1. Overheads

2. Overheads Overhead includes a large number of types of indirect costs
Direct cost are identifiable to cost units, but overhead which are often considerable, cannot be related directly to cost units

3. Two-stage method to allocate overhead to products
Overheads are assigned to the cost centres such as department
An allocation base is selected for allocating production centre expenses to products

4. Procedures of overhead allocation to product
Assign all factory overheads to cost centres
Reallocate service-centre overheads to production cost centres
Calculate separate overhead absorption rate for each cost centre
Assign cost-centre overhead to products

5. Assign all factory overheads to cost center

6. Assign all factory overhead to cost centres
Cost allocation
Cost apportionment

7. Cost allocation
Where a cost can be clearly identified with a cost center or cost unit, then it can be allocated to that cost center or cost unit

8. Cost apportionment
It is not possible to identify a discrete item of cost with a cost center and it is necessary to split a cost over several cost centers on some agreed basis

9. Bases of apportionment
Apportionment of indirect expenses to cost centers must be made on fair and reasonable bases
Different types of expense require different bases according to their individual characteristics

10. Rent and rates, heat and lighting, insurance of lighting
Base of apportionment
Costs
Area
Rent and rates, heat and lighting, insurance of lighting
Machine value
Depreciation, machine insurance
No. of employees
Wages of supervisors, canteen cost
Example textbook P.183

11. Reallocate service-center overheads to production center

12. Reallocate service-centre overheads to production cost centres
Service departments are not directly involved in production
They only support service to other production departments in order to facilitate the production process
Therefore, it is necessary to reallocate the service-centre overheads to production departments so that all production costs can be absorbed into production.
Typical bases are listed as follows:

13. Typical bases are listed as follows: Service departments
Possible bases of apportionment
Maintenance
Maintenance labour hours, machine value
Stores
Value or weight of materials issued, number of requisitions
inspection
No. of employees, no. of jobs
Example textbook P.183

14. Calculate separate overhead absorption rate for each cost center

15. Calculate separate overhead absorption rate for each cost centre
To determine the overheads to be absorbed by a cost centre, it is necessary to establish an overhead absorption rate (OAR)
Total overhead of cost centre
OAR =
Total number of units of absorption base applicable
to cost centre

16. Some commonly used absorption bases are listed as follows:
An appropriate OAR should reflect the effort or time taken to produce the products
Some commonly used absorption bases are listed as follows:
Direct labour hours
It is frequently used in the labour intensive department because overheads assigned to this department are closely related to the direct labour hours worked
Machine hours
It is most appropriate for the appropriate for the machining department since most of the overheads are closely related to machine hours

17. Direct wages
It is only suitable in the department where the uniform wage rate is applied
Direct materials
This method is not recommended unless the majority of overheads incurred in a department are related to materials instead of time
Units of output
This method is suitable only where all units produced in a period are identical in the production process and time. Therefore, this application is very rare
Example textbook P.183

18. Refer to textbook P.183 and P.184
Example 1
Refer to textbook P.183 and P.184

19. O/H Apportionment Total Production dept. Service dept.
item Basis Maching Assembly Finishing Stores Maintenance
$ $ $ $ $ $000
Indirect Actual
material
Indirect Actual
wages
Rent& Area
Rates
Machine Machine
Insurance Value
Dep. Machine
Value
Heat & Area
Light
Production No. of
Supervisor Employees

20. O/H Apportionment Total Production dept. Service dept.
item Basis Maching Assembly Finishing Stores Maintenance
$ $ $ $ $ $000
Reallocation
of service-centre
overheads
Stores Materials issued (147)
Maintenance Maintenance (200)
Work

21. Calculation of overhead absorption rates:
Maching
Assembly
Finishing
Overhead absorption basis
Machine hours
Labour hours
Overhead absorption rates
$884000/ hrs
= $4.42/hr
$671000/ hrs
= $6.71 /hr
$472000/40000 hrs
= $11.8/hr

22. Assign cost-center overhead to products

23. Assign cost-centre overheads to products
The final step is to charge the overheads to the products passing through the production departments

24. Example

25. The facts are the same as those in Example on slide no. 18
The facts are the same as those in Example on slide no. 18. The number of hours needed to finish the products are listed as follows:
Departments
Product A
Product B
Machining
4 hours
5 hours
Assembly
2 hours
1 hour
Finishing
1/10 hour

26. Departments Product A $
Machining 4 hours at $4.42 per mach. hr
Assembly 2 hours at $6.71 per mach. hr
Finishing 1/10 hour at $11.88 per labour hr
Total overhead charged per unit
Departments Product A $
Machining 5 hours at $4.42 per mach. hr
Assembly 1 hours at $6.71 per mach. hr
Finishing 1/10 hour at $11.88 per labour hr
Total overhead charged per unit

27. Predetermined overhead absorption rates (POAR)

28. Predetermined overhead absorption rates (POAR)
The overhead absorption rates are usually computed in advance of operations
In practice, most absorption rates are only predetermined because the actual overheads are not known until the end of the period
If the actual overheads are used to compute the OAR, the product cost can only be obtained at the end of the accounting period
A delay in product cost calculation will also affect the pricing setting, the profit calculation and stock valuation

29. The formula of POAR The formula are as follows:
Budgeted total overheads
POAR =
Budgeted total number of units of absorption base

30. Under-absorption and over-absorption base
Since the POAR are based on the estimated production and estimated overheads, the overheads absorbed seldom agree with the actual overheads incurred for the period
Under-absorption occur when overhead absorbed are small than the actual overheads
Over-absorption occurs when the overhead absorbed are greater than actual overheads

31. For financial accounting, under- or over-absorption of overheads should be treated as period cost and written off against the profit and loss account in the current accounting period
The under- or over-absorption of overheads should be debited or credited to the profit and loss account
The under-absorbed overheads should be deducted from profit and vice versa

32. Example

33. Example Estimated annual overheads $400
Estimated machine hours 200 machine hour
POAR =
$400
200 hrs
= $2 per machine hour

34. Product 1 Product 2 Product 3 Product 4 $400 $300 $500 250 hrs 160 hrs
Actual overheads incurred
$400
$300
$500
Actual machine hours
250 hrs
160 hrs
200 hrs
Overhead absorbed
Under- or over-absorption
$2 * 250 hrs
= $500
$2 * 160 hrs
= $320
$2 * 200 hrs
= $400
$2 * 200 hrs
= $400
Over-absorbed
$100
Under-
absorbed
$80
Over-
absorbed
$100
Under-
absorbed
$100s

35. Blanket Overhead Rate

36. Blanket overhead rate
According to the overhead allocation procedure, the overheads are allocated to departments and each department calculate its own OAR and allocate the overheads to products passing through that department
Alternatively, some firms do not assign overheads to departments. Rather, they adopted a single overhead rate, i.e. a blanket overhead rate, that is assigned to all products produced within the whole factory

37. The use of the blanket overhead rate is not recommended as many products are produced in different production centres, and products consume cost-centre overheads in different proportions

38. Example

39. The annual overhead costs of a factory with three production departments are shown as follows:
Dept. A
Dept.B
Dept. C
Total
Overheads
$20000
$400000
$180000
$600000
Direct machine hours
100000
300000
Departmental overhead rate per direct machine hour
$0.2 $4
$1.8
Blanket overhead rate pre machine hour $2

40. If the production of product X only requires 10 direct machine
hours in department A, the overheads absorbed will be computed as
follows:
Using departmental overhead rate
Using blanket overhead rate
Overhead absorbed
$0.2 *10
= $2
$2 *10
= $20
In this example, the production of product X does not consume
Large amounts of overheads in department B and C. Therefore,
there will be over-absorption of overheads if the blanket overhead
rate is used