Overhead part 1

MA1
Sadiq Farooq
The following are the stages of overhead costing are:
1 Allocation
2 Apportionment and reapportionment: here we have now estimated OH cost and
activity level

3 Absorption
4 calculation of under or overabsorbed overhead amount
5 Treatment of under or over absorbed overhead amount
Learning of overhead accounting (journal entries)
What is overhead Allocation:
Allocation is the process by which whole cost items are charged direct
to a cost unit or cost centre.
Cost centers may be one of the following types.
(a) A production department, to which production overheads are
charged
(b) A production area service department, to which production
overheads are charged

Now lets understand the process of Allocation by the following

example…
Stage 1: Undestanding the process of
overhead Allocation…
Consider the following costs of a company:

Wages of the foreman of department A $200

Wages of the foreman of department B $150
Indirect materials consumed in department A $50
Wages of Maintenance incharge = $ 150
Wages of Stores incharge = $ 150
The company has 2 production cost centers: Department A and Department B
Company also has 2 Service cost centers: Maintenance Department and stores
Answer..
Detail Depart A Depart B Maintenance Stores Total
Wages of Department A 200 200
Answer..
Detail Depart A Depart B Maintenance Stores Total
Wages of Department A 200 200
Wages of Department B 150 150
Answer..
Detail Depart A Depart B Maintenance Stores Total
Wages of Department A 200 200
Wages of Department B 150 150
Materials in Department A 50 50
Answer..
Detail Depart A Depart B Maintenance Stores Total
Wages of Department A 200 200
Wages of Department B 150 150
Materials in Department A 50 50
Wages of maintenance incharge 150 150
Answer..
Detail Depart A Depart B Maintenance Stores Total
Wages of Department A 200 200
Wages of Department B 150 150
Materials in Department A 50 50
Wages of maintenance incharge 150 150
Wages of stores incharge 150 150
 Answer..
Detail Depart A Depart B Maintenance Stores Total

Wages of Department A 200 200

Wages of Department B 150 150

Materials in Department A 50 50

Wages of maintenance incharge 150 150

Wages of stores incharge 150 150

total 250 150 150 150

Understanding the process of Apportionment (first
stage apportionment)
Apportionment is a procedure whereby indirect costs are divided (split) fairly
between cost centers. ( all cost centers) (departments)
Overhead apportionment is done after overhead allocation.
There are many such overhead costs incurred where the benefit of such overhead
costs is enjoyed by more than one cost center.
The examples of these costs are costs for heat and light, rent and rates, the
canteen and other such costs must therefore be shared between the cost centers.
 Continued…
It is considered important that overhead costs should be shared out on a fair basis.
The bases of apportionment for the most usual cases are given in the next slide.
Very comprehensive example…
Swotathon Inc has two production departments (A and B) and two
service departments (maintenance and stores). Details of next year's
budgeted overheads are shown on the next slide:
The above are common costs which are to be apportioned. The following are
the already allocated overheads.

Production A Production B Maintenance Stores

$ $ $ $

Allocated overheads 15000 20000 12000 5000

Continued from previous Slide…
The following steps are followed…
A) do allocation ( already allocation is done)
B ) do apportionment (First stage apportionment/ primary
apportionment)
C) do reapportionment ( 2nd stage apportionment/secondary
apportionment )
Answer: Workings for the question…
Using the Swotathon question above, how overheads should be apportioned
between the four departments is shown below: this is first stage apportionment
Workings shown here…
1) Overhead apportioned by Floor Area=
Total overhead/Floor area* Area occupied by Department
For example Heat and Light = 19200/15000 * 6000 = 7680
Heat and Light, repair costs, and rents and rates will be apportioned by Floor
Area.
2) Overhead apportioned by Machine Value =
Total overhead /Total Value of Machinery * Value of Machinery of Department
Machine Depreciation and Machine insurance will be apportioned by machine
value
3) Overhead apportioned by number of Employees=
Total overhead / total number of Employees * Employees in the department
Cost of canteen will be apportioned by number of Employees
Here is the Answer
what is reapportionment.
Only production departments produce goods that will ultimately be
sold. In order to calculate a correct price for these goods, we must
determine the total cost of producing each unit – that is, not just the
cost of the labour and materials that are directly used in production,
but also the indirect costs of services provided by such departments as
maintenance, stores and canteen.
Our aim is to reapportion all the service department costs to the
production departments in one of the 3 ways..
(a) The direct method:
(b) The step-down method,
(c) Reciprocal Method:
Continued…
Whichever method is used to apportion service cost center costs, the basis
of apportionment must be fair. A different apportionment basis may be
applied for each service cost center. This is demonstrated in the following
table:

Continuing with the example…

What is direct method…
• The direct method of reapportionment involves apportioning the
costs of each service cost centre to production cost centers only.

• In this method, if the service cost centers are giving services to each
other, then such services are ignored.
Continued: previous example
Answer
Direct method…
Step down Method of reapportionment
This method works as follows:
Reapportion one of the service cost center's overheads to all the other centers
which make use of its services (production and service).
Reapportion the overheads of the remaining service cost center to the production
departments only. The other service cost center is ignored.
How to start:

The service department that does the largest proportion of work for other service
departments is closed first; the service department that does the second largest
proportion of work for other service departments is closed second; and so on.

But if question tells us to close us a particular department first, we will follow the
question requirement.
Re apportionment with step down method.
Re apportionment using repeated distribution
method
Example for simultaneous equation method
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
To start, we have to pick the figures of Service cost centers after apportionment
and before reapportionment.
These are Maintenance = $34840 and Stores $ 18660
Now we can say that M = $34840 + 0.2S (20% S) (this means 20% of stores cost in
M)
We can also say that S = $18660 + 0.1M (10% M) (this means 10% of Maintenance
costs in Stores)

Lets look at the next slide to see what happens next

Rearranging the above equation =
M – 0.2S = $34840 this is our equation 1
-0.1M + S =$18660 this is our equation 2

Multiply equation 1 by 5 and Multiply equation to 2 by 1

The following will be the results.
5M – S = 174200 this is our equation 3
-0.1M +S = 18660 this is our equation 4
We will add Equation 4 into equation 3. Now –S in equation 3 and +S in
equation 4 will cancel each other out.
Answer will be 4.9M = 192860
So M = 192860 / 4.9 =39359
• Now putting the value of M into any equation to compute the value of S
• S = 18660 + 0.1M (this was our first equation which we formed)
• So
• S =18660 +( 0.1 * 39359 ) (replacing M with its value of 39359)
• S = 22596
• Now we have to do the reapportionment using the above computed
figures of M and S
• Lets see how it is done…
Continued…

The key learning point is that we will reapportion the values of M and S computed above

Now the value of Stores is in fact itself equal to the value we have computed as the value of S = $22596
Re apportionment using equation method.