CHAPTER

FOUR

OVERHEAD
Learning Outcomes
 At
the end of this topic, students should be
able to :
 Define & classify overhead cost
 Allocate & apportion overhead costs to different cost
centers.
 Reapportion overhead costs of service cost center to
production cost center.
 Calculate absorption of overhead into product costs.
 Calculate over or under absorption of overhead.
Recap-Cost Classification!!
NATURE IDENTIFIABILIY
MATERIALS = DIRECT MATERIALS + INDIRECT
MATERIALS
+ + +

LABOUR = DIRECT LABOUR + INDIRECT LABOUR

+ + +

EXPENSES = DIRECT EXPENSES + INDIRECT EXPENSES

= = =

TOTAL COST = PRIME COST + OVERHEAD

(DIRECT COST) (INDIRECT COST)
 DEFINITION OF OVERHEAD COST
 Alsocalled as indirect cost.
 Refer to cost that cannot be allocated or indirectly
traceable to a particular product.

Overhead

Indirect Indirect Indirect

Material Wages Expenses

Paint in Cleaner, Rental &

making security electricity
furniture guard salary cost
 CLASSIFICATION OF OVERHEADS
2.
1. Production 3. Selling 4. Distribution
Administration
Overhead Overhead Overhead
Overhead

Cost Cost Cost

incurred in Cost incurred in incurred for incurred to
product- the the purpose deliver
making administration of selling product to
activities of the business goods customers.

E.g.: Indirect E.g.: E.g.:

Stationery E.g.: Travelling
material, Advertisement
expenses, expenses
factory rental cost
Clerk salary
 There are 2 cost
centres involved in
assigning the
COST CENTERS overhead costs

1. Production 2. Service Cost

Cost Center Center

• A department • A department that

where production provides
activities take services/support
place production activities
• E.g.: Painting, • E.g.: Cleaning,
Machining, Maintenance,
Assembly Inspection
 COST ALLOTMENT
 Overhead cannot be charged direct to cost centers,
thus it must be shared equitably between the cost
center.
 Cost Allotment refers to distribution of overhead to
each cost center.
 Overhead can be distributed using 2 methods:
1. Cost allocation(Distributing the overhead)
2. Cost apportionment ( sharing out the overhead)
 Cost Allocation vs Cost apportionment
Cost Allocation Cost Apportionment
When? -When overhead cost are When the overhead costs
given specific & direct to are given for the whole cost
a particular cost centre. centers.
Direct or Overhead cost can be Overhead cost cannot be
indirect? allocated directly to cost allocated directly must be
center. apportioned based on a
suitable basis.

*Suitable basis: the

appropriate basis of the
activities of the overhead.
Example Salary of the manager of -Electricity cost
the packing department -Rental of building
 Suitable Basis of Apportionment
OVERHEAD COST
Rental, heating & lighting,
electricity
Supervision, cafeteria &
canteen expenses
Depreciation &Insurance
Power consumption
Materials handling/ store
Maintenance expenses
BASIS OF APPORTIONMENT
Area or space occupied
No of employees, direct
wages, direct labour hours
The value of assets: cost / net
book value
Horse Power / Kilowatt hours
No of material requisitions
Maintenance hours
COST REAPPORTIONMENT
 All overhead cost incurred by the service cost center is
reapportion to production cost center using suitable
basis.

 Reason: cost incurred by service cost center should be

borne by the production cost center because the
function of service cost center is to support production
cost center.

 2 methods of reapportionment:
1. Direct Method – When there is only 1 service cost
center
2. Repeated Method (reciprocal) – When there is >
1service cost center
 Remember!!!

Overhead cost

Production cost Service Cost

center Center

Reapportion to
Absorbed all OH
production cost
cost incurred by
center until become
service cost center
zero/insignificant
Basis of Reapportionment
SERVICE CENTRE COMMONLY USED BASIS FOR
REAPPORTIONMENT
Maintenance Maintenance Labour Hour
Maintenance Wages
Plant Values
Machine Hours
Stores No. of Material Requisition Notes
Weight of Material Issued
Personnel No. of Employees
Labour Hours
Power Generation Meter Usage / Kwh
Cafeteria/ No. of Employees
Canteen
Overhead Absorption Rate (OAR)

 OAR is a pre-determined rate (estimation rate)

use to know how much overhead has been
absorbed during the year.

OAR = Total Budgeted Production Overhead

Budgeted Basis
Why pre-determined rate is
used in computing overhead?
 The actual costs are not known until the
end of costing period.
 The use of pre-determined rate enables
product cost to be calculated as soon as
production is completed.
Overhead Absorption Rate (OAR)
2 Type of OAR:

1. Single/ Blanket • All department using one

Overhead Rate single rate

• Each department have its

2. Departmental
own overhead rate based
Overhead Rate
on its core activities.
 Basis of Overhead Absorption
o Different department might have different basis to
absorb overhead depends on nature of their activity.

Direct
Machine
Materials Prime Cost
Hour
Cost

Direct Direct
Unit of
Labour Labour
Production
Hour Cost
 Calculation of OAR
OAR = Total Budgeted Production Overhead
Budgeted Basis*

*Absorption Formula Answer

Basis
Direct Material Total Budgeted Overhead / Total % of DM Cost
Cost DM Cost

Direct Labour Total Budgeted Overhead / Total DL % of DL Cost

Cost Cost
Direct Labour Total Budgeted Overhead / Total DL RM per DL Hour
Hour Hour
Machine Hour Total Budgeted Overhead / Total RM per
Machine Hour Machine Hour
Unit of Total Budgeted Overhead / Total RM per unit of
Production unit of output output
OVER OR UNDER ABSORPTION OF
OVERHEAD
 Because OAR is based on estimation rate, there
will be a difference between the overhead
absorbed & actual overhead incurred at the
end of costing period.

Under Absorption Actual Overhead > Overhead

Absorbed
Over Absorption Overhead Absorbed > Actual
Overhead

Overhead Absorbed = OAR X Actual Basis

 OVERHEAD ANALYSIS SHEET
 Functions :
 To show the overhead charged to each cost center.
 Only indirect cost are recorded in the overhead
analysis sheet.
 Steps to follow:
1) Calculation of Total Overhead
2) Calculation of Total Budgeted Production Overhead
3) Calculation of OAR
4) Calculation of Overhead Absorbed
5) Calculation of Over / Under overhead absorption of
overhead (compare overhead absorbed vs actual
overhead)
 OVERHEAD COSTS

Direct Apportionment
Allocation

Production Service Department

department X Y
A B
Re apportionment service
dept costs to production dept

Absorption
(OAR)

PRODUCTS COST
Past Year Questions
 Dec2019
 January2018
 March 2017