Overheads – IBA

Manufacturing overhead must be included along with prime cost in the calculation of manufacturing cost pf the
product, since manufacturing overhead is also a product cost. However, assigning manufacturing overhead to
units of product can be a difficult task. There are four reasons for this:

1. Manufacturing overhead costs are indirect costs. This means that it is either impossible or difficult to trace
these costs directly to a particular product or job.
2. Manufacturing overhead consists of many different items, ranging from the grease used in machines to the
annual salary of the production manager.
3. Even though output may fluctuate due to seasonal or other factors, manufacturing overhead costs tend to
remain relatively constant due to the presence of fixed costs.
4. The timing of payment of manufacturing overhead costs often varies. Some items, such as property taxes for
the land on which the factory is built, may be paid once per year, while other items are paid for quarterly,
monthly, or as acquired. But we produce finished items continuously and rather uniformly all year long.

Given these problems, about the only way to assign overhead costs to products is to use an absorption process.
This absorption of overhead costs is accomplished by selecting an absorption base that is common to all of the
company’s products and services. An allocation base is a measure, such as direct labour-hours (DLH) or
machine-hours (MH), that is used to assign overhead costs to products and
services.
The most widely used absorption bases are units of product (where a company has only a single product), direct
labour-hours and machine-hours (where a company has more than one product).
Manufacturing overhead is commonly applied to products using a predetermined overhead absorption rate. The
predetermined overhead rate is computed by dividing the total estimated manufacturing overhead cost for the
period by the estimated total amount of the allocation base as follows:

Note that the predetermined overhead rate is based on estimated rather than actual results. This is because
the predetermined overhead rate is computed before the period begins and is used to apply overhead cost to jobs
throughout the period. The process of assigning overhead cost to jobs is called overhead absorption.

IN CASE OF MULTIPLE DEPARTMENTS

Basis of apportionment
Building rent Floor area
Building insurance BV or WDV
Asset’s depreciation WDV or BV
Heating m³

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Power units consumed
Store department no of material requisition
Maintenance cost maintenance hours
Personnel department number of employees
Supervision no of workers
Canteen no of employees
Indirect wages no of indirect employees

Q1. Trio Ltd. has three production departments, Cutting, Machining and finishing. Following are some
estimation about expenses for the next year.
Cutting Machining Finishing Total
£ £ £ £
Indirect wages 15,000 21,000 8,000 44,000
Building Rent 32,500
Power 200,000
Supervision 78,000
OTHER INFORMATION
Direct labour hour 7,250 8,500 6,500 22,250
Machine hour 18,000 20,000 1,000 44,000
Employees 75 40 60 175
Floor area(m2) 1,700 2,800 2,000 6,500
Required:

 Overhead absorption rate

 Cost per unit of product A8 whose prime cost is £20. following information is also available to absorb
production overheads
Cutting dept Machining dept Finishing dept
Direct labour hours 0.15 0.2 2
Machine hours 1.5 2.15 1.3

Q2. There are two production cost centres (PCC1 and PCC2) and one service cost centre (SCC1) in a factory.
Budgeted overhead costs for a period are listed below

Factory manager supervise direct labour as well as indirect labour.

It is estimated that the work done by SCC1 can be attributed 70% to PCC1 and 30% to PCC2.
Each of the production staff works 40 hours per week for 50 weeks during the period.

Required:
(a) Calculate the total of the allocated, apportioned and re-apportioned overheads of each production cost
centre.
(b) Calculate a direct labour hour overhead absorption rate for each production cost centre.
(c) Calculate cost per unti of product X whose prime cost is £12 per unit and which will consume 1.2
hours in PCC1 and 2.5 hours in PCC2

Practice questions

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A company is having two production department and two service department. Following are overheads related
to a it
PD1 PD2 SD1 SD2 Total
(STORE)
Allocated overheads 50,000 90,000 20,000 10,000
Factory rent expense 40,000
Insurance of machinery 60,000
Factory supervisor’s salary 30,000

Other information
Machine value 120,000 80,000 0 0 200,000
Floor area 4,000 1,500 500 5000 ?
Number of workers 80 140 20 10 ?
Material Requisitions 800 200 1000
Direct labour hours 2,000 15,000
Machine hours 20,000 3,000
 SD2 will distribute overheads to PD1 and PD2 in the ratio of 1:2

Required:
Calculate
a) Total overheads after reapportionment of PD1 and PD2
b) Calculate overhead absorption rate of both production departments
c) Calculate cost per unit of product AB whose prime cost is $20 and which is expected to consume 4
machine hours in PD1 and 2.25 labour hours in PD2
d) Actual overheads of PD1 were $130,000 and actual machine hours of PD1 were 21,000 then calculate
under/over absorption of PD1 only

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Hint: Ignore number of workers related to S1 while the reapportionment of S1

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