TOPIC 4

ACCOUNTING FOR OVERHEADS

Learning Outcomes

At the end of this chapter, student should be able to learn:

1. Items that classified as production overhead.
2. The allocation, apportionment and re-apportionment of overheads to cost centres.
3. The calculation of overhead absorption rate

4.1 Introduction
Production overheads consist of __________________, _____________________
and _______________________.

Such costs cannot be conveniently identified with o charged directly to specific jobs,
process or products.

Production overheads can be classified as:

(a)
(b)

4.2 Production overhead cost allocation, apportionment and re-apportionment

The process of assigning or applying overheads to products involves:

(a)
(b)
(c)

Cost allocation - is the charging of discrete identifiable items of cost

to cost centres or cost units

Cost apportionment - is the division of costs (amongst two or more cost

centres) in proportion to the estimated benefit
received using logical basis.

Overhead absorption - is the charging of overheads in various cost centres

to cost units, jobs or processes. Overhead
absorption is also known as ________________.

The amount that absorbed to the product is called

________________________.

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4.2.1 Production overhead allocation

When overhead costs can be directly traced to a cost centre, they will be allocated to
that cost centre.

A cost centre may be:

(a) A production department (production overhead);
(b) A service department within the factory (production overhead);
(c) An administration department (administration overhead);
(d) A selling and distribution department (sales and distribution overhead);
(e) Items of expenses shared by other departments (e.g. rent, light, maintenance,
insurance, etc.)

4.2.2 Cost apportionment

When overhead costs cannot be directly traced to a cost centre, they cannot be
allocated. As they are incurred for the benefit of many departments, it is necessary to
apportion them to these departments using logical basis.

The following table gives some commonly used bases for cost apportionment.

Costs Basis of Apportionment

Rent, rates Floor area / space occupied
Light, heat Floor area / space occupied
Power Kilowatt hours / capacity of machine
Employee related costs Number of employees / wages cost
Depreciation of plant and machinery Value of machine / age of machine
Insurance of plant and machinery Value of machine
Canteen costs Number of employees

The choice of an appropriate basis is to ensure that cost apportioned to the cost
centres reflects the benefit received.

However, it must be pointed out that no matter how “appropriate” a basis a chosen,
there always remains another acceptable basis. Hence, the choice of the most
appropriate basis is subjective and the apportionment of overhead costs is arbitrary.

4.2.3 Re-apportionment overhead costs

The end requirement is to identify the production overheads, thus overheads incurred
in the service department will be re-apportion to production department since service
centre servicing production department in a factory.

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Production overhead incurred

Standing orders
Code numbers

Allocation and Allotment

Final distribution

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Illustration 1
Factory XYZ incurs the following overhead costs:
RM
Wages for foremen in Machining Department 800
Wages for foremen in Finishing Department 2,000
Salaries for supervisors: Machining Department 1,500
Finishing Department 2,000
Indirect material issued to: Machining Department 600
Finishing Department 800
Power 4,000
Rent 8,000
Canteen expenses 4,000

For cost accounting purposes, cost centres are set up which include:

Machining Department
Finishing Department
Service Department

The additional information are given below.

Area occupied Machining Department 2,500 sq.m

Finishing Department 1,000 sq.m
Canteen 500 sq.m

Horsepower of machinery Machining Department 3,000 kwh

Finishing Department 1,000 kwh

Number of employees Machining Department 50

Finishing Department 150

Required:
Prepare overheads analysis sheet to allocate, apportion and re-apportion overheads
costs to the various cost centres.

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Solution

Production overhead analysis sheet

Production Service
Production Overheads Total (RM)
Machining Finishing Canteen
Wages

Salaries

Indirect material

Power

Rent

Canteen expenses

total
Re-apportionment

4.3 Overheads absorption rate (OAR)

There is no single correct way of charging overhead to the product and the final
choice is a matter of judgement. The reasonable way is to identify the nature of
overhead.

Where production is machine-intensive overheads incurred are related to machine

expenses thus using ‘machine hour’ as the base to absorb overhead into production
is seems reasonable.

In a labour-intensive department the base use most appropriate is ‘labour hour’.

Nonetheless there are other bases available to be used as bases for absorption.

Production overhead absorption rate is determined by the following relationship.

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Illustration 2
The following data was collected for Hay Vee Machinery Ltd.

Production overheads RM10,000

Direct labour hours 2,000 hours
Direct labour cost RM8,000
Machine hours 4,000 hours
Direct material costs RM5,000
Production 2,500 units

Required:
Calculate overhead absorption rate using the following bases.

(a) Direct labour hours;

(b) Direct labour costs (Direct wages);
(c) Machine hours;
(d) Direct material costs; and
(e) Production output.

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4.3.1 Departmental Overhead Absorption Rates

Departmental overhead absorption rates may be developed for each department by
using an appropriate activity base.

Illustration 3
Zenon Manufacturing Company has two departments, A and B, engaged in
manufacturing operations and they are serviced by a maintenance department and a
store.

The following data was collected for the month just ended:

Total A B Maintenance Store

RM RM RM RM RM
Indirect labour 105,000 80,000 20,000 4,000 1,000

Supervision 3,000

Power 5,000

Rent 4,000

Plant insurance 1,000

118,000

Additional information:

Maintenanc
A B Store
e
Floor area (sq.m) 1,500 1,500 300 700
Number of employees 110 60 15 15
Power (kwh) 20,000 10,000 3,000 2,000
Maintenance (hrs) 400 600 - -
Plant value (RM) 30,000 20,000 - -
Number of material requisition 500 300 100 -
Machine hours 5,000 - - -
Labour hours - 2,000

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Calculate overhead absorption rates for production department.

(a) A, using machine hours as a base; and
(b) B, using labour hour as a base.

4.3.2 Calculation of product cost

Illustration 4
Gorby manufactured a revolutionary new product, the Stroika. The following was
taken from Gorby’s budget for 20X0.

Department A (Machining) B (Finishing)

Production overhead cost RM24,000 RM21,000
Direct material cost RM50,000 RM30,000
Direct labour hours 2,500 30,000
Direct labour rate per hour RM10 RM5
Machine hours 10,000 500

The work of department A is heavily automated, with machines doing most of the
work. Individual workers in each department earn slightly different rates of pay, and
occasionally work overtime.

Required

(a) Calculate an appropriate production overhead absorption rate for each

department.

(b) During 20X0, Perry asked for a Stroika to be made for him. Production data
was as follows.

Direct material RM100

Direct labour (department A) 2 hours
(department B) 10 hours
Machine hour (department A) 20 hours
(department B) 10 hours

Calculate the cost of Perry’s Stroika.

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TUTORIAL EXERCISES

1. The Montani Company estimated its factory overhead for the next period at
RM160,000. It is estimated that 40,000 units will be produced at material costs of
RM200,000. Production will require 40,000 labour hours at an estimated wage cost of
RM80,000. The machine will run about 25,000 hours.

Required
Calculate the overhead absorption rate using the following bases:
(a) Material cost
(b) Direct labour cost
(c) Direct labour hours
(d) Machine hours

2. Landmark Manufacturing Sdn Bhd has a building which house three production
departments, A, B and C, and one service department D. the service department D is
wholly involved in working for the three production departments and it is estimated
that department A uses 50%, department B uses 30% and department C uses 20%
of the services of department D.

The actual costs for the four departments for a period were:

RM
Allocated overhead cost 2,800
Insurance on building 600
Insurance on machines 800
Rent 1,000
Heating 800
Pension fund 850
General supervision 1,400
Electricity (general) 600
Electricity (power) 1,960
Depreciation 2,00

The following information is available in respect of the departments.

A B C D
Allocated overhead cost (RM) 800 320 1,200 480
Value of machines (RM) 5,000 5,000 8,000 2,000
Kilowatt hours (000s) 100 100 150 50
Number of employees 20 8 30 12
2
Area occupied (m ) 2,000 1,000 4,000 1,000
Total wages (RM) 2,500 1,000 3,200 1,800

Required
Prepare overhead analysis sheet and determine the production overhead incurred.

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3. A factory comprises three production cost centres and two service cost centres. The
factory overhead costs for the year ended 31 December 201X are detailed below.

Indirect Material Indirect Wages

RM’000 RM’000
Allocated overhead
(P1) Machine shop 1 274 750
(P2) Machine shop 2 326 900
(P3) Assembly shop 170 380
(S1) Material services 38 230
(S2) Personnel services 22 130

Apportionable overhead: RM’000

Insurance (buildings) 60
Insurance (plant) 180
Depreciation (plant) 900
Rent and rates 300
Power 120
Light and heat 120

To facilitate apportionments, the cost accountant has converted appropriate

quantitative figures into percentages as follows:

P1 P2 P3 S1 S2
Book value of machines 35 45 15 5 -
Floor area 25 30 20 15 10
Values of stores issues 40 50 10 - -
Power usage 40 45 10 5 -
Number of employees 35 45 20 - -

Production capacities: P1 P2 P3
Machine hours (thousand) 600 800 -
Labour hours (thousand) - - 450

Information relating to Product PPD:

P1 P2 P3
Direct material (RM) 12 3 2
Direct labour cost (RM) 12 12 12
Machine hours 2 3 -
Labour hours - - 4

Required:
Draw up a suitable columnar form and, using appropriate bases, distribute the
overhead costs over the cost centres.

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4. Metal Ltd has three production departments as follows:

Code
Heavy machine HM
Light machine LM
Finishing F

Direct materials and wages are charged to jobs whilst production overhead is added
by applying a fixed percentage on direct wages cost (based on the annual budget),
one “blanket” rate being used for all factory production. Consideration is being given
to a suggestion that the application of separate departmental rate, based on
budgeted working hours, would result in more accurate job costs.

The following data appears in the budget for the current year:

Department Direct wages Machine Labour hours Production

hours overhead
RM RM
HM 102,000 25,000 - 150,000
LM 40,000 10,000 - 26,000
F 8,000 - 2,000 4,000

The actual figures for the month of May were:

Department Direct wages Machine Labour hours Production

hours overhead
RM RM
HM 8,000 2,000 - 12,500
LM 3,000 800 - 1,950
F 1,000 - 250 550

Job No. 782 commenced and finished during may and the following details were
recorded:

Department Direct Direct wages Machine Labour hours

materials hours
RM RM
HM 520 160 40 -
LM - 200 50 -
F - 40 - 10

Required:
(a) Calculate the current “blanket” overhead absorption rate (% on direct wages)
(b) Calculate separate departmental overhead absorption rate per hour (machine
or labour)
(c) Compute the total production cost for Job No. 782:
(i) Using the current blanket absorption rate; and
(ii) Using a separate hourly rate for each department.

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5. (a) State an appropriate basis of apportionment for each of the following production
overhead costs:

(i) Factory rent;

(ii) Staff canteen.

(b) Overheads allocated, apportioned and re-apportioned to the two production

cost centres in a factory for a period were:

Production Cost Centre

X Y
Budget RM161,820 RM97,110
Actual RM163,190 RM96,330

Overheads are absorbed using predetermined rates. A machine hour rate is

used in Production Cost Centre X and a direct labour hour rate in Production
Cost Centre Y. Machine and direct labour activity in each production cost
centre is:

Production Cost Centre

X Y
Machine hours:
Budget 8,700 1,760
Actual 8,960 1,725

Direct labour hours:

Budget 6,220 8,300
Actual 6,276 7,870

Required:
Calculate for each production cost centre for the period:

(i) the predetermined production overhead absorption rate;

(ii) the production overheads absorbed;

(iii) the over/under absorption of production overhead.

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6. A company has three production departments (X, Y and Z) in its factory. After
completion of all overhead allocation and apportionment, the production department
budgets for Year 6 included the following:

Department
X Y Z
Overhead costs RM51,240 RM87,120 RM66,816
Direct labour hours – – 11,520
Machine hours 4,200 5,280 –

A predetermined overhead absorption rate is established for each production

department each year.

Actual data for Month 1 of Year 6 included:

Department
X Y Z
Overhead costs RM4,410 RM7,190 RM5,610
Direct labour hours – – 985
Machine hours 340 426 –

Required:

(a) Calculate, from the data provided, an appropriate predetermined overhead

absorption rate for each production department for Year 6.

(b) Calculate the amount of the over/under absorption of overhead in Month 1 in

each production department and in total for the factory.

(c) Suggest two general causes of overhead under absorption.

7. Elm Co has two service cost centre serving two production cost centres. Overheads
costs apportioned to each cost centre are as follows.

P1 P2 S1 S2
Total overheads RM97,428 RM84,947 RM9,384 RM15,823
Service 1 hours worked 20,000 15,000 - 5,000
Service 2 hours worked 3,000 8,000 1,000 -

Required:

(1) Reapportion the service cost centres’ overhead using direct method.

(2) Reapportion the service cost centres’ overhead using step down method.

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MCQ EXERCISES

1. Which of the following would be the most suitable way of apportioning depreciation of
plant and machinery?
A Power consumption of the machinery
B Number of workers using the machinery
C Floor area occupied by the machinery
D Cost of the machinery

2. Which of the following could be suitable ways of apportioning maintenance of plant

and machinery?

1. Number of hours the machinery runs for

2. Number of machines
3. Book value of the machinery
4. Cost of the machinery

A Any of the above

B 1 or 2 only
C 1, 2, or 3
D 1, 2, or 4

3. If an entire cost can be related to a department, then the cost is said to be:

A apportioned to that department

B allocated to that department
C absorbed by that department
D allotted to that department

4. It is possible for an item of overhead expenditure to be shared amongst several cost

centres. It is also possible that an item of overhead expenditure may relate to just
one specific cost centre.

What term is used to describe charging an item of overhead to just one specific cost
centre?

A Absorption
B Allocation
C Apportionment
D Re-apportionment

5. What would be the most appropriate basis for apportioning factory building insurance
costs to cost centres within a factory?

A Floor area occupied by the factory

B Number of machines
C Operating hours of machinery
D Value of machinery

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6. The following indirect costs were incurred in a factory in a period:

Rental of premises RM80,000

Utilities RM25,000

There are two cost centres, A and B, in the factory which between them occupy the
20,000 square metres (sq m) of floor space (cost centre A, 8,000 sq m; cost centre B,
12,000 sq m).

What is the total indirect cost apportionment to cost centre B in the period if floor
space is used as the basis of apportionment?

A RM42,000
B RM52,500
C RM63,000
D RM105,000

7. Budgeted overheads = RM12,000; budgeted production = 2,000 units

Actual overheads = RM13,000; actual production = 1,900 units.

Which of the following is correct?

A Overheads under-absorbed = RM1,000
B Overheads under-absorbed = RM1,600
C Overheads over-absorbed = RM1,600
D Overheads over-absorbed = RM1,000

8. Budgeted overheads = RM50,000; budgeted production = 20,000 units

Actual overheads = RM46,000; actual production = 19,000 units.

Which of the following is correct?

A Overheads under-absorbed = RM2,000
B Overheads under-absorbed = RM1,500
C Overheads over-absorbed = RM1,500
D Overheads over-absorbed = RM2,000

9. A factory consists of two production cost centres (A and B) and two service cost
centres (X and Y). The total allocated and apportioned overhead for each is as
follows:

A B X Y
RM95,000 RM82,000 RM46,000 RM30,000

It has been estimated that each service cost centre does work for other cost centres
in the following proportions:

A B X Y
Percentage of service cost centre X to 50 50 – –
Percentage of service cost centre Y to 30 60 10 –

The reapportionment of service cost centre costs to other cost centres fully reflects
the above proportions.

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After the reapportionment of service cost centre costs has been carried out, what is
the total overhead for production cost centre A?

A RM124,500
B RM126,100
C RM127,000
D RM128,500

10. The process of cost apportionment is carried out so that

A costs may be controlled
B cost units gather overheads as they pass through cost centres
C whole items of cost can be charged to cost centres
D common costs are shared among cost centres

11. A cost centre is

A A unit of product or service in relation to which costs are ascertained
B An amount of expenditure attributable to an activity
C A production or service location, function, activity or item of equipment for which
costs are accumulated
D A centre for which an individual budget is drawn up

Question 4
12. A company manufactures two products L and M in a factory divided into two cost
centres, X and Y. The following budgeted data are available:

Cost centre
X Y
Allocated and apportioned fixed
overhead costs RM88,000 96,000

Direct labour hours per unit:

Product L 3·0 1·0
Product M 2·5 2·0

Budgeted output is 8,000 units of each product. Fixed overhead costs are absorbed
on a direct labour hour basis.

What is the budgeted fixed overhead cost per unit for Product M?
A RM10
B RM11
C RM12
D RM13

13. A company operates a job costing system. Job number 1203 requires RM300 of
direct materials and RM400 of direct labour. Direct labour is paid at the rate of RM8
per hour. Production overheads are absorbed at a rate of RM26 per direct labour
hour and non-production overheads are absorbed at a rate of 120% of prime cost.

What is the total cost of job number 1203?

A RM2,000
B RM2,400
C RM2,840
D RM4,400

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14. The management accountant of Warsaw Limited has already allocated and
apportioned the fixed overheads for the period although she has yet to reapportion
the service centre costs. Information for the period is as
follows:

Production dept Maintenance dept

1 2 S M Total
Allocated and apportioned 17,500 32,750 6,300 8,450 65,000
(RM)

Work done by :
Stores 60% 30% - 10%
Maintenance 75% 20% 5% -

What are the total overheads included in production department 1 if the reciprocal
method is used to reapportion service centre costs?

A RM27,618
B RM28,171
C RM28,398
D RM28,453

15. There are two production cost centres and two service cost centres in a factory.
Production overheads have been allocated and apportioned to cost centres and now
require re-apportionment from service cost centres to production cost centres.
Relevant details are:

Service Cost Service Cost

Centre A Centre B
Total overhead RM42,000 RM57,600
% to Production Cost Centre X 40 55
% to Production Cost Centre Y 60 45

What is the total re-apportionment to Production Cost Centre Y?

A RM42,720
B RM48,480
C RM51,120
D RM56,880

16. The overheads of two service departments (SCC1 and SCC2) in a factory require re-
apportionment to the two production departments (PCC1 and PCC2):

Total overhead % to PCC1 % to PCC2

SCC1 RM32,170 35 65
SCC2 RM24,850 65 35

What is the total re-apportionment to production department PCC2?

A RM19,957
B RM27,412
C RM29,608
D RM37,063

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