Total Administrative

2,170

2,190

2,200

2,210

8,170

Less: Bad Debts Expense

(60)

(80)

(90)

(100)

(330)

Cash Requirement

2,110

2,110

2,110

2,110

7,840

Overhead

Bibliography

Wikipedia.com
Investopedia.com
Accountingtools.com
Icmai.in

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Overheads Budget

Wikinvest.com