Chapter 8

ACCOUNTING FOR OVERHEADS

1. Introduction
A business needs to know the cost per unit of goods or services that they produce for many reasons. E.g.
to value stock to fix a selling price to analyse profitability In principle, the unit cost of materials and of
labour should not be a problem, because they can be measured. It is the fixed overheads that present
the real difficulty.
2. Absorption of overheads
Example 1
X plc produces desks.
Each desk uses 3 kg of wood at a cost of $4 per kg, and takes 4 hours to produce.
Labour is paid at the rate of $2 per hour.
Fixed costs of production are estimated to be $700,000 p.a..
The company expects to produce 50,000 desks p.a..
Calculate the cost per desk.

$ p.u.
Material (3kg × $4) 12
Labour (4hrs × $2) 8
Overheads ($700,000 ÷ 50,000) 14
$34

Absorbing of overheads- dividing total overheads by total production

3. First problem – more than one product produced in the

same factory
In this situation we have to decide on a basis for absorption first. There are many bases for absorption
that could be used (e.g. per unit, per labour hour, per machine hour etc.)

Example 2
X plc produces desks and chairs in the same factory.
Each desk uses 3 kg of wood at a cost of $4 per kg, and takes 4 hours to produce.
Each chair uses 2 kg of wood at a cost of $4 per kg., and takes 1 hour to produce.
Labour is paid at the rate of $2 per hour.
Fixed costs of production are estimated to be $700,000 p.a..
The company expect to produce 30,000 desks and 20,000 chairs p.a.
(Overheads are to be absorbed on a labour hour basis)
Calculate the cost per unit for desks and chairs

Total overheads $700,000

Total labour hours
Desks (30,000 × 4hr) 120,000
Chairs (20,000 × 1 hr) 20,000
140,000hrs
Overhead absorption rate: $700,000 = $5 per hour
140,000 hr
Costs cards:
Desks Chairs
Materials (3kg X $4) 12 (2kg X $4) 8
Labour (4hrs X $2) 8 (1hr X $2) 2
Overheads (4kg x $5) 20 (1hr X $5) 5
$40 $15

Example 3
X plc produces desks and chairs in the same factory. The factory has two departments, assembly
and finishing.
Each desk uses 3 kg of wood at a cost of $4 per kg., and takes 4 hours to produce – 3 hours in
assembly and 1 hour in finishing.
Each chair uses 2 kg of wood at a cost of $4 per kg, and takes 1 hour to produce – ½ hour in
assembly and ½ hour in finishing.
All labour is paid at the rate of $2 per hour.
Fixed costs of production are estimated to be $700,000 p.a.. Of this total, $100,000 is the salary
of the supervisors – $60,000 to Assembly supervisor, and $40,000 to Finishing supervisor.
The remaining overheads are to be split 40% to Assembly and 60% to Finishing.
The company expects to produce 30,000 desks and 20,000 chairs.
(Overheads to be absorbed on a labour hour basis)
Calculate the cost per unit for desks and for chairs

Total overheads: Total Assembly Finishing

Supervisors (allocated) 100,000 60,000 40,000
Other (apportionment/sharing) 600,000 240,000 360,000

$700,000 $300,000 $400,000

Total hours:
Desks (30,000 × 3 hr; 30,000 × 1 hr) 90,000 30,000
Chairs (20,000 × ½ hr; 20,000 × ½ hr) 10,000 10,000
100,000 hrs 40,000 hrs
O.A.R 300,000 = $3 per hr $10 per hr = 400,000
100,000 40,000
Cost cards:
desk chair
Materials (3kg X $4) 12 (2kgX$4) 8
Labour (4hr X $2) 8 (1hr X $2) 2
Overheads/fixed:
Assembly (3hrX$3) = 9 (1/2 X$3) = 1.50
Finishing (1hrX$10) = 10 (1/2 X$10) = 5.00
19 6.50
$39 $16.50
The charging of supervisors’ salaries to the relevant department is known as allocation of
overheads. The splitting or sharing of overheads between departments (as in the remaining
$600,000 in our example) is known as the apportionment of overheads.
Example 4
Production overhead costs for the period
$
Factory rent 20,000
Factory heat 5,000
Processing Dept – supervisor 15,000
Packing Dept – supervisor 10,000
Depreciation of equipment 7,000
Factory canteen expenses 18,000
Welfare costs of factory employees 5,000
80,000
Processing Dept Packing Dept Canteen
Cubic space 50,000 m3 25,000 m3 5,000 m3
NBV equipment $300,000 $300,000 $100,000
No. of employees 50 40 10

Allocate and apportion production overhead costs amongst the three departments using a
suitable basis.
 Total Processing Packing Canteen
Factory rent 20,000 12,500 6,250 1,250
(cubic space)
Factory Heat 5,000 3,125 1,563 312
(cubic space)
Supervisors 25,000 15,000 10,000 –
Depreciation 7,000 3,000 3,000 1,000
(NBV equipment)
Canteen 18,000 – – 18,000
Welfare 5,000 2,500 2,000 500
(No of employees)
$80,000 $36,125 $22,813 $21,062

Processing Packing Canteen

Already apportioned 36,125 22,813 21,062
Recharge canteen 11,701 9,361 (21,062)
(no. of employees)
$47,826 $32,174 –

4. Reapportionment of service cost centre overheads

PRODUCTION COST CENTRES - these make the cost units.

SERVICE COST CENTRES - these do work for the production cost centres and one another.

We therefore need to transfer all service cost centre overheads to the production centres so that all
production overheads for the period are shared between the production cost centres alone

Example 5
Reapportion the canteen costs in Example 4 to the production cost centres.
Above in the diagram.
No Inter Service Work Done If there is just one service department, or if there is more than one service
department but there is no work done by one service department for another, then reapportionment is
done using a suitable basis (e.g. canteen costs by the number of employees).
Inter-Service Work Done
The problem is a little more complicated if there is more than one service cost centre and
where they do work for one another. The way to deal with this is the reciprocal method. The
reciprocal method can be carried out in one of two ways:
๏Either the continuous or repeated distribution (tabular) method; or
๏The algebraic method.
Example 6
Production Depts Service Centres
X Y Stores Maintenance
$ $ $ $
Allocated and apportioned overheads 70,000 30,000 20,000 15,000
Estimated work done by the service centres for other departments:
Stores 50% 30% - 20%
Maintenance 45% 40% 15% -
Reapportion service department costs to departments using:
(a) repeated distribution method; and
(b) algebraic method.
Repeated distribution method
X Y Stores Maintenance
Already allocated 70,000 30,000 20,000 15,000
Recharge stores 10,000 6,000 (20,000) 4,000
– 19,000
Recharge maintenance 8,550 7,600 2,850 (19,000)
–
Recharge stores 1,425 855 (2,850) 570
–
Recharge maintenance 257 228 85 (570)
–
Recharge stores 43 25 (85) 17
–
Recharge maintenance 8 7 2 (17)
–
Recharge stores 1 1 (2)
$90,284 $44,716 –

Algebraic method
Stores: S = 20,000 + 0.15M (1)
Maintenance M = 15,000 + 0.20S (2)
Replace M in (1): S = 20,000 + 2,250 + 0.03S
0.97S = 22,250
S = 22,250/0.97 = $22,938
Replace S in (2): M = 15,000 + 0.20 × 22,938
M = $19,588
X Y Stores Maintenance
Already allocated 70,000 30,000 20,000 15,000
Recharge stores:
($22,938) 11,469 6,881 (22,938) 4,588
Recharge maintenance:
($19,588) 8,815 7,835 2,938 (19,588)
$90,284 $44,716 – –
Question 1
The process of cost apportionment is carried out so that common costs are shared among cost
centres.
Question 2
A cost centre is a production or service location, function, activity or item pf equipment for
which costs are accumulated/
Question 3
A company manufactures two products L and M in a factory divided into two costs centres, X
and Y. the following budgeted data are available:
Cost centre
X Y
Allocated and apportioned fixed overhead costs $88,000 $96,000
Direct labor hours per unit:
Product L 3.0 1.0
Product M 2.5 2.0
Budgeted output is 8000 units of each product. Fixed overhead costs are absorbed on direct
labor hour basis.
What is the budgeted fixed overhead cost per unit for Product M?

 $13
 $12
 $11
 $10

The absorption rate per hour for cost centre X=

88,000 / ( (8000 X 3.0) + (8000 X 2.5) ) = $2 per hour
The absorption rate per hour for cost centre Y=
96,000 / ( (8000 X 1.0) + (8000 X 2.0) )= $4 per hour
Overhead cost per unit for M = (2.5 X $2) + (2.0 X $4)
= $13 per unit
Ans A
Question 4
A company operates a job costing system. Job number 1203 requires $300 of direct materials
and $400 of direct labor. Direct labor is paid at the rate of $8 per hour.
Production overheads are absorbed at a rate of $26 per direct labor hour and non-production
overheads are absorbed at a rate of 120% of prime cost.
What is the total cost of job number 1203?

 $4400
 $2000
 $2840
 $2400
(Labor hours on the job = $400 / $ 8 = 50 hours)
Direct materials 300
Direct labor 400
Prime cost 700
Production overheads
(50 hours X $26) 1300
Other overheads
(120% X 700) 840
Total cost $2,840