ACCOUNTING FOR OVERHEAD

COST AND MANAGEMENT ACCOUNTING I

ACC 211
 Overheads

 Are indirect expenses which cannot be traced

directly to a product, service or department. For
example, rent, rates, insurance, depreciation,
electricity, water, maintenance of plant and
machinery. They are also classified as overheads
which consist of the total of all indirect cost
 Production and non-production overheads

 Production / Manufacturing overheads are indirect costs

that are related to the production of the products of the
business. They make up part of the production cost.
 Non-production / Non-manufacturing overheads are
expenses that are not directly or indirectly, related to the
production. They are classified as Selling overheads,
Distribution overheads, Administration overheads and
Finance overheads
 Overheads

Overhead is actually the total of the following

 Indirect materials
 Indirect expenses
 Indirect labor
 Overheads categories

The total of these indirect costs is usually split

into the following categories.
Production
Selling and distribution
Administration
Accounting Treatment - Product and Period Cost

 Product cost is taken into profit and loss account

only to the extent of number of units sold and cost of
unsold units is taken into to the balance sheet as a
closing stock.
 Whereas period cost in total is charged to profit and
loss account. Product cost is used for stock valuation
purpose but period cost is least concern with stock
valuation.
 Under Absorption costing system there are four steps
of charging overhead costs to cost centers and cost
units.
1.Allocation.
2. Apportionment.
3.Re-apportionment.
4.Absorption
 Cost Allocation

 Is the process by which whole cost items are charged

direct to a cost unit or cost Center
 Allocation is the charging or distributing of cost
directly to the cost centers or cost units. Costs that
relate to a single cost center are allocated to that cost
center. Normally indirect materials and indirect labor
costs are allocated
 Cost Center

 The department or sub-part of a division, to which

costs can be identified
 Cost centers
Cost centers may be one of the following types.
 A production department, to which production overheads are charged
 A production area service department, to which production overheads are
charged
 An administrative department, to which administration overheads are
charged
 A selling or a distribution department, to which sales and distribution
overheads are charged
 An overhead cost center, to which items of expense which are shared by a
number of departments, such as rent and rates, heat and light and the
canteen, are charged
 Allocation to cost centers

 Direct labor will be charged to a production cost

center.
 The cost of a warehouse security guard will be charged
to the warehouse cost center.
 Paper (recording computer output) will be charged to
the computer department.
 Costs such as the canteen are charged direct to various
overhead cost centers.
 Example: Overhead allocation
 Consider the following costs of a company.
 Wages of the foreman of department A TZS200,000
 Wages of the foreman of department B TZS150,000
 Indirect materials consumed in department A TZS50,000
 Rent of the premises shared by departments A and B TZS300,000
 The cost accounting system might include three overhead cost centers.
Cost Centre:
101 Department A
102 Department B
201 Rent
 Solution
 Overhead costs would be allocated directly to each
cost center, ie TZS200,000 + TZS50,000 to cost
Centre 101,
 TZS 150,000 to cost center 102 and
 TZS 300,000 to cost center 201.
 The rent of the factory will subsequently be shared
between the two production departments but, for
the purpose of day to day cost recording, the rent
will first of all be charged in full to a separate cost
center
 Overhead apportionment

 Apportionment is a procedure whereby indirect costs are

spread fairly between cost centers. Service cost center
costs may be apportioned to production cost centers by
using the reciprocal method.
 Apportionment is where an overhead is common,
combined or joint to more than one cost center and
therefore it needs to be shared out amongst the relevant
cost centers based on benefit received by each cost center
 Illustration qn.
 Malenda Inc has two production departments (A and
B) and two service departments (maintenance and
stores). Details of next year's budgeted overheads are
shown below. Total (TZS) Total (TZS)
Heat and light 19,200 Rent and rates 38,400
Repair costs 9,600 Canteen 9,000
Machinery 54,000 Machinery insurance 25,000
depreciation
 Details of each department are as follows

A B Maintenance Store Total

Floor area (m2) 6,000 4,000 3,000 2,000 15,000
Machinery book value 48,000 20,000 8,000 4,000 80,000
Number of employees 50 40 20 10 12,000
Indirect labour 15,000 20,000 12,000 5,000 50,000
 Service departments' services were used as follows.

A B Maintenance Store Total

Maintenance hours worked 5,000 4,000 - 1,000 10,000
Number of stores requestion 3,000 1,000 1,000 - 5,000
 Apportionment of Overhead

 Stage 1:
 The first stage of overhead apportionment is to identify all overhead costs as
production department, production service department, administration or selling
and distribution overhead

 Bases of apportionment
 It is considered important that overhead costs should be shared out on a fair basis
 Overhead to which the basis applies

Overhead Basis
Rent, rates, heating and light, Floor area occupied by each cost
repairs and depreciation of centre
buildings
Depreciation, insurance of Cost or book value of equipment
equipment
Personnel office, canteen, welfare, Number of employees, or labor
wages and cost offices, first aid hours worked in each cost center
(Wage cost)
Power Kilowatt hour / capacity of
machines (horse power)
 Solution
Item cost Basis of A B Maintenance Store Total
apportionment
Allocated Allocated 15,000 20,000 12,000 5,000
Heat and Light Floor Area 7,680 5,120 3,840 2,560 19,200
Repair Cost Floor Area 3,840 2,560 1,920 1,280
9,600
Machine depreciation Machine Value 32,400 13,500 5,400 2,700 54,000

Rent and rates Floor Area 15,360 10,240 7,680 5,120 38,400

Canteen No of employee 3,750 3,000 1,500 750 9,000

Machine insurance Value of Machine 15,000 6,250 2,500 1,250 25,000

Total 93,030 60,670 34,840 18,660
 Reapportion service department costs

 Service departments are cost centers, which exist to

provide services to other departments. The canteen is
a common example, having allocated and apportioned
the costs to the production and service departments,
the totals of service cost centers, the latter need to be
reapportioned to the production cost centers.
 Basis of reapportionment

Service Cost center Basis of Reapportionment

Store Number of material requisitions
Maintenance Number of maintenance hours or
number of maintenance calls
Canteen Number of employees
Production Direct labor hours worked in each
Planning production cost center
 Methods are available for reapportionment

 Direct method
 Indirect method
 Repeated distribution (reciprocal method)
 Direct method of reapportionment

 The direct method of reapportionment involves

apportioning the costs of each service cost center to
production cost centers only
 It is used when service centers do not exchange
services with each other, means they only provide
services to production centers
 Example: Malenda qns

A B Maintenan Store
ce
Allocated 78,030 40,670 22,840 13,660
costs
General costs 15,000 20,000 12,000 5,000
Total 93,030 60,670 34,840 18,660
 Service departments' services were used as follows

A B Maintenan Store Total

ce
Maintenance hours 5,000 4,000 - 1,000 10,000
worked
Number of stores 3,000 1,000 1,000 - 4,000
requestion

 Calculate the total production overhead costs of Departments A and B using

the direct method of reapportionment
Service Basis of apportionment Total cost Dept. A Dept B
department
Maintenance maintenance Hrs 34,840 19,356 15484
Store No of Store requisition 18,660 13,995 4,665
53,500 33,351 20,149
Previous Allotd 153,700
cost 93,030 60,670
Total Overhead 207,200 126,381 80,819
 Step down method of reapportionment

 Step 1
 Reapportion one of the service cost center’s
overheads to all the other centers which make use of
its services (production and service).
 Step 2
 Reapportion the overheads of the remaining service
cost center to the production departments only. The
other service cost center is ignored.
 Solution

A B Maintenance Store
General
allocated 93,030 60,670 34,840 18,660
Apportion Store 11,196 3,732 3,732 (18,660)
38,572
Apportion
maintenance 21,429 17,143 (38,572) -
125,655 81,545 - -
 If the first apportionment had been the
maintenance department

A B Maintenance Store
General allocated 93,030 60,670 34,840 18,660
Apportion
maintenance 17,420 13,936 (34,840) 3,484
22,144
Apportion Store 16,608 5,536 - (22,144)
127,058 80,142 - -
 The reciprocal (algebraic) method of apportionment

 Example: Malenda qn using the algebraic method of apportionment

 Whenever you are using equations you must define each variable

 Let M = total overheads for the maintenance department

S = total overheads for the stores department
 Remember that total overheads for the maintenance department
consist of general overheads apportioned, allocated overheads and the
share of stores overheads (20%).
 Similarly, total overheads for stores will be the total of general
overheads apportioned, allocated overheads and the 10% share of
maintenance overheads.
 THE RECIPROCAL (ALGEBRAIC) METHOD OF APPORTIONMENT

 M = 0.2S + $34,840 (1) ($34,840 was calculated in previous example)

 S = 0.1M + $18,660 (2) ($18,660 was calculated in previous example)
 Let solve the equations.

 Multiply equation (1) by 5

 5M = S + 174,200

 S = 5M – 174,200
 THE RECIPROCAL (ALGEBRAIC) METHOD OF APPORTIONMENT

 Subtract equation (ii) from equation (iv)

 S = 5M – 174,200 (iv)

 S = 0.1M + 18,660 (ii)

 0 = 4.9M – 192,860

 4.9M = 192,860
192,860
 𝑀= =39,359
4.9
 THE RECIPROCAL (ALGEBRAIC) METHOD OF APPORTIONMENT

 Substitute M = 39,359 into equation (ii)

 S = 0.1 x 39,359 + 18,660

 S = 3,936 + 18,660 = 22,596

THE RECIPROCAL (ALGEBRAIC) METHOD OF APPORTIONMENT

A B Maintenance Store
General allocated 93,030 60,670 34,840 18,660
Apportion maintenance 19,680 15,743 (39,359) 3,936
Apportion stores
(60%/20%/20%) 13,558 4,519 4,519 (22,596)
Total (22,596) 80,932 Nil Nil
 Overhead absorption

 Overhead absorption is the process whereby

overhead costs allocated and apportioned to
production cost centers are added to unit, job or
batch costs. Overhead absorption is sometimes
called overhead recovery
 Absorption rate

 Overheads are usually added to cost units using a

predetermined overhead absorption rate, which is
calculated using figures from the budget.
 Absorption rate is a method of including a fair
proportion of the total overheads costs as part of the
cost of each cost unit.
 Absorption rate

Budgeted Production Overhead

 𝐎𝐯𝐞𝐫𝐡𝐞𝐚𝐝 𝐀𝐛𝐬𝐨𝐫𝐩𝐭𝐢𝐨𝐧 𝐑𝐚𝐭𝐞
𝐵𝑢𝑑𝑔𝑒𝑡𝑒𝑑 𝐴𝑐𝑡𝑖𝑣𝑖𝑡𝑦 𝐿𝑒𝑣𝑒𝑙
 Calculation of overhead absorption rates

 Step 1: Estimate the overhead likely to be incurred during the

coming period
 Step 2: Estimate the activity level for the period. This could be
total hours, units, or direct costs or whatever it is on which the
overhead absorption rates are to be based.
 Step 3: Divide the estimated overhead by the budgeted activity
level. This produces the overhead absorption rate.
 Step 4: Absorb the overhead into the cost unit by applying the
calculated absorption rate.
 ABC cooperation has the fallowing budgeted hours for the year 2012
 Estimated overhead Tsh.800,000
 Estimated direct labor hour Tsh. 10,000
 Required
 Calculate overhead applied per direct labor hour
 Calculate the overhead applied if 9,500 actual direct labor hour are
used during 2012
 Calculate under and over applied overhead if the actual overhead is
TZS752,000
 Blanket Rate and Departmental Rate

 Blanket rate refers to a situation where single OAR is

used for the whole factory or organization. It is
appropriate
 Fewer departments
 Fewer products
 Similar processes and activities
 Departmental rate

 Departmental rate is also known as separate

absorption rate. It uses a separate OAR for each
department or cost Centre. It is appropriate,
 Multiple departments
 Wide range of products
 Different processes and activities
 Comparison blanket and departmental rate
 If blanket overhead absorption rate is used for the whole factory then some
products will receive a higher overhead proportion and some will be under
charged. Using a separate absorption rate is more appropriate where product
spent different amount of time in each department.

 The use of blanket rate saves time and thus cost, but less accurate than
departmental rates.

 Therefore, a careful selection of which type of rate to use is essential, taking into
account the cost-benefit analysis.
 Illustration

The Old Grammar School has two production departments, for which the following
budgeted information is available.
Department A Department B Total
Budgeted overheads 360,000 200,000 560,000
Budgeted direct labor 200,000 40,000 240,000
hours
If a single factory overhead absorption rate is applied, the rate of overhead recovery
would be:
 560000
 =2.33 per direct labor hours
240000 ℎ𝑟𝑠
 If separate departmental rates are applied, these would be
Department A = 360,000
200,000
= 1.8 per Direct Labor hour

200,000
Department B = = 5 per Direct labor hour
40,000
Department B has a higher overhead rate of cost per hour
worked than department A.
Job X has a prime cost of $100, takes 30 hours in
department B and does not involve any work in
department A.
Job Y has a prime cost of $100, takes 28 hours in
department A and 2 hours in department B. What would be
the factory cost of each job, using the following rates of
overhead recovery?
a) A single factory rate of overhead recovery
b) Separate departmental rates of overhead recovery
 Solution

Job X Job Y
(a) Single factory rate $ $
Prime cost 100 100
Factory overhead (30 x$2.33) 70 70
Factory cost 170 170
Separate departmental rates $ $
Prime cost 100 100.00
Factory overhead: department A 0 (28 x $1.80) 50.40
department B (30 x $5) 150 (2 x $5) 10.00
Factory cost 250 160.40
 Over/ under absorption of overheads

 Predetermined absorption rate or Overhead absorption rate (OAR) is based on

budgeted overheads and budgeted activity levels. The absorbed overheads will
differ from actual overheads incurred.

 Absorbed OH < Actual OH = UNDER absorption

 Absorbed OH > Actual OH = OVER absorption
 Under or over absorption of overheads will occur if:
 Actual overheads are different from the budgeted
overheads
 Actual activity level different from the budgeted
activity level
 Or both situations arise
 Pembele has a budgeted production overhead of $50,000 and a
budgeted activity of 25,000 direct labor hours and therefore a
recovery rate of $2 per direct labor hour.
 Calculate the under-/over-absorbed overhead, and the reasons for
the under/over absorption, in the following circumstances.
 Actual overheads cost $47,000 and 25,000 direct labor hours are
worked.
 Actual overheads cost $50,000 and 21,500 direct labor hours are
worked.
 Actual overheads cost $47,000 and 21,500 direct labor hours are
worked
 Case I
Actual overhead 47,000
Absorbed overhead (25,000 x $2) 50,000
Over-absorbed overhead 3,000
Thank you so much.........