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OVERHEADS

Apportionment
& Absorption

Introduction
Indirect Material + Indirect Labour +
Indirect other expenses= Ohs

Cannot be conveniently charged to any
job, process or cost unit

stores department . 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 . Departmentalisation For collection.

Apportionment Common costs (non-allocable) allotted to two or more cost centers or cost units on some rational basis (a matter of judgment) .

miles Remuneration of works director DLHs/Wages/Number of employees . rates. repair. repairs. canteen Number of employees Carriage inwards Value of material Marketing and distribution Sales value Delivery expenses Weight. staff welfare. Sample apportionment OH Item: Basis: Rent. volume. heating. Floor Area depreciation of building Lighting Floor Area / number of light points Power HP of machines Depreciation. insurance Book value or original cost and maintenance of plant Personnel.

asset value. cost objects • Equity/fairness . Criteria for allocation and apportionment • Neutrality: should not distort decision making • Ability to bear: sales value. gross profit. 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.

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 .

MHs:5 Use different methods of OH absorption and recommend to the company. MHs:1500.2.500.000. Number of jobs: 300 A job enquiry has come and the prime cost estimation is as under: DM:Rs. DLHs: 8.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. Praxis Manless Limited does job order processing which involves manual and machine operations. DL:Rs. S&D cost 15 60 Profit 15 Other budgeted data: LHs: 2500.2. .

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 don’t pass through all departments/ different jobs spend unequal time in different departments • Then departmental rates are required .

2 Microsoft Office Excel 97-2003 Worksheet . Praxis Refer to excel sheet .

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 .

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 .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.

30.00.000 Peripheral equipment division: 3.000 and variable cost per hour:Rs.: Rs. Data for both the methods Sand Hill Company’s Central Computer Department renders service to Microcomputer division and Peripheral equipment division Budgeted Fixed cost for 2007 for operating central computer dept.000 Peripheral equipment division: 4.000 .200 (relevant range: 6000 to 18750 hours) Practical capacity: 18750 hours Budgeted usage in hours: Microcomputer division: 8.000 Actual usage in 2007: Microcomputer division: 9.

13.450 = Rs.00.000 Rate per hour = Rs. Single rate Sand Hill uses budgeted rate and actual usage Total budgeted cost = Rs.40.50. What if an outside vendor offers the same service @Rs.450 = Rs.30.000 Peripheral equipment: 3.000 X Rs.200 = Rs.00.340? .000 X Rs.000 + 12000 X Rs.450 is VCU.50.54.000 Single rate sends a signal that Rs.450 Allocation: Microcomputer: 9.000 Budgeted hours= 12.

000 Peripheral: 4.00. Dual rate Sand Hill uses actual hours for VC and budgeted hours for FC Allocation: Microcomputer: 8.250 + 9.250 + 3.000 X Rs.16.000 .200 = Rs.000 X Rs.00. 38.200 = Rs.000 X Rs.000 X Rs.

10.80.000 X Rs.160/hr Budgeted VC per hr.32.360 = Rs.160 =Rs.200/hr Single rate method: Microcomputer: 9.40.000 Peripheral equipment: 3.360 = Rs. Allocation based on supply of capacity Budgeted FC per hours (18750 hrs): Rs.10.80.: Rs.000 Fixed cost of unused capacity: 6750 X Rs.000 .000 X Rs.

160 =Rs.000 X Rs. 30. 6..000 X Rs.200 = Rs.80.160 = Rs.12.00.000 Peripheral equipment: Fixed cost: 4.80.000 .000 Fixed cost of unused capacity: 6750 X Rs.000 VC: 9. Cont.000 Rs.000 X Rs.00.200 = Rs. Dual Rate Method: Microcomputer: Fixed cost: 8.40.12. 6.000 VC: 3.80.000 X Rs.18.160 = Rs.000 Rs.40.10.

it makes sense for allocating the unused capacity cost to that department . total FC is passed on to users! • In case unused capacity arises only because of one division. 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.

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 v.

Practical Capacity level allocation See excel sheet 3 Microsoft Office Excel 97-2003 Worksheet . Budgeted and Actual usage.

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) .

50 gel + razor Rs. 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.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 .