OVERHEADS

By Ejaz Khan
Learning outcomes
(i) Explain the different treatment of direct and indirect expenses.
(ii) Describe the procedures involved in determining production overhead absorption
rates.
(iii)Allocate and apportion production overheads to cost centres using an
appropriate basis.
(iv)Reapportion service cost centre costs to production cost centres (including using
the reciprocal method where service cost centres work for each other)[s]
(v) Select, apply and discuss appropriate bases for absorption rates.[s]
(vi)Prepare journal and ledger entries for manufacturing overheads incurred and
absorbed.[s]
(vii)Calculate and explain the under and over absorption of overheads.[s]

By Ejaz Khan
 Absorption
Rates
There are two types of absorption rates used in an organization:

• Factory wide/blanket Overhead rate

• Departmental Overhead rates

1. Factory Wide rate = Total Budgeted Overheads

Total Budgeted Activity Level *

2. Departmental Overhead rates = Budgeted Departmental Overheads

Budgeted Departmental Activity Level*

* Activity level can be Units Produced, Direct labor hours, Machine hours, Direct labor costs, Direct Material
costs & Prime costs.

By Ejaz Khan
Example: (Absorption rate is calculated using Budgeted Production)

Budgeted Overheads = $50,000

Budgeted Production = 10,000 units
Actual Production = 12,000 units
Actual Overheads = $56,000

Required: Calculate under/over absorbed overheads.

Solution:

FOH/unit = Budgeted Overheads

Budgeted production

Absorbed Overheads = FOH/unit x Actual Production

Under/ Over absorbed Overheads = Absorbed Overheads – Actual Overheads

By Ejaz Khan
Example: (Absorption rate is calculated using Budgeted Hours)

Budgeted Overheads = $80,000

Budgeted Hours = 20,000
Actual Hours= 21,000
Actual Overheads = $87,000

Required: Calculate under/over absorbed overheads.

Solution:

FOH/Hour = Budgeted Overheads

Budgeted Hours

Absorbed Overheads = FOH/hour x Actual Hour

Under/ Over absorbed Overheads = Absorbed Overheads – Actual Overheads

By Ejaz Khan
Journal Entries

WIP XXX
FOH Control A/C XXX

( To record Absorbed Overheads)

FOH control A/c XXX

Income statement XXX

(To record Over-absorbed Overheads)

Income Statement XXX

FOH control A/c XXX

(To record Under-absorbed Overheads)

By Ejaz Khan
Example : Factory Wide rate vs Departmental Overhead rates

Assembly Finishing Total

Budgeted Overheads ($) 100,000 150,000 250,000
Budgeted Machine Hours 10,000 5,000 15,000

Budgeted Labor hours 5,000 20,000 25,000

Required: Calculate Factory wide rate and Departmental Overhead rates:

Solution:

Factory Wide rate =

Departmental Overhead rates:

By Ejaz Khan
Example : Assume that company produces two products X and Y and has following information
available:

Assembly Finishing Total

Product X:
Machine Hours Per unit 2 3 5

Labor hours Per units 1 2 3

Product Y:

Machine hours Per unit 3 4 7

Labor hours per unit 2 3 5

Using the factory wide and departmental overhead rates in the previous example calculate the
amount of overheads absorbed into one unit of each product.

By Ejaz Khan
Try yourself:

Assembly Finishing Total

Budgeted Overheads ($) 50,000 100,000 150,000
Budgeted Machine Hours 20,000 10,000 30,000

Budgeted Labor hours 5,000 20,000 25,000

Required: Calculate Factory wide rate and Departmental Overhead rates:

Solution:

Factory Wide rate =

Departmental Overhead rates:

By Ejaz Khan
Example : Assume that company produces two products X and Y and has following information
available:

Assembly Finishing Total

Product X:
Machine Hours Per unit 1 2 3

Labor hours Per units 0.5 3 3.5

Product Y:

Machine hours Per unit 2 1 3

Labor hours per unit 1 3 4

Using the factory wide and departmental overhead rates in the previous example calculate the
amount of overheads absorbed into one unit of each product.

By Ejaz Khan
 FOH/unit Using Factory Wide rate:

Product X

Product Y

FOH/unit Using Departmental Overhead rates:

Product X

Product Y

By Ejaz Khan
 Allocation, Apportionment and Re-apportionment
1) A company has following budgeted information available for a period:
$
Factory building rent 200,000
Factory building insurance 10,000
Miscellaneous expenses---assembly dept 25,000
Miscellaneous expenses---finishing department 20,000
Machinery insurance 15,000
Depreciation of machinery 40,000
Finishing department –indirect material 10,000
Indirect labor 22,000
Administration salaries 28,000
Storeroom expenses 7,500
Canteen costs 10,000

The administration salaries have to be apportioned into the production cost centers equally.
By Ejaz Khan
Following information is also relevant:
Assembly Finishing Storeroom Canteen

Floor Area 10,000 5,000 3,000 2,000

Cost of Machinery $250,000 $150,000

Share of Canteen Services 60% 40%

Share of Storeroom Services 70% 30%

Labor Hours 20,000 10,000

Machine Hours 4,500 10,000

Required:
•Allocate, apportion, and re apportion overheads into cost centers.
•Calculate absorption rate on appropriate basis.

By Ejaz Khan
 Overheads Allocation Schedule

Assembly Finishing Store Canteen Total

Allocation:
Miscellaneous
Indirect Material
Indirect Labor
Allocated Overheads
Apportionment:
Factory Building
Rent
Factory Building Insurance
Machinery Insurance
Machinery Depreciation
Administration Salaries
Apportioned Overheads
Allocated & app, OHS

By Ejaz Khan
 Overheads Allocation Schedule
Assembly Finishing Store Canteen Total

Allocated & app, OHS

Re-apportionment:

Store
Canteen

Re-apportioned OHs
Total Overheads

By Ejaz Khan
Example: Step down method
Assembly Finishing Store Canteen Total

Allocated & app, OHS $100,000 $200,000 $75,000 $50,000 $425,000

%age of services:
Store 60% 40%
Canteen 40% 40% 20%

Calculate total overheads of each production cost center after re-

apportionment.

By Ejaz Khan
Solution:
Assembly Finishing Store Canteen Total

Allocated & app, OHS

Re-apportionment:

Canteen
Store

Re-apportioned OHs
Total Overheads

By Ejaz Khan
Example: Reciprocal
Method
Assembly Finishing Store Canteen Total

Allocated & app, OHS $100,000 $200,000 $75,000 $50,000 $425,000

%age of services:
Store 50% 40% 10%
Canteen 40% 40% 20%

Calculate total overheads of each production cost center after re-

apportionment.

By Ejaz Khan
Solution: Algebraic Method

By Ejaz Khan
Solution: Algebraic
Method Assembly Finishing

Allocated & app, OHS $100,000 $200,000

Re-apportionment:

Canteen
Store

Re-apportioned OHs
Total Overheads

By Ejaz Khan
Test yourself: Reciprocal
Method
Assembly Finishing Store Canteen Total

Allocated & app, OHS $250,000 $150,000 $50,000 $30,000 $480,000

%age of services:
Store 40% 40% 20%
Canteen 40% 50% 10%

Calculate total overheads of each production cost center after re-

apportionment.

By Ejaz Khan
Solution: Algebraic Method

By Ejaz Khan
Solution: Algebraic Method
(continued)

Assembly Finishing

Allocated & app, OHS $250,000 $150,000

Re-apportionment:

Canteen
Store

Re-apportioned OHs
Total Overheads

By Ejaz Khan
Solved: Test yourself

Simultaneous Equations:

Store (x)
Canteen (y)

X = 50,000 + 0.1y

Y = 30,000 + 0.2x

After Solving Simultaneously we get:

X = 54,082
Y = 40,816

By Ejaz Khan
Solved: Test yourself
Assembly Finishing

Allocated & app, OHS $250,000 $150,000

Re-apportionment:

Store 21,633 21,633

Canteen 16,326 20,408

Re-apportioned OHs 37,959 42,041

Total Overheads 287,959 192,041

By Ejaz Khan
By Ejaz Khan
THE END

By Ejaz Khan