1. Paper F2 Management Accounting
2019/1/1

2. Chapter 8 Accounting for overheads
2019/1/1

3. Accounting for OHs Chapter Preview Absorption costing
(3-stage approach)
Absorption
Allocation
Apportionment
Predetermined OAR
Under/Over absorbed
2019/1/1
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4. Aim – to find the full cost of one unit
Cost card
Aim – to find the full cost of one unit
$/unit
Direct materials $2/kg X
Direct labour 3 $7/hr X
Prime cost X
Overheads X
Full Product cost X
Trace
(Allocate)
3 Steps
2019/1/1
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5. Types of overheads
Overhead is … cannot be traced directly and in full to the product, service or department.
Overheads include the following items:
Indirect materials +
Indirect labour
Indirect expenses
Production OHs +
Administration OHs
Selling &distribution OHs
2019/1/1
Ji Weili, JXUFE

6. Methods of dealing with OHs
One of the most difficult tasks in computing accurate unit costs lies in determining the proper amount of overhead cost to assign to each unit produced.
Assigning
overhead is
difficult.
I agree!
2019/1/1
Ji Weili, JXUFE

7. Absorption costing method
Total Production Costs
Direct Costs
Indirect Costs
(overheads)
COST UNIT
Allocate
Allocate & Apportion
COST CENTRES
Production 1
Production 2
Service
Production 1
Production 2
Reapportion
Absorb
2019/1/1
Ji Weili, JXUFE

8. Is absorption costing necessary
Practical reasons
--Inventory valuation
--Pricing decisions
--Profitability of different products
Accounting regulations
--IAS 2
2019/1/1
Ji Weili, JXUFE

9. Three-Stage absorption costing
Stage One:
OHs allocated
to cost centers
Indirect
Labor
Indirect
Materials
Indirect
Expenses
Pro. Dept.
Pro. Service Dept.
Adm. Dept.
SellingDept.
OH cost center
2019/1/1
Ji Weili, JXUFE

10. Three-Stage absorption costing
Stage One:
OHs allocated
to cost centers
Indirect
Labor
Indirect
Materials
Indirect
Expenses
Pro. Dept.
Pro. Service Dept.
Adm. Dept.
SellingDept.
OH cost center
2019/1/1
Ji Weili, JXUFE

11. Three-Stage absorption costing
Stage One:
OHs allocated
to cost centers
Indirect
Labor
Indirect
Materials
Indirect
Expenses
Pro. Dept.
Pro. Service Dept.
Adm. Dept.
SellingDept.
OH cost center
2019/1/1
Ji Weili, JXUFE

12. Three-Stage absorption costing
Stage Two:
Costs apportioned
to departments
Indirect
Labor
Indirect
Materials
Indirect
Expenses
Pro. Dept.
Pro. Service Dept.
Adm. Dept.
SellingDept.
OH cost center
Apportion 2-costs of service cost center
Apportion 1-general OH
2019/1/1
Ji Weili, JXUFE

13. Three-Stage absorption costing
Stage One:
OHs allocated
to cost centers
Indirect
Labor
Indirect
Materials
Indirect
Expenses
Stage Two:
Costs apportioned
to departments
Pro.
Dept.1
Pro.
Dept. 2
Pro.
Dept. 3
Stage Three:
Costs absorbed
to cost units
cost units
2019/1/1
Ji Weili, JXUFE

14. Three-Stage absorption costing
Stage One:
OHs assigned
To cost centers
Indirect
Labor
Indirect
Materials
Indirect
Expenses
Stage Two:
Costs absorbed
to departments
Pro.
Dept. 1
Pro.
Dept. 2
Pro.
Dept. 3
Direct
Labor
Hours
Machine
Hours
Rate
per unit
Stage Three:
Costs absorbed
to cost units
cost units
Absorption Bases
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15. Total Production Costs
Overheads – step 1 & 2
Total Production Costs
Direct Costs
Indirect Costs
(overheads)
COST UNITS
Allocate & Apportion
COST CENTRES
Production 1
Production 2
Service
Allocate
2019/1/1
Ji Weili, JXUFE

16. Step 1 -- Allocation
Allocation is the process by which whole cost items are charged direct to a cost unit or cost centre.
Cost centre: When costs are incurred, they are generally allocated to a cost centre. A cost centre acts as a collecting place for certain costs.
2019/1/1
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17. Example Why we need three cost centres rather than two?
Wages of the foreman of department A…………$200
Wages of the foreman of department B…………$150
Indirect materials consumed in department A…………$50
Rent of the premises shared by department A and B $300
The cost accounting system might include three cost centres:
Cost centre Department A
102 Department B
201 Rent
Why we need three cost centres rather than two?
2019/1/1
Ji Weili, JXUFE

18. Step 2 – Apportion general OHs
The costs called general OHs for heat and light, rent and rates, the canteen and so on must be shared out between the other cost centres.
Basis of apportionment
Example: 4.1 & 4.2.2
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19. Total Production Costs
Overheads – step 3
Total Production Costs
Direct Costs
Indirect Costs
(overheads)
COST UNITS
Allocate & Apportion
COST CENTRES
Production 1
Production 2
Service
Allocate
Production 1
Production 2
Reapportion
2019/1/1
Ji Weili, JXUFE

20. Sept 3 -- Reapportionment
To reapportion service cost centre overheads to production cost centres there are several methods
Direct Method
Inter-service department work is ignored
ReciprocalMethod
All inter-service department work is recognised
2019/1/1
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21. The reciprocal method of apportionment
There two ways to work out—repeated distribution & algebraic method
Basis of apportionment
Example: & 4.5.1
Exercise: 4.6
2019/1/1
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22. Total Production Costs
Overheads – step 4
Total Production Costs
Direct Costs
Indirect Costs
(overheads)
COST CENTRES
Production 1
Production 2
Service
Allocate & Apportion
Reapportion
COST UNIT
Allocate
Absorb
2019/1/1
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23. What activity level should you use?
Step 4 -- Absorbtion
The final step is to charge these overheads to cost units. This is called absorption.
Production overhead
_______________
Activity level
OAR (overhead absorption rate) =
What activity level should you use?
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24. Absorption bases (a) Per unit OAR/unit (b) Per labour hr OAR/lab hr
(c) Per machine hr
OAR/mach hr
(d) % Direct Labour cost
OAR/$ labour
(e) % Direct material cost
OAR/$ mats
(f) % Prime cost
OAR/$ prime cost
2019/1/1
Ji Weili, JXUFE

25. Pre-determined OARs
Businesses estimate (or pre-determine) their OAR at the start of the year
OAR =
__________________
Activity level
Production Overhead
Budgeted overhead
Pre-determined OAR =
_________________
Budgeted activity level
2019/1/1
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26. Businesses want to record overheads regularly during the year
Cont.
Businesses want to record overheads regularly during the year
Overhead Absorbed =
Actual Activity (eg labour hrs) x
Pre-determined OAR
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27. Reasons for using a predetermined overhead rate
Cont.
Reasons for using a predetermined overhead rate
Overhead is not incurred uniformly during the year.
Actual overhead rate might vary from month to month.
Predetermined rate makes it possible to estimate job costs sooner.
2019/1/1
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28. Adjusting of Under/over absorbed OH
The POHR is based on estimates.
What happens if actual results differ from the estimates?
The result will be either under-absorbed or over-absorbed overhead and we will adjust Profit and Loss account at the end of the period.
Here, let me show you.
2019/1/1
Ji Weili, JXUFE

29. Adjusting of Under/over absorbed OH
Overhead is over-absorbed.
Overhead absorbed to Work in Process
(POHR × actual activity)
Actual overhead costs incurred
2019/1/1
Ji Weili, JXUFE

30. Adjusting of Under/over absorbed OH
Overhead is under-absorbed.
Actual overhead costs incurred
Overhead absorbed to Work in Process
(POHR × actual activity)
2019/1/1
Ji Weili, JXUFE

31. Question
FishCo had actual production overhead costs of $180,000. FishCo absorbed $192,000 of production overhead to jobs based on a POHR of $8.00 per direct labor hour. FishCo’s production overhead is:
a. $12,000 over-absorbed.
b. $12,000 under-absorbed.
c. $96,000 over-absorbed.
d. $96,000 under-absorbed.
2019/1/1
Ji Weili, JXUFE

32. Question
FishCo had actual production overhead costs of $180,000. FishCo absorbed $192,000 of production overhead to jobs based on a POHR of $8.00 per direct labor hour. FishCo’s production overhead is:
a. $12,000 over-absorbed.
b. $12,000 under-absorbed.
c. $96,000 over-absorbed.
d. $96,000 under-absorbed.
2019/1/1
Ji Weili, JXUFE

33. Question
The difference between FishCo's actual and absorbed overhead will result in an adjustment that increases profit.
a. True
b. False
2019/1/1
Ji Weili, JXUFE

34. Question
The difference between FishCo's actual and absorbed overhead will result in an adjustment that increases profit.
a. True
b. False
If overhead is over-absorbed, cost of goods sold is too high. The adjustment will increase profit.
2019/1/1
Ji Weili, JXUFE

35. Adjusting of Under/over absorbed OH
At the end of the year actual overheads will be known
Overhead Absorbed 
Actual Overhead
Difference = under or over absorption
Discuss why there are differences – actual volume and expenditure may differ from budget
2019/1/1
Ji Weili, JXUFE

36. Reasons for under/over absorption
Why do we get an under or over absorption?
Pre-determined OAR
Budgeted overhead
_________________
Budgeted activity level =
Expenditure variance
Budgeted overhead 
Actual overhead
Volume variance
Budgeted activity 
Actual activity
2019/1/1
Ji Weili, JXUFE

37. Under-/over-absorbed OHs
Ledger entries relating to OHs
Work in process
Production OHs
Actual
Absorbed
Balance (over)
Balance (under)
Profit and loss
Under-/over-absorbed OHs
2019/1/1
Ji Weili, JXUFE

38. Non production overheads
For internal reporting non-production overheads can also be allocated to units
One approach may be:
Production overhead
OAR =
Non-Production Overhead
2019/1/1
Ji Weili, JXUFE

39. Outline: Absorption costing--3A Procedure
Product X
Costs incurred
Allocate
Apportion 1
Apportion 2
Absorb
Production
overhead
Service
department
General service
Administration
Selling
Distribution
2019/1/1
Ji Weili, JXUFE

40. Tips
这一方法习惯上被称为“完全成本法”或“全部成本法”，重点在于如何将归集起来的制造费用分配到产品成本中去，分配的基本原则是受益原则—— “谁受益，谁承担”；在分配标准的选择上应体现 “受益多，多承担，受益少，少承担”
解题时牢记三个问题：
分什么？——明确待分配费用
分给谁？——明确分配对象
按什么分？——选择恰当的分配标准
2019/1/1
Ji Weili, JXUFE

41. End of Chapter 8
2019/1/1