Topic 4

Overhead
LEARNING OBJECTIVES

1 2 3
Explain nature and Understand allocation, Calculate overhead
classification of apportionment and re- absorption rates (OAR)
overhead apportionment of
overheads (no
reciprocal servicing)
 TYPES OF OVERHEAD
 Overhead can be classified according to their function, nature and behavior.

 Function:
 Manufacturing / Production Overhead: Factory rent, supervisor’s salary,
depreciation of machinery, and lubricants (all indirect material).
 Non-Manufacturing Overhead:
Administration Overhead: Accountant’s, director and clerk’s salary,
depreciation of photocopy machine, and depreciation of administration
building.
Selling and Distribution: Salesman commissions, depreciation of
delivery van, and advertising.
Finance: Interest on loan, and bad debt expenses.
Research and Development: Cost of laboratory maintenance, feasibility
costs, salaries for research staff, and cost of testing prototype.
 Nature:
 Indirect
Material: Nuts and bolts in producing table; and salt
and seasoning in restaurant.
 Indirect
Labor: Supervisor’s salary, clerk’s salary and
manager’s salary.
 Indirect
Expenses: Utilities, rent and depreciation of
machinery.

 Behavior:
 Fixed cost: Depreciation of plant, rent and cashier’s salary.
 Variable cost: Nuts and bolts in producing table.
 Mixed cost: Water and electricity bill, and telephone bill.
 Step cost: Supervisor’s salary.
 In manufacturing company, there are 2 COST CENTERS:
 Production cost center – directly concerned in the making
of products. Examples: machining department, assembly
department, finishing department etc.
 Service cost center – providing services to production cost
centers. Examples: maintenance department, store,
canteen, human resource department etc.
 ALLOCATION, APPORTIONMENT AND
RE-APPORTIONMENT OF OVERHEAD
 Direct costs can be conveniently allocated to the product, whereas
manufacturing overhead are incurred for the factory as a whole and
cannot be traced directly to the product. They are shared among
various cost centers. Thus, to charge overhead cost, they need to go
through several steps as below:
 Cost allocation – is the process of charging the overhead costs into
the related cost center.
 Cost apportionment – is the allotment of proportion of overhead cost
to cost center based on the suitable basis chosen.
 Cost reapportionment – is a process where overhead cost in the
service department are transferred to production department.
 Cost absorption – is the allotment of overhead to cost units by
means of rates separately calculated for each cost center.
 Manufacturing/Production Overhead Costs

Cost Allocation/Cost Apportionment to Production Cost Centre and Service Cost Centre

Production Production Production Service Service

Cost Centre Cost Centre Cost Centre Cost Centre Cost Centre
A B C X Y

Reapportionment of service cost centre overhead cost to the Production Cost Centre

Production Production Production

Cost Centre A Cost Centre B Cost Centre C

Overhead Absorption

Cost Unit
The Senegal Enterprise has three departments. The overhead incurred in a particular period
was:

Indirect materials: RM I
Production cost center A 2,000
Production cost center B
Service cost center C
1,500
1,000
L
COST
Indirect wages
Production cost center A 3,000 ALLOCATION L
U
Production cost center B 2,800
Service cost center C 2,200

S
Maintenance 5,000
Rent
Heat & light
1,200
4,800
COST
APPORTIONMENT
Insurance of building
Depreciation of machinery
Supervision
800
7,500
4,600
T
R
Total Overhead Costs
--------
36,400
A
=====
T
The following additional information is available:

Dept. Area Cost of No. of No. of Requisition Maintenance D. Labour hrs.

I
O
(sq. feet) machinery employees hours (budgeted)
A 800 15,000 20 70 2,000 2,000
B 1,000 25,000 25 30 3,400 3,000
C
Total
200
2,000
10,000
50,000
5
50
-
100
2,400
7,800
-
 
N
Note: Service Cost Center overheads are to be reapportioned using Number of Requisition
 COST ALLOCATION
 Cost allocation is where overhead is charged to its related cost
center.
 This can only be done if the amount of overhead is KNOWN
and the cost center has caused the overhead to be incurred.

Basis of Total Prodn. Prodn. Service

Cost Center Cost Center Cost Center
Overheads A B C
Apportionment RM RM RM RM
Indirect Direct allocation 4,500 2,000 1,500 1,000
Materials
Indirect Wages Direct allocation 8,000 3,000 2,800 2,200
 Cost apportionment is where the
overhead costs are not possible
to be allocated directly to a
specific cost center.
COST
It should be apportioned to both
APPORTIONMENT production and service cost
centers on a suitable basis
known as basis of
apportionment.
BASIS OVERHEAD COSTS TO WHICH THE BASIS APPLIES
Area Rents, rates, heating, light, depreciation of buildings, building
service, fire insurance
Book value or capital Depreciation of machinery, equipment, building, vehicles,
value insurance
Number of employees Supervision, canteen expenses, welfare, wages, cost office
expense, administration, payments under profit sharing
schemes, employer’s liability
Technical estimates Power consumptions
Volume of space Heating, lighting, building depreciation
Number of material Materials handling, materials storage
requisitions
Weight of material Materials handling
Value of stock Fire insurance
Horse power or Power
kilowatt hours
Overheads Basis of Total Production Production Service
  Cost Center A Cost Center B Cost Center C
Apportionment RM RM RM RM

Indirect Direct allocation 4,500 2,000 1,500 1,000

Materials COST
Indirect Direct allocation 8,000 3,000 2,800 2,200 ALLOCATION
Wages
Maintenance Maintenance hrs 5,000 1,282 2,179 1,539
(W1)
Rent (W2) Area (sq feet) 1,200 480 600 120
Heat & Light Area (sq feet) 4,800 1,920 2,400 480
(W3)
Insurance of Area (sq feet) 800 320 400 80
COST
Building (W4)
APPORTIONMENT
Depn. of Cost of machinery 7,500 2,250 3,750 1,500
Machinery
(W5)
Supervision No. of e’yees 4,600 1,840 2,300 460
(W6)
Total OH   36,400 13,092 15,929 7,379
   Production Cost Center Service Cost Center
Overheads A B C

Maintenance (W1) RM5,000 x2,000 RM5,000 x3,400 RM5,000 x 2,400

7,800 7,800 7,800
= RM1,282 = RM2,179 = RM1,539
 

Rent (W2) RM1,200 x 800 RM1,200 x1,000 RM1,200 x 200

2,000 2,000 2,000
= RM480 = RM600 = RM120
 

Heat & Light (W3) RM4,800 x 800 RM4,800 x1,000 RM4,800 x 200
2,000 2,000 2,000
= RM1,920 = RM2,400 = RM480
Insurance of Building (W4) RM800 x 800 RM800 x 1,000 RM800 x 200
2,000 2,000 2,000
= RM320 = RM400 = RM80
 

Depreciation of Machinery (W5) RM7,500x15,000 RM7,500 x25,000 RM7,500 x 10,000

50,000 50,000 50,000
= RM2,250 = RM3,750 = RM1,500
 

Supervision (W6) RM4,600 x 20 RM4,600 x 25 RM4,600 x 5

50 50 50
= RM1,840 = RM2,300 = RM460
     
WHAT IS COST RE-APPORTIONMENT?
 Once overhead costs have been apportioned fairly to all the cost centers,
we then need to re-apportion overhead cost of the service center to the
production cost center.
 Reason - This is because only production cost center are directly involved
in the manufacture of cost units. Service cost center are those
departments that exist to provide services of various kinds to other units
within the organization. They do not deal directly to the products.
 Service Possible Bases of Apportionment to Production Cost
Department Centre

re-apportionment
 
Maintenance Maintenance labor hour
  Maintenance wages
  Plant values
   
Stores No of requisitions
  Weight of material issued
Basis for

   
Inspection No of employees per cost centre
  No of inspection tickets
  No of jobs
   
Production No of production employees per cost centre
Control
  No of jobs
   
Power Generation Metered usage
  Notional capacity
  Technical estimates
   
Personnel No of employees per department
Department
   
Canteen No of employees
 
The following additional information is available (DIRECT METHOD)
Dept. Area Cost of No. of No. of Maintenance D. Labour
(sq. feet) machinery employees Requisition hours hrs.
(budgeted)
A 800 15,000 20 70 2,000 2,000
B 1,000 25,000 25 30 3,400 3,000
C 200 10,000 5 - 2,400 -
Total 2,000 50,000 50 100 7,800  

Overheads Basis of Total Prodn. Prodn. Service

  Cost Center A Cost Center B Cost Center
Apportionment   RM RM C
RM RM
Total OH   36,400 13,092 15,929 7,379
Reapportionment No. of 7,379 5,165 2,214 (7,379)
of Service Cost Requisition (0.7 X 7,379) (0.3 X 7,379)
Center OH
Total OH   36,400 18,257 18,143 -
OVERHEAD ABSORPTION RATES

OH that have been apportioned to production cost centers

needs to be absorb into cost units through computation of
Overhead Absorption Rates (OAR).

To find out the amount of OH to include in the cost of the

jobs, units of production, processes and batches.
Purpose of OAR:
To estimate the OH cost applicable to a product in advance
of actual production

There are two Departmental rate

(2) methods to
Factory rate / single rate / blanket rate
calculate OAR:
 Departmental
• Use when each department will
use different OAR with the other
department.
• This is appropriate when
performance of the department
manager will be evaluated
separately or each department has
different method used in the
production process.
Blanket
• Use when the company
established a single rate for the
factory as a whole.
• It is appropriate if each department
used the same procedure, or uses
the same proportion of overhead
costs.
• It also can be applied suitably in
small concerns and only where a
single product is manufactured.
 Basis of Absorbing OH
BASIS FORMULA
Direct material cost Total estimated overheads of cost centre X 100%
percentage rate Total estimated direct material costs
 
Direct labour cost Total estimated overheads of cost centre X 100%
percentage rate Total estimated direct labour costs
 
Prime cost Total estimated overheads of cost centre X 100%
percentage rate Total estimated prime material costs
 
Direct labour hour Total estimated overheads of cost centre
rate Total estimated direct labour hours
Machine hour rate Total estimated overheads of cost centre
Total estimated machine hours
 
Cost unit rate Total overheads of cost centre
Total unit of production
Overheads Prodn. Prodn. Service Dept. D. Labour

E
CC A CC B CC C hrs.
RM RM RM (budgeted)
Total OH 13,092 15,929 7,379 A 2,000
Reapportionment 5,165
(0.7 X 7,379)
2,214
(0.3 X 7,379)
(7,379) B
C
3,000
-
X
Total OH 18,257 18,143 - Total  
A
a) Departmental OAR
Prodn. Prodn.
b) Wide Blanket OAR M
Overheads Cost Center A
RM
Cost Center B
RM
OAR = 18,257 + 18,143
2,000 + 3,000
P
Total OH
OAR
18,257
18,257/2,000
18,143
18,143/3,000
= RM7.28 per DLH L
RM9.13 per DLH RM6.05 per
DLH E
 OAR: BUDGETED vs ACTUAL?
 Overhead are usually absorbed before the end of the costing period. In such case,
predetermined absorption rates have to be used. Predetermined absorption rates
are based on estimated or budgeted units of base.

 Why we didn’t used ACTUAL OAR? Because…

 Product cost calculations have to be delayed until the end of the accounting
period whereas the information on product costs is required quickly if it is to be
used for monthly profit calculations and inventory valuations or as basis for
setting selling prices.
 OH rates cost incurred is varied due to the influenced of seasonal nature of OH,
change in volume of production and efficiency of the factory in different period.
OAR: UNDER vs OVER ABSORPTION
 Because of the costs have been determined in advance of
ocurrence of the overhead expenditure it will lead to difference of
overhead incurred and overhead absorbed.
 Such a difference is said to be under absorption of overhead or
over absorption of overhead.
 Under absorption of overhead means that the amount of overhead
absorption is less than the actual overhead incurred.
 Over absorption means that the amount of overhead absorption is
more than the actual overhead.
Reasons for UNDER or OVER Absorption OH
 Actual overhead cost incurred may be more or less than
the budgeted overhead.
 Actual machine hours, labour hour and output may be
lower or higher than the budgeted or predetermined
base.
 Seasonal fluctuations.
 Wrong computation of overhead absorption rate, output
and machine hours:
 Under or over utilization of production capacity.