1. THE INSTITUTE OF CHARTERED ACCOUNTANTS OF SRI LANKA
POSTGRADUATE DIPLOMA IN BUSINESS AND FINANCE / Principles of Financial and Cost Accounting
Thilanka Warnakulasooriya B.Com Special, FCA, MBA-Fin

2. Accounting for Overhead
Overhead is the Expenditure incurred in the course of making a product, providing a service or running a department, but which cannot be traced directly and fully to the product, service or department

3. Classification of Overhead
Overhead can be classified under 3 basis
Overhead
Element Base
Indirect Material
Indirect Labor
Indirect Expense
Behavior based
Fixed Overhead
Variable OH
Semi-Variable OH
Function Based
Production OH
Administration OH
Selling & Distribution OH
General OH

4. Overhead Allocation, apportionment & absorption
Steps.
Identify OH cost & Accumulate the cost
i.e. Rent , Electricity,
Identify the Cost Center of the Organization
Identify the activity or item or equipment where the cost are accumulated.
Cost centers can be either production cost center or service cost center
i.e Garment Factory
Production cost centers
Service cost centers
Cutting, Sawing, washing, Packaging
Maintenance , HRM, Planning

5. 3. Allocation of OH cost to cost centers
Some OH can be directly identify to a particular cost centers. Accordingly that OH cost can be allocated to that cost center called “allocation”
i.e. Cutting supervisor salary directly identified to the cutting cost center
4. Apportioning overhead cost to cost centers
Some OH can not be directly identified to particular cost center. Accordingly such cost should be shared among the cost centers. These cost should be divided among cost centers based on most reasonable basis.
(Apportionment of overhead is distribution of overheads to more than one cost centre on some equitable basis)

6. Basis for Apportionment OH
Basis for Apportionment
Rent, rates, heating and light, repairs and depreciation of building
Floor area occupied by each cost centre
Deprecation and insurance of equipment
Cost or book value of equipment
Personnel, office, canteen, welfare, wages and costs of offices
Number of employees, or labor hours worked in each cost centre
i.e. Garment factory monthly electricity bill was Rs. 200,000. Factory consist of 4 cost centers . The floor area occupied by each cost center are as follows.
Apportion the electricity between cost centers.
Cost Center
Floor area (Sq. Feet)
Cutting
3,000
Sawing
5,000 HR
500
Warehouse
1,500

7. Possible basis of apportionment
5. Reapportioning the service cost centre cost to production cost centers. Service cost centers cost should charged to production cost centers since salable units does not pass through service departments. The reasonable apportionment basis should be used
Service cost centre
Possible basis of apportionment
Stores
Number of cost value of material requisitions
Maintenance
Hours of maintenance work done for each cost centre
Production planning
Direct labor hours worked in each production cost centre

8. Reapportioning the service cost centre cost to production cost centers
Secondary Distribution with reciprocal Servicing overhead absorption rates
Direct Method
Only to Production Department
To production & service department
Simultaneous Equation Method
Repeated Distribution Method
Step Down Method

9. 6. Calculate the overhead absorption rate & absorb the cost
Overhead absorption is the process whereby overhead costs allocated and apportioned to production cost centers are added to unit, job or Cost object.
Overhead absorption is sometimes known as overhead recovery
Overheads are usually added to costs units using a predetermined overhead absorption rate, which is calculated using figures from the budget.
Overhead absorption rate (OAR)
“Attributing OH to particular product or service based on particular basis”
Generally OAR calculated by dividing the OH cost of the cost center by number of units/ Volume of absorption base which is appropriate for the cost center

10. Calculation of overhead absorption rate
OAR = Budgeted Overhead cost
Budgeted volume
Estimate the overhead likely to be incurred during the period
Estimate the activity level for the period
Divide the estimated overhead by the budgeted activity level
Absorb the overhead into the cost unit by applying the calculated absorption rate
Ex 04
There is no ideal OAR, depending on the company some use machine hours or labor hours. The most appropriate OAR depends on factors such as cost, information availability, nature of the product, technology used etc.

11. Choosing the appropriate absorption base
A percentage of direct materials cost
A percentage of direct labor cost
A percentage of prime cost
A rate per machine hour
A rate per direct labor hour
A rate per unit
A percentage of factory cost (for admin overhead)
A percentage of sales or factory cost ( for selling and distribution overhead)

12. Over and under absorption of overheads
The rate of overhead absorption is based on estimates ( of both numerator and denominator) and it is quite likely that either one or both of the estimates will nit agree with what actually occurs
Over absorption means that the overheads charged to the cost of sales is more than the overheads actually incurred
Under absorption means that insufficient overheads have been included in the cost of sales
Actual Overhead incurred xxxx
Overhead absorbed xxxx
(budgeted OAR * actual activity level)
Under/ Over absorption xxx

13. The reasons for over/under absorbed overheads
The overhead absorption rate is predetermined from budget estimates of overhead cost and the expected volume of activity.
Over or under recovery of overhead will occur in the following circumstances:-
Actual overhead costs are different from budgeted overhead
The actual activity level is different from the budgeted activity level
Actual overhead costs and actual activity level differ from the budgeted costs and levels
i.e . Following information with regard to “ A” Company
Budgeted overhead cost per month 80,000
Actual Overhead cost per month 70,000
Budgeted units plan to produce 10,000
Actual units Produced 8,000
Calculate over or under absorption of overhead per month