Cost and Management Accounting: Paper 7

Cost and Management accounting
LEVEL 1
PAPER 7
Cost and Management Accounting
May 2021 Examination

Overheads
Lecturer: Samuel Mukobe
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Prepared by: Samuel mukobe
OVERHEADS
INTRODUCTION
Overheads are costs incurred in the course of manufacturing a product, providing a

service or running a department which cannot be traced directly to the product, service or
department.
It is the total cost of indirect materials, indirect labour and indirect expenses.
Overhead Classification
Overheads can be classified in the following ways;
 By behavior for example fixed, variable, and semi fixed/ semi variable/ mixed.
 By nature for example rent, depreciation
 By function for example manufacturing, selling and distribution etc
 By element for example material and labour expenses
Overhead Classification based on behavior
Fixed Overheads
This is the amount of overheads that remain fixed at all levels of output within a certain
range.
For example, interest on capital, audit fee, deprecation, rent of buildings etc.
The amount of fixed costs is constant implying that it’s uncontrollable and therefore
irrelevant for decision making.
Variable overheads
These are costs that very with the level of output. The cost per unit remains the same
regardless of the level of output. For example, indirect labour, indirect material, cost of
lubricants, cost of utilities etc.
Semi variable costs/semi fixed/mixed overheads

These involve both a fixed element and a variable element. There is need to segregate
them into their fixed and variable elements for effective decision making;
Segregation of these costs be done using various methods such as;
The high low method;

This utilizes data from two time periods representing the highest volume and costs and
the lowest volume and costs.
From the cost function; Y = a + bx
Where Y = Total cost
a = Total fixed cost
b = Variable cost per unit
x = number of units,
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The high low method helps to obtain the variable cost per unit(b) as;
b = costs at high level – costs at lower level/units at high level – units at lower level.
The value obtained can be used with in the formulae to determine total fixed costs and
total variable costs as per our example in class.
The least squares method;

This is also known as the simple regression method. Under this method, a straight line
equation is used to find the line of best fit to solve equations.
The straight line can be defined using the formulae
Y = a + bx
Where;
a = Total fixed cost (the intercept on the y axis)
b = Variable cost per unit (the slope of the line)
x = number of units, (the position on the x axis)
Example;
The following are semi-variable maintenance costs and the corresponding machine hours
incurred in a Bwaise welding workshop for a period of six months for the year ending 30
September, 2018.
Month Maintenance Machine
Costs Shs000 Hours
April 4,800 2,000
May 4,200 1,800
June 4,400 2,000
July 6,000 2,400
August 4,500 1,500
September 5,000 1,400
Required:
Using the least squares method, determine maintenance costs that will be incurred during the
month of December, 2018 when 3,500 machine hours are expected to be available
Main sources of overhead cost information

- Payment vouchers.
- Store requisition forms
- Wages and salaries records
- General journal entries.
Examples Overhead cost information

a) Rent receipts, lease/tenancy agreement
b) Rates demand note
c) Fuel suppliers' invoices
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d) Stationery suppliers' invoices

e) Power and light payment advice
f) Indirect wages wage analysis
g) Salaries salaries summary
h) Depreciation G/L journal entry, plant register
i) Indirect material requisition forms
Analysis of Overheads
Overhead analysis is the first step in determining how to treat overheads
This involves collection and classification of overheads.
Collection involves recording each item of cost in the records maintained for purposes of
ascertainment of the costs incurred by each cost center or cost unit
The main sources of information here may include invoices, stores requisitions, wage
analysis sheets etc.
Overhead Allocation & Apportionment

After the collection of overheads, the next step is to allocate and apportion them to the
production units.
Allocation; this is the process by which overheads are charged directly to a cost unit or a
cost center. Examples of such costs include the salary of a service department manager,
electricity bills to different departments if separate meters are installed, depreciation of
machinery used by separate departments etc.
Apportionment; it means charging a cost center with a fair sum of overheads using
appropriate bases. The apportionment base is predetermined after a careful study of the
relationship between the base and the other variables within the organization.
The purpose of allocation and apportionment is to ensure that all indirect costs are
directly identified to a cost center that already bears direct costs.
Bases of apportionment
The base of apportionment of overhead cost should be a fair basis. The common bases of
apportionment include the following.
Overhead to which basis applies Basis

 Rent, rates, heat and light, repairs and  Floor area occupied by each cost center
depreciation of building
 Depreciation, insurance of equipment  Cost or book value of equipment
 Personnel office, canteen, welfare,  Number of employees, or labour hours
wages and cost office, and worked in each cost center
 Heating, lighting  Volume of space occupied by each
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cost center.
Distinction between allocation and apportionment
 Allocation deals with the whole items of cost and apportionment deals with
proportion of items of cost.
 Allocation is the direct process of departmentalization of overheads whereas
apportionment needs a suitable basis for subdivision of the cost.
Primary apportionment of overheads
Example,
The production process of FKM Ltd is based on two production departments A and B,
supported by one service department.
The following information was provided for the month of July 2017.
Departments
Direct Total
overheads (UGX) A (UGX) B(UGX) Maintenance(UGX)
Direct material 15,000,000 8,000,000 5,000,000 2,000,000
Direct Labour 6,000,000 4,000,000 1,000,000 1,000,000
Total 21,000,000 12,000,000 6,000,000 3,000,000
Indirect costs
Overheads UGX
Depreciation 7,000,000
Supervision 6,000,000
Rent 10,000,000
The following information has also been provided:
Basic
Apportionments Total A B Maintenance
Book Value 70,000,000 35% 65% -

NO: of employees 60 30 20 10
Floor Area 100,000 50,000 40,000 10,000
Maintenance hrs 2,500 1,500 1,000 -
Direct labour hrs 10,000 5,000 5,000
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Required:
Apportion and allocate the overheads to cost centers
Re- apportionment of overheads (secondary apportionment)
It occurs when service department overhead costs are charged to user departments.
For example, the maintenance department overhead costs are summarized and then
charged to the user department, which will probably include other service or non-
production departments.
Service departments do not participate directly in the manufacturing process but play a
supportive indirect role. However, Products do not pass through the support departments.
It is for this reason that service department cost have to be reapportioned to the
production cost centers or departments.
The re-apportionment of service department costs may be implemented in a number of
ways.
These include:
Direct method; this is where costs of each service department are only charged to
production centers. Administration; selling and distribution centers are not charged with
the cost of the service departments as they are not production centers.
The repeated distribution method: this recognizes fully the reciprocal nature of service
departments.
It continuously reapportions a share of a service cost centre to other service centers
instead of eliminating a center once its costs have been reapportioned.
Simultaneous equation method: simultaneous equations are formed using the service
departments share with each other. These costs are later distributed among production
departments using ratios.
Elimination method or stepwise method; may be used where by the costs of each
service cost centers are re-apportioned in turn.
The costs of the first service center will be reapportioned to all user centers including
other service centers, if any.
The first service center, however, is then eliminated from any further reapportionment.
The cost of the second service center including any costs already reapportioned from the
first service center is then reapportioned to all user centers other than the first service
center.
The process continues until all service centers are eliminated.
Example:
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MKS manufactures energy drinks whose production passes through three production
departments A, B, C supported by two service departments, stores and maintenance.
Below is the cost data that was extracted from the company’s books of accounts for the
year ended 30-6-2017
Indirect Material
costs UGX UGX
PDN Departments
A 190,000
B 240,000
C 40,000
Service Departments
Maintenance(D) 300,000
Stores 80,000 850,000
Indirect Labour costs

PDN Departments
A 180,000
B 220,000
C 60,000
Service departments
D 200,000
E 130,000 790,000
The following overheads were incurred:
overheads Amount UGX

Power and Lighting 1,200,000
Rent 560,000
Insurance on
machinery 200,000
canteen charges 600,000
Deprecation 400,000 3,560,000
The following information was also provided;
Net book No. of

Details Area Kilowatts Value Employees
Departments (Sq.metres) (Units)
A 4,000 4,000 10,000,000 90
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B 4,000 4,400 12,000,000 120

C 3,000 1,600 8,000,000 30
D 2,000 1,500 6,000,000 40
E 1,000 500 4,000,000 20
Total 14,000 12,000 40,000,000 300
Maintenance Department details
Time
Departments spent(HRS)
A 3,600
B 3,200
C 2,200
Total 9,000
Stores Department details

Frequency
Departments (Times)
A 900
B 600
C 500
Total 2,000
Required;
I. Prepare an overhead analysis sheet using the above information
II. Reapportion service department costs using the direct method
III. Based on the data below, reapportion service department costs to

production departments using the simultaneous equation method,
Details Departments
A B C D E
D 40% 30% 20% 10%
E 30% 30% 20% 20%
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IV. Re-apportion service department costs using elimination and repeated

distribution methods using the following data
Details Departments
A B C D E
D 40% 30% 20% 10%
E 30% 20% 20% 30%
OVERHEAD ABSORPTION
After overhead apportionment, the accumulated overhead costs are absorbed into final
products through overhead absorption.
Production costs are added to prime cost (direct materials, labour and expenses) to give
the factory cost (full cost of production).
Production overheads are therefore included in the value of stocks of finished goods.
Administration and selling and distribution overheads are then added, the sum of the
factory cost and these overheads being the total cost of sales. These overheads are
therefore not included in the value of closing stock.
Production overheads are charged to cost units with the use of overhead absorption
rates (OAR) for each production cost centre.
Overhead absorption rates are estimated or budgeted figures calculated prior to the
beginning of the period in question.
Predetermined overhead absorption rates are used because.
a) Collection, apportionment and absorption of actual overhead is only made at the end
of the financial period, therefore product cost information may not be available on
time i.e. during the year.
b) If production volume has a seasonal pattern, actual overheads being absorbed into
each unit of output would vary with output volume, thus resulting in fluctuating unit
costs.
Overhead absorption rates are therefore calculated as follows:
Predetermined overhead rate
a) The overhead likely to be incurred during the coming year is estimated.

b) The activity level (total hours, units, or direct costs) on which the overheads
absorption rates are to be based is estimated.
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c) The estimated overhead is divided by the budgeted activity level to arrive at an

absorption rate.
Predetermined OAR = Budgeted annual total O/H for production cost centre
Budgeted level of activity (Total number of units, hours
etc)
Actual overhead rate

This is based on actual overheads incurred and the actual absorption base selected;
Actual OAR = Actual annual total O/H for production cost centre
Actual level of activity (Total number of units, hours etc)
Blanket overhead rate

The overhead rate represents a single rate for the entire factory.
Blanket overhead rate = Total overhead rate for the entire factory
Total units of the base for the factory
Departmental Absorption Rates

The overhead rate represents a single rate for the department
Department overhead rate = Total overhead rate for the department

Total units of the base for the department
Choosing the appropriate absorption base
Bases of absorption (or overhead recovery rates) include: -

 Direct material cost method
Overhead of the cost center

Direct material cost of the cost center
 Direct labour cost method

Direct labour cost of the cost center
 prime cost method

Prime cost of the cost center
 Machine hours method.

 Direct labour method
 Units of output method
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 A percentage of factory cost (for administration O.H)

 A percentage of sales or factory cost (for selling and distribution overhead)
And so many others
An absorption base should be a fair basis of sharing out production overhead cost to the
cost units passing through that cost centre i.e. an absorption basis which realistically
reflects the characteristics of a given cost centre and which avoids undue anomalies.
Many factories use a direct labour rate or machine hour rate in preference to a rate based
on a percentage of direct materials cost, wages or prime cost.
a) A direct labour hour basis is most appropriate in a labour intensive environment.

b) A machine hour rate would be used in departments where production is controlled or
dictated by machines.
c) A rate per unit would be effective only if all units were identical.
Selection of overhead recovery rates depends on the following factors;
 The nature of the product and processes of manufacture

 The nature of overhead expenses
 Organization set up
 Management policy
Features of a satisfactory overhead rate include;
 Simple, easy to operate

 Economic in application
 Fairly stable for purposes of consistency
 Relate to time factor as far as practical
Reasons for absorbing overheads

There are a number of situations in which the analysis of overhead costs will assist in the
satisfactory evaluation of the relevant cost data. These include:
a) The control of overhead expenditures: there must be a link between overhead

costs and the manager responsible for its control. This is best achieved by having
the planned level of overhead costs for each cost center compared to the actual
cost incurred in order that any differences may be investigated and corrective
measures taken.
b) Charging of overheads to cost unit: overheads relating to a specific job must be

charged to that product, job or process in order to come up with the correct cost of
the cost object or unit. Each product or job should share a part of indirect costs of
the business.
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c) Valuation of work in progress: At any point in time, there may be partly

completed goods in the production cycle. Such work in progress must be valued at
the end of an accounting period to enable calculate profit and derive a balance
sheet. To calculate profit, the cost of goods manufactured must be determined.
A statement of goods manufactured (Manufacturing account) is prepared, which

incorporates both opening and ending work in progress in order to determine cost
of goods manufactured.
d) Valuation of abnormal losses: Abnormal losses arise when the actual output
given the budgeted input yields less than expected output. (Abnormal loss =
Expected output – Actual output). (Abnormal loss = Actual loss – Normal loss).
They arise due to unanticipated inefficiencies in production. Such losses need to
be charged to the departments that incur them for efficiency analysis purposes.
e) Profit measurement: The valuation of work in progress and finished goods stock
will affect the profit reported. The basis on which production overheads has been
absorbed by cost units will, therefore, have a direct influence on the level of profit
reported during the period.
f) Decision making: It is vital that relevant costs are used in any decision making
situation. Production overhead costs may be allocated to a department (cost
center) or apportioned to it using some arbitrary apportionment basis. In addition,
overhead cost may be a fixed or variable behavior pattern as activity changes.
The total costs associated with cost center and the organization as a whole affect
the kind of decisions made by the management. But such relevant cost need to be
incremental and future costs that are controllable by management.
Over and Under Absorption of Overheads
 At the month end, the production overheads are absorbed into the cost units passing
through the production cost centres.
 For each production cost centre where an overhead absorption rate has been
determined, the amount of work performed by that production centre is recorded and
accounted for, and overhead is absorbed into the production cost of the cost units that
passed through that production cost centre.
 For each production cost centre
Absorbed (applied) overhead
= Predetermined OAR x units of absorption base
The absorbed overhead for each production cost centre is aggregated for each month.
 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 not
agree with what actually occurs.
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 Over-absorption means that the overheads charged to the cost of sales are greater
than the overheads actually incurred.
Under-absorption means that insufficient overheads have been included in the cost
of sales.
Reasons for the under/over-absorbed overheads

.
 Actual overhead costs are different from budgeted overheads
 The actual activity level is different from the budgeted activity level.
 Actual overhead costs and activity levels differ from the budgeted costs and level.
 Poor estimates by planners
 Unexpected changes in production methods.
The distinction between overheads incurred (actual overheads) and an overhead absorbed
is known as under/over-absorbed overheads.
The accounting treatment for over/under recovery of overheads
 In case of under absorption write off to the P & L account and incase of over
absorption, add back.
 Carry forward to the next period using a reserve account. This is not
recommended since its inconsistent with accounting standards
 Use supplementary rates to adjust the effect on cost of sales, finished stock and
work in progress. This aims at splitting the effect between the cost of sales and
stock.
Capacity levels
The determination of overheads and overhead rates is highly dependent on the capacity
levels. The following capacity concepts may be considered in overhead rate
determination;
Practical capacity;
This represents the available capacity after giving allowance for unavoidable
interruptions like; machine breakdown, time lost due to repairs, delay in raw material
delivery etc.
Idle capacity
This refers to the temporary idleness of the available resources due to irregular
interruptions
Excess capacity
This refers to the proportion of practical capacity available but not attempt is made for its
utilization due to strategic or other reasons
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Normal capacity
This is the operating capacity that is determined after a long term trend analysis of events
under usual operating conditions.
Maximum capacity
this refers to the ideal capacity for which a plant is designed to operate.
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Examples,
A company makes a range of products with total budgeted manufacturing overheads

of ₤973,560 incurred in three production departments (A, B, and C) and one service
department.
Department A has 10 direct employees who each work 37 hours per week.
Department B has five machines each of which is operated 24 hours per week.
Department C is expected to produce 148,000 units of final product in the budget
periods.
The company will operate for 48 weeks in the budget period.
Budgeted overheads incurred directly by each department are as follows.
₤
Production department A 261,745
Production department B 226,120
Production department C 93,890
Service department 53,305
The balance of budgeted overheads is apportioned to departments as follows.
Production department A 40%

Production department B 35%
Production department C 20%
Service department 5%
Service department overheads are apportioned equally to each production department.
Required:
a) Calculate an appropriate predetermined overhead absorption rate in each

production department.
b) Calculate the manufacturing overhead cost per unit of finished product in a
batch of 100 units which take nine direct labour hours in Department A and
three machine hours in department B to produce.
Solution:
Production Production Production Service Total

department department department department
A B C
₤ ₤ ₤ ₤ ₤
Directly 261,745 226,120 93,890 53,305 635,060
allocated
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Apportioned 135,400 118,475 67,700 16,925 338,500

397,145 344,595 161,590 70,230 973,560
Service 23,410 23,410 23,410 (70,230) -
department
overheads
apportioned
equally
420,555 368,005 185,000 - 973,560
Overhead absorption rates
Production department A: labour intensive = direct labour rate

Direct labour hours worked in period = 10 employees x 37
hours x 48 weeks = 17,760
Therefore, overhead absorption rate = ₤420,555 =
17,760
₤23.68 per direct labour hour
Production department B: machine intensive = machine hour rate machine hours in

period = 5 machines x 24 hours x 48 weeks = 5,760 hours
Therefore overhead absorption rate = ₤368,005
5,760 hour
Production department C: units basics
Therefore overhead absorption rate = ₤185,000 = ₤1.25 per
148,000 = unit
b) Overhead cost per unit
₤
Dept A overhead (9 x ₤23.68)/100 2.13
Dept B overhead (3 x ₤63.89)/100 1.92
Dept C overhead 1.25
5.30
1. Alpha Ltd has two production cost centers A and B and two service cost centers X
and Y in its factory. The following information is available in respect of overhead
costs for period 5 2017
 Indirect materials are issued from stores and the analysis of materials
requisition notes shows the allocation to cost centers as: A £ 5,000, B
£ 3,000, X £2,000, Y £1,000
 Labour cost analysis shows that indirect wage cost in the production
departments A and B are £500 and £600 respectively. All wage cost in
the service center are indirect costs and the total for center X and Y are
£ 1,400 and £ 1,200 respectively.
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 Specific overhead costs identified with cost centers from invoices

received from suppliers are:
Center A £ 1,200 for equipment-testing work carried out

Center B £ 800 for repairs to a damaged doorway
Center X £1,000 for staff training course
Center Y £600 for safety equipment repairs
General expenses incurred, which must be apportioned to, centers A,

B, X and Y on an acceptable basis are power £2,000: insurance £1,200
Other information has been gathered which will be of assistance in the

overhead cost apportionment for power and insurance costs. The chief
engineer has looked into the power requirements for each cost center
and has estimated the proportion of cost, which should be apportioned
to A, B, X and Y as 40%, 30%, 20% and 10% respectively. The
administration manager has estimated that the insurance cost should be
apportioned to cost centers A, B, X and Y in the ratio 10%, 30% 40%
and 20% respectively.
Required:
1. Prepare a statement of the estimated costs for each cost center

2. Alpha ltd has obtained estimates for the use of the service centers by the
production centers as follows
To: center A Center B

From Center X 60% 40%
Center Y 20% 80%
Re- apportion the service centers costs to the production cost centers
3. Recognizing the reciprocal nature of service costs
Assume that alpha ltd has altered its estimates for the use of service centers to
include the use of one service by another as follows:
TO: Center A Center B Center X Center Y

From center X 30% 20% - 50%
Center Y 15% 60% 25% -
Re-apportion the service centers costs to the production cost center using the
algebraic method and the repeated distribution method.
a) Data for cost centre 2, year 1996
Total cost centre overhead (budgeted) ₤62,100
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Production output 13,800 units

Direct labour hours 27,000 hours
Machine hours 34,500 hours
Direct wages cost ₤17,250
Direct materials cost 49,680
Find the six overhead absorption rates.
b)
Job 123 was manufactured solely in cost centre 2 in the previous example. A direct
labour hour rate is to be used to absorb this cost centre’s overhead costs. Data relating to
job 123 is as follows:
Direct material cost ₤367

Direct labour cost ₤405
Direct labour hours 90
Machine hours 120
3. Data for the latest period in two of the cost centres of XY Limited are as
follows:
Machining department Finishing department
Estimated/budgeted data ₤340,000 ₤120,000

Production overhead 170,000 4,200
Machine hours 16,500 40,000
Direct labour hours
Actual results
Production overhead ₤360,000 ₤129,400

incurred
Machine hours 150,000 3,900
Direct labour hours 18,290 44,100
Required:
Using appropriate overhead absorption rates, investigate any under or over absorption of
overheads.
4. The information given below relates to the forthcoming period for a

manufacturer’s operation. There are four cost centres of which two are involved
in production and two are service cost centres.
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Total A B Canteen Stores

₤ ₤ ₤ ₤ ₤
Allocated costs 70,022 21,328 29,928 8,437 10,329
Other costs:
Rent and rates ₤4,641

Building insurance ₤3,713
Electricity and gas ₤6,800
Plant depreciation ₤28,390
Plant insurance ₤8,517
Additional information:
Area occupied (square metres) 7,735 6,188 1,547 3,094
Plant at cost (₤000) 1,845 852 - 142
Number of employees 600 300 30 70
Machine hours 27,000 800 - -
Direct labour hours 6,800 18,000 - -
Number of stores requisition 27,400 3,400 - -
Required:
a) Use this information to calculate a production overhead absorption rate

for department A and department B.
b) Calculate the total production cost of the following job.
Job 847
Direct material cost ₤487
Direct labour cost ₤317
Machine hours in department A 195 hours
Direct labour hours in department B 102 hours
c) Calculate the under or over absorbed overhead in each of the departments

using the following data:
Department A Department B
Actual results
Overhead incurred ₤70,483 ₤52,874
Direct labour hours 6,740 18,300
Machine hours 27,900 850
5. The Utopian Hotel is developing a cost accounting system. Initially it has been
decided to create four cost centres: Residential and Catering deal directly with
customers whilst Housekeeping and Maintenance are internal service cost
centres.
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The following overhead details have been estimated for the nest period:
Residential Catering House- Maintenance Total

keeping
₤ ₤ ₤ ₤ ₤
Consumable 14,000 23,000 27,000 9,000 73,000
materials
Staff costs 16,500 13,000 11,500 5,500 46,500
Rent and rates 37,500
Contents insurance 14,000
Heating and lighting 18,500
Depreciation on 37,500
equipment etc
227,000
The following information is also available:
Residential Catering House- Maintenance Total

keeping
Floor area (square 2,750 1,350 600 300 5,000
metres)
Value of equipment etc ₤350,000 ₤250,000 ₤75,000 ₤75,000 ₤750,000
Number of employee 20 20 15 5 60
In the period it is estimated that there will be 2,800 guest-nights and 16,000 meals will be
served. House-keeping works 70% for Residential and 30% for Catering, and
Maintenance works 20% for House-keeping, 30% for Catering and 50% for Residential.
Required:
a) Prepare an overhead statement showing clearly allocations and apportionments to

each cost centre.
(7 marks)
b) Calculate appropriate overhead absorption rates for Residential and Catering.
(2 marks)
c) Calculate the under/over absorption of overheads if the actual results were as
follows:
Residential: 3,050 guest-nights with overheads of ₤144,600.

Catering: 15,250 meals with overheads of ₤89,250
(3 marks)
d) Comment briefly on possible future developments in Utopian Hotel’s cost
accounting system.
(3 marks)
6. Bookdon Public Limited Company manufactures three products in two
production departments, a machine shop and a fitting section; it also has two
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service departments, a canteen and a machine maintenance section shown below

are next year’s budgeted production data and manufacturing costs for the
company.
Product X Y Z
Production 4,200 units 6,900 units 1,700 units
Prime cost:
Direct materials ₤11 per unit ₤14 per unit ₤17 per unit
Direct labour
Machine shop ₤6 per unit ₤4 per unit ₤2 per unit
Fitting section ₤12 per unit ₤3 per unit ₤21 per unit
Machine Hours, per unit 6 hours per unit 3 hours per unit 4 hours per unit
Budgeted Overheads: Machine Fitting Canteen Machine Total

shop section maintenance
section
₤ ₤ ₤ ₤ ₤
Allocated overheads 27,660 19,470 16,600 26,650 90,380
Rent, rates, heat, light 17,000
Depreciation and Insurance of equipment 25,000
Additional Data:
Gross Book value of equipment ₤150,000 ₤75,000 ₤30,000 ₤45,000

Number of employees 18 14 4 4
Floor space occupied square metres 3,600 1,400 1,000 800
It has been estimated that approximately 70% of the Machine Maintenance Section’s cost
are incurred servicing the Machine shop the incurred servicing the Fitting section.
Required:
(i) Calculate the following budgeted overhead absorption rates:
A machine hour rate for the Machine shop
A rate expresses as a percentage of direct wages for the fitting section
All workings and assumptions should be clearly shown.
(ii) Calculate the budgeted manufacturing overhead cost per unit of product X and
the total production cost per unit of product X.
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7. A company makes a range of products with total budgeted with total budgeted
manufacturing overheads of ₤973,560 incurred in three production departments
(A, B, and C) and one service department.
Department A has 10 direct employees who each work 37 hours per week.
Department B has five machines each of which is operated for 24 hours per
week. Department C is expected to produce 148,000 units final product in the
budget period.
The company will operate for 48 weeks in the budget period.
Budgeted overheads incurred directly by each department are:
Production Department A ₤261,745
Production Department B ₤226,120
Production Department C ₤93,890
Service Department ₤53,305
The balance of budgeted overheads is apportioned to departments as follows:
Production Department A 40%
Production Department B 35%
Production Department C 20%
Service Department 5%
Service department overheads are apportioned equally to each production

department.
You are required to:
a) Calculate an appropriate predetermined overhead absorption rate in each

production department.
(9 marks)
b) Calculate the manufacturing overhead cost per unit of finished product in a batch
of 100 units which take nine labour hours in Department A and three machine
hours in Department B to produce.
(3 marks)
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22
8. C ltd is a manufacturing company. In one of the production departments in its

main factory a machine hour rate is used for absorbing production overhead.
This is established as a predetermined rate, based on normal activity (i.e. the
output that is expected to be achieved on average in the medium term). The rate
that will be used for the period which is just commencing is ₤15.00 per machine
hour. Overhead expenditure anticipated at a range of activity levels, is as
follows:
Required:
Calculate:
(i) The variable overhead rate per machine hour;

(ii) The total budgeted fixed overhead;
(iii) The normal activity level of the department; and
(iv) The extent of over/under absorption if actual machine hours are 1,700
and expenditure is as budgeted.
Solutions for Overhead Costs
1. Alpha limited
a) Overhead cost analysis statement
Production departments Service department

Overhead Basis of A B X Y TOTAL
charge £ £ £ £ £
Indirect material Allocated 5,000 3,000 2,000 1,000 11,000
Indirect wages 500 600 1,400 1,200 3,700
allocated Allocated
Specific overhead Allocated 1,200 800 1000 600 3,600

allocated
Power (apportioned) 800 600 400 200 2,000
% estimate (40:30:20:10)
Insurance(apportioned) 120 360 480 240 1,200

%estimate. (10:30:40:20)
Subtotal 7,620 5,360 5,280 3,240 21,500
Is this the true measure of the cost of production cost centers?

The information provided does not indicate the extent to which production cost
centers benefit from the service centers.
______________________________________________________________________________________
23
The total cost of an operation center should include an estimate of its use of service
centers. This will be useful for control purposes and for charging cost to product
units, which pass through each production center.
The next requirement is therefore, that the service center costs are re-apportioned to
the production centers.
(b)
Production department Service department
Overhead Basis of charge A B X Y TOTAL
£ £ £ £ £
Subtotal 7,620 5,360 5,280 3,240 21,500
Re-apportionment of service
center
X Estimate (given) 3,168 2,112 (5,280)
Y Estimate (given) 648 _2,592 ______ (3240) ______
TOTAL COSTS 11,436 10,064 ___NIL __NIL 21,500
(c) Algebraic method
Let X be the cost of center X + share of its cost of center Y

Let Y be the cost of center Y + share of its cost of center X
X= 5,280 +0.25Y (1)

Y = 3,240 +0.5X (2)
Y = 5,280 + 0.25 (3,240 +0.5X)

X = 5,280+810+0.125X
0.875X =6,090
X = 6,090/0.875 =£6,960
Y = 3,240 +0.50*6,960 =£6,720
Production dept A
Total costs
=£7,620+30%X+15%Y
=£7,620+0.3*6,960+0.15*6,720
=£10,716
Production dept B
Total costs
=£5,360 +20%X+60%Y
=£5,360+0.2*6,960+0.6*6,720
=£10,784
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24
Repeated distribution method

Production depts. Service depts.
A B X Y TOTAL
£ £ £ £ £
Subtotal 7,620 5,360 5,280 3,240 21,500
1st distribution of x 1,584 1,056 (5,280) 2,640
9,204 6,416 - 5,880
1st distribution of y 882 3,528 1,470 (5,880)
10,086 9,944 1,470 -
2nd distribution of x 441 294 (1,470) 735
10,527 10,238 - 735
2nd distribution of y 110 441 184 (735)
10,637 10,679 184 -
3rd distribution of x 55 37 (184) 92
10,692 10,716 - 92
3rd distribution of y 14 55 23 (92)
10,706 10,771 23 -
4th distribution of x 7 5 (23) 11
10,713 10,776 - 11
4th distribution of y (15/75x11 (60/75) - (11)
2 x11
9 ______
10,715 10,785 - - 21,500
2.
a) Production overhead absorption rate (OAR) = budgeted overhead
Budgeted level of activity
Rate per unit = budgeted overhead/budgeted number of units = ₤62,100/13,800 units

= ₤4.50 per unit
direct labour hour rate = budgeted overhead/budgeted direct labour hours

= ₤62,100/27,000 hours = ₤2.30 per direct labour hour
machine hour rate = budgeted overhead/budgeted machine hours

= 62,100/34,500 hours = ₤1.80 per machine hour
percentage on direct wages cost = (budgeted overhead/budgeted direct wages cost) x 100
=(₤62,100/₤49,680) x 100 = 125%
percentage on direct materials = (budgeted overhead/budgeted direct material cost) x 100

= (62,100.₤49,680) x 100 = 125%
percentage of prime cost = (budgeted overhead/budgeted prime cost) x 100

= (62,100/₤49,680 + ₤17,250) x 100 = 93%
______________________________________________________________________________________
25
b) Job 123
₤
Direct material cost 367
Direct labour cost 405
Prime cost 772
Production overhead 207
(90 hours @ ₤2.30)
Production cost 979
3.
Machining dept. Finishing dept.

OAR = ₤340,000/170,000 machine hrs OAR = ₤120,000/40,000 direct labour hrs
= ₤2 per machine hour = ₤3 per direct labour hour
Total overhead absorbed Total overhead absorbed

(150,000 machine hours x ₤2) = ₤300,000 (44,100 direct labour hrs x ₤3) = ₤132,300
Actual overhead incurred = ₤360,000 Actual overhead incurred = ₤129,400
Under absorbed by ₤60,000 Over absorbed by = ₤2,900
4.
a)
Overhead item Basis of charge A B Canteen Stores Total

₤ ₤ ₤ ₤ ₤
Allocated costs Direct (given) 21,328 29,928 8,437 10,329 70,022
Rent and rates Area 1,934 1,547 387 773 4,641
Building insurance Area 1,547 1,238 309 619 3,713
Electricity and gas Area 2,833 2,267 567 1,133 6,800
Plant depreciation Plant at cost 18,450 8,520 - 1,420 28,390
Plant insurance Plant at cost 5,535 2,556 - 426 8,517
Subtotal 51,627 46,056 9,700 14,700 122,083
Re-apportionment
Of:
Canteen Employees 6,000 3,000 (9,700) 700
((600/970 x 9,700)
Stores Stores requisition 13,700 1,700 - (15,400)

((27,400/30,800) x 15,400)
Total costs 71,327 50,756 nil nil 122,083
______________________________________________________________________________________
26
Production dept A
Budgeted machine hours = 27,000 hours
OAR = ₤71,327/27,000 machine hours = ₤2.64 per machine hour
Production dept B
Budgeted direct labour hours = 18,000 hours
OAR = ₤50,756/18,000 hours = ₤2.82 per direct labour hour
b) Job 847
₤
Direct material cost 487
Direct labour cost 317
Prime cost 804
Production overhead
Dept A (195 hrs x ₤2.64) 514.80
Dept B (102 hrs x ₤2.82) 287.64
Total production cost 1,606.44
c)
Production department A
Total overhead absorbed

(27,900 machine hours x ₤2.64) = ₤73,656
Actual overhead incurred = ₤70,483
Over absorbed by =₤3,173
Production department B
Total overhead absorbed
(18,300 labour hrs x ₤2.82) = ₤51,606
Actual overhead incurred = ₤52,874
Under absorbed by ₤1,268
5.
a) Utopian Hotel
Overhead Basis of Residential Catering House- Maintenance Total

item charge keeping
______________________________________________________________________________________
27
₤ ₤ ₤ ₤ ₤
Consumable Allocated 14,000 23,000 27,000 9,000 73,000
Staff costs Allocated 16,500 13,000 11,500 5,500 46,500
Rent andFloor 20,625 10,125 4,500 2,250 37,500
rates area
Contents ins Value of 6,533 4,667 1,400 1,400 14,000
equip.
Heat and Floor 10,175 4,995 2,220 1,110 18,500
light area
Depreciation Value of 17,500 12,500 3,750 3,750 37,500
equip.
85,333 68,287 50,370 23,010 227,000
Maintenance 11,505 6,903 4,602 (23,010)

re-
apportioned
(50%) (30%) (20%)
98,838 75,190 54,972 Nil
House- 38,480 16,492 (54,972)

keeping re-
apportioned
(70%) (30%)
b)
Overhead absorption rates:
Residential = ₤135,318/2,800 = ₤48.33 per night

Catering = ₤91,682/16,000 = ₤5.73 per meal
c) Under/over absorption
Residential: Overheads absorbed (3,050 x = ₤147,406.50

₤48.33)
Actual overheads = ₤144,600.00
Over-absorbed by ₤2,806.50
Catering: Overheads absorbed (15,250 x = ₤87,382.50
₤5.73)
Actual overheads = ₤89,250.00
Under-absorbed by ₤1,867.50
d) Possible future developments

(i) The use of cost control techniques such as budgetary control
______________________________________________________________________________________
28
(ii) The use of a more equitable basis for the apportionment of

costs than those currently used through the use of a more
detailed cost centre and cost analysis system.
(iii) The use of a range of financial and non-financial
performance measures
6. Bookdon plc
(i)
Overhead Basis of Machine Fitting Canteen Maintenance Total
item charge shop section
£ £ £ £ £
Allocated Direct 27,660 19,470 16,600 26,650 90,380
overheads (given)
Rent, rates, Area 9,000 3,500 2,500 2,000 17,000
heat, light
Depreciation Gross 12,500 6,250 2,500 3,750 25,000
and insurance book value
of equipment
49,160 29,220 21,600 32,400 132,380
Re-
apportionment
of service
centers:
Canteen Employees 10,800 8,400 (21,600) 2,400
Maintenance % estimate 24,360 10,440 - (34,800)
Machine shop:
Budgeted level of activity = 4,200 x 6 hrs + 6,900 x 3 hrs + 1,700 x 4hrs = 52,700 hrs.
OAR = £84,320/52,700 hrs = £1.60 per machine hours.
Fitting section:
Budgeted direct wages cost = 4,200 x £12 + 6,900 x £3 = 1,700 x £21 = £106,800
OAR = (£48,060x£106,800) x 100 = 45%
(ii) Product X:
£/unit
Direct materials 11.00
Direct labour (£6 + £12) 18.00
Prime cost 29.00
Production overhead
______________________________________________________________________________________
29
Machine shop (6 hrs @ £1.60 per hr) 9.60

Fitting section (£12 x 45) 5.40
Production cost of product X 44.00
Budgeted manufacturing overhead cost per unit = £15.00 (£9.60 + 5.400)
7.
Production dept Service Total

dept
Overhead Basis of A B C
item charge
₤ ₤ ₤ ₤ ₤
Allocated Oh Direct 261,745 226,120 93,890 53,305 635,060
Apportioned % given 135,400 118,475 67,700 16,925 338,500
Oh
397,145 344,595 161,590 70,230 973,560
Service dept % given 23,410 23,410 23,410 (70,230)

apportionment (equally)
Total costs 420,555 368,005 185,000 nil 935,560
Department A
Budgeted direct labour hours = 10 workers x 37 hours x 48 weeks = 17,760 hrs
OAR = ₤420,555/17,760 hrs = ₤23.68 per direct labour hour
Department B
Budgeted machine hours = 5 machines x 24 hours x 48 weeks = 5,760 machine hours
OAR = ₤368,005/5,760 hrs = ₤63.89 per machine hour
Department C
Budgeted number of units = 148,000
OAR = ₤185,000/148,000 units = ₤1.25 per unit.
(b)
₤
Dept A (9 direct labour hrs x ₤23.68) 213.12
Dept B (3 machine hours x ₤63.68) 191.67
Dept C (100 units x ₤1.25) 125.00
______________________________________________________________________________________
30
Manufacturing overhead for 100 units 529.79
Manufacturing cost per unit = ₤529.79/100 units = ₤5.30
8.
(i)
High low method
Activity level (machine hours) Overhead

₤
1,500 25,650 (lowest cost)

2,000 27,900 (highest cost)
Change 500 2,250
Variable overhead rate per machine hour = ₤2,250/500 = ₤4.50
(ii) At 1,500 machine hours variable overhead = 1,500 x ₤4.50 = ₤6,750
Therefore budgeted fixed overhead = 25,650 - ₤6,750 = 18,900
(iii) Total overhead rate per machine hour = ₤15.00
Variable overhead rate per machine hour = ₤4.50
Therefore fixed overhead rate per machine hour = ₤15.00 - ₤4.50 = ₤10.5
₤18,900/₤10.50 = 1,800 machine hours, which must be the normal level of

activity in the department.
(iv) Absorption would be 1,700 x ₤15.00 = ₤25,500

Actual (=budgeted – expenditure: ₤18,900 + (1,700 x ₤4.50) = ₤26,550
Under absorbed by ₤1,050
Which is (1,800 – 1,700) x ₤10.50, being the amount of fixed overhead under-
absorbed
______________________________________________________________________________________
31

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Cost and Management accounting

May 2021 Examination

Overheads are costs incurred in the course of manufacturing a product, providing a

Overhead Classification based on behavior

Semi variable costs/semi fixed/mixed overheads

Segregation of these costs be done using various methods such as;

The high low method;

The least squares method;

The straight line can be defined using the formulae

Main sources of overhead cost information

Examples Overhead cost information

d) Stationery suppliers' invoices

Overhead Allocation & Apportionment

Overhead to which basis applies Basis

Distinction between allocation and apportionment

Primary apportionment of overheads

The following information has also been provided:

Book Value 70,000,000 35% 65% -

Apportion and allocate the overheads to cost centers

Re- apportionment of overheads (secondary apportionment)

Indirect Labour costs

The following overheads were incurred:

overheads Amount UGX

The following information was also provided;

Net book No. of

B 4,000 4,400 12,000,000 120

Maintenance Department details

Stores Department details

I. Prepare an overhead analysis sheet using the above information

II. Reapportion service department costs using the direct method

III. Based on the data below, reapportion service department costs to

IV. Re-apportion service department costs using elimination and repeated

Predetermined overhead absorption rates are used because.

Overhead absorption rates are therefore calculated as follows:

Predetermined overhead rate

a) The overhead likely to be incurred during the coming year is estimated.

c) The estimated overhead is divided by the budgeted activity level to arrive at an

Actual overhead rate

Blanket overhead rate

Departmental Absorption Rates

Department overhead rate = Total overhead rate for the department

Choosing the appropriate absorption base

Bases of absorption (or overhead recovery rates) include: -

Overhead of the cost center

Overhead of the cost center

 prime cost method

Overhead of the cost center

 Machine hours method.

 A percentage of factory cost (for administration O.H)

a) A direct labour hour basis is most appropriate in a labour intensive environment.

Selection of overhead recovery rates depends on the following factors;

 The nature of the product and processes of manufacture

Features of a satisfactory overhead rate include;

 Simple, easy to operate

Reasons for absorbing overheads

a) The control of overhead expenditures: there must be a link between overhead

b) Charging of overheads to cost unit: overheads relating to a specific job must be

c) Valuation of work in progress: At any point in time, there may be partly

A statement of goods manufactured (Manufacturing account) is prepared, which

Over and Under Absorption of Overheads

Reasons for the under/over-absorbed overheads

The accounting treatment for over/under recovery of overheads