OVERHEADS

Apportionment
& Absorption
 Introduction
Indirect Material + Indirect Labour +
Indirect other expenses= Ohs

Cannot be conveniently charged to any

job, process or cost unit
 Departmentalisation
For collection, allocation and apportionment
of overheads
Allocation: charging identifiable cost items to
cost centers or cost units
Examples:
Depreciation of a machine in machining
department - machining department
Salary of stores clerk - stores department
 Apportionment
Common costs (non-allocable) allotted to
two or more cost centers or cost units on
some rational basis (a matter of judgment)
 Sample apportionment
OH Item: Basis:
Rent, rates, heating, repairs, Floor Area
depreciation of building
Lighting Floor Area / number of light points
Power HP of machines
Depreciation, repair, insurance Book value or original cost
and maintenance of plant
Personnel, staff welfare, canteen Number of employees
Carriage inwards Value of material
Marketing and distribution Sales value
Delivery expenses Weight, volume, miles
Remuneration of works director DLHs/Wages/Number of
employees
 Criteria for allocation and
apportionment
Neutrality: should not distort decision making
Ability to bear: sales value, gross profit, asset
value, total costs
Cause and effect relationship: maintenance cost
on the basis of hours spent for different cost
objects
Benefits received: cost of power plant on the
basis of power used by diff. cost objects
Equity/fairness
 Apportionment of service center
costs
OH allocated or apportioned to production
and service departments: primary
distribution
Service department costs apportioned to
production departments: secondary
distribution
 Secondary distribution
Direct method
Step-down
Reciprocal
 Absorption
Allocated or apportioned overhead absorbed by
cost units
Methods:
Production unit method: Budgeted/Actual OH
Budgeted/Actual units
% of DM cost Budgeted/Actual OH
Budgeted/Actual DM cost
% of DL cost
% of Prime cost
DLH rate
MH rate
 Praxis
Manless Limited does job order processing which involves manual and machine
operations.The budgeted P&L Account is as under:
Sales 75 lacs
Cost: DM 10
DL 5
Prime cost 15
Production overhead 30
Production cost 45
Admin, S&D cost 15 60
Profit 15

Other budgeted data: LHs: 2500, MHs:1500, Number of jobs: 300

A job enquiry has come and the prime cost estimation is as under:
DM:Rs.2,500; DL:Rs.2,000; DLHs: 8, MHs:5
Use different methods of OH absorption and recommend to the company.
 Blanket rate v Departmental rate
A plant wide rate for every job irrespective
of the department in which it is processed
Not correct in case all jobs dont pass
through all departments/ different jobs
spend unequal time in different
departments
Then departmental rates are required
 Praxis
Refer to excel sheet - 2

Microsoft Office
Excel 97-2003 Worksheet
 Predetermined OH rate
Actual OH will be known after the time
period is over
So absorbed on estimated basis taking
expected level of activity
 Under/Over absorption
Predetermined rate X actual production =
absorbed amount
May be less than or more than the actual
overheads
Treatment:
Application of supplementary rate
Transfer to costing P&L Account
Carry forward to the next period
Support department cost allocation
to operating departments
Support department Cost pool Cost object (operating
department)
Single rate (no distinction between variable and fixed
cost)
Dual rate (variable cost pool + fixed cost pool)
Under both the rate methods, allocation can happen by
using
i) Budgeted rate and budgeted hours to be used by
operating division
ii) Budgeted rate and actual hours used by operating
divisions
iii) Actual rate and actual hours used by operating
divisions
 Data for both the methods
Sand Hill Companys Central Computer Department renders
service to Microcomputer division and Peripheral equipment
division
Budgeted Fixed cost for 2007 for operating central computer
dept.: Rs.30,00,000 and variable cost per hour:Rs.200
(relevant range: 6000 to 18750 hours)
Practical capacity: 18750 hours
Budgeted usage in hours:
Microcomputer division: 8,000
Peripheral equipment division: 4,000
Actual usage in 2007:
Microcomputer division: 9,000
Peripheral equipment division: 3,000
 Single rate
Sand Hill uses budgeted rate and actual usage
Total budgeted cost = Rs.30,00,000 + 12000 X Rs.200 =
Rs.54,00,000
Budgeted hours= 12,000
Rate per hour = Rs.450
Allocation:
Microcomputer: 9,000 X Rs.450 = Rs.40,50,000
Peripheral equipment: 3,000 X Rs.450 = Rs.13,50,000
Single rate sends a signal that Rs.450 is VCU. What if
an outside vendor offers the same service @Rs.340?
 Dual rate
Sand Hill uses actual hours for VC and budgeted hours
for FC
Allocation:
Microcomputer: 8,000 X Rs.250 + 9,000 X Rs.200 = Rs. 38,00,000
Peripheral: 4,000 X Rs.250 + 3,000 X Rs.200 = Rs.16,00,000
 Allocation based on supply of
capacity
Budgeted FC per hours (18750 hrs): Rs.160/hr
Budgeted VC per hr.: Rs.200/hr
Single rate method:
Microcomputer: 9,000 X Rs.360 = Rs.32,40,000
Peripheral equipment: 3,000 X Rs.360 = Rs.10,80,000
Fixed cost of unused capacity: 6750 X Rs.160
=Rs.10,80,000
 Cont..
Dual Rate Method:
Microcomputer:
Fixed cost: 8,000 X Rs.160 = Rs.12,80,000
VC: 9,000 X Rs.200 = Rs.18,00,000
Rs. 30,80,000
Peripheral equipment:
Fixed cost: 4,000 X Rs.160 = Rs. 6,40,000
VC: 3,000 X Rs.200 = Rs. 6,00,000
Rs.12,40,000
Fixed cost of unused capacity: 6750 X Rs.160
=Rs.10,80,000
 Cont
Using practical capacity highlights the
unused capacity cost and its management
It also reduces the burden on the users
But if FC is allocated on budgeted or
actual use, total FC is passed on to users!
In case unused capacity arises only
because of one division, it makes sense
for allocating the unused capacity cost to
that department
 Budgeted v. Actual rate
Affects the uncertainty faced by users
departments
Budgeted rate:
users know the rate in advance and
decide whether to use internal service or
external service
cost variance or inefficiency to be borne
by supplier of service
 Budgeted and Actual usage,
Practical Capacity level allocation
See excel sheet 3

Microsoft Office
Excel 97-2003 Worksheet
 Common cost allocation
A cost of a common facility, activity or cost
of cost object shred by more than one user
Stand-alone cost-allocation method
Incremental cost allocation: primary user,
incremental users (everybody claims to be
incremental user)
Cost plus contracts: fertile ground for
litigation (bring clarity)
 Revenue allocation & Bundled
Products
When department managers have revenue or profit
responsibilities, allocation is called for
Saving gel + saving brush + razor
Stand-alone price 30 25 15
Bundled price: gel + brush Rs.50
gel + razor Rs.38
gel + brush + razor: Rs.64
Stand-alone allocation methods
Selling price: considers customers
willingness to pay
Unit cost
Physical units: used when selling prices
are unstable and unit costs are difficult to
calculate
 Incremental allocation method
Products to be ranked by:
Product in the bundle with most sales can
be ranked first
Customer survey can reveal importance of
the products
Stand-alone performance of individual
products
Top managers knowledge or intuition