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8: Accounting For Overheads: Topic List

Absorption costing is a method of accounting for overheads that involves three stages: 1) allocation of overheads to cost centers, 2) apportionment of overheads between cost centers, and 3) absorption of overheads into product costs using predetermined overhead absorption rates. This method helps determine more accurate product costs by spreading overheads across production activities rather than expensing them entirely in the period they are incurred.

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79 views5 pages

8: Accounting For Overheads: Topic List

Absorption costing is a method of accounting for overheads that involves three stages: 1) allocation of overheads to cost centers, 2) apportionment of overheads between cost centers, and 3) absorption of overheads into product costs using predetermined overhead absorption rates. This method helps determine more accurate product costs by spreading overheads across production activities rather than expensing them entirely in the period they are incurred.

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Ujjal Shiwakoti
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© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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8: Accounting for overheads

Absorption฀costing฀is฀a฀method฀of฀accounting฀for฀overheads.
Topic List It฀is฀basically฀a฀method฀of฀sharing฀out฀overheads฀incurred
amongst฀units฀produced.
Cost฀allocation
The฀three฀stages฀of฀absorption฀costing฀are:
Overhead฀apportionment
 Allocation
Overhead฀absorption  Apportionment
 Absorption

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Cost allocation Overhead Overhead


apportionment absorption

Allocation฀is฀the฀process฀by฀which฀whole฀cost฀items฀are฀charged฀directly฀to฀a฀cost฀unit฀or฀cost฀centre.

Allocated฀directly Direct฀costs C Product฀costs


to฀cost฀units o Example
s Warehouse฀security
t Production฀cost฀centres
guard:
If฀clearly฀identifiable a
with฀cost฀centres, Service฀cost฀centres  Cost฀of฀security
l
they฀are฀allocated฀to l guard฀charged฀to
those฀cost฀centres Indirect o General฀overhead฀cost warehouse฀cost
costs c centres centre
(overheads) a
t  Cost฀of฀heat฀and
If฀not฀clearly i Administration฀and light฀to฀general
identifiable฀with o selling฀and฀distribution overhead฀cost
n cost฀centres
particular฀cost฀centres,฀they centre
are฀allocated฀to฀general
overhead฀cost฀centres

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Cost฀allocation Overhead Overhead


apportionment absorption

The฀first฀stage฀of฀overhead฀apportionment฀is฀the฀identification฀of฀all฀overheads฀as฀production,฀service,
administration฀or฀selling฀and฀distribution.

Share฀out฀between฀other฀cost฀centres
Overheads within general overhead cost centres
Use฀a฀fair฀basis฀of฀apportionment

The฀second฀stage฀of฀overhead฀apportionment฀is฀to฀apportion฀the฀costs฀of฀service฀cost฀centres฀(both฀directly
allocated฀and฀apportioned)฀to฀production฀cost฀centres. This฀is฀known฀as฀reapportionment.

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Cost฀allocation Overhead Overhead


apportionment absorption

The฀final฀stage฀in฀absorption฀costing฀is฀the฀absorption฀of฀overheads฀into฀product฀costs฀using฀overhead
absorption฀rates฀(OARs).

Bases of absorption
Predetermined OARs
Many฀overheads฀are฀not฀known฀until฀the
end฀of฀a฀period. If฀waited฀until฀end฀of
 Unit฀(identical฀units) period,฀would฀cause฀delays฀in฀invoicing,
 Direct฀labour฀hour฀(labour฀intensive) inventory฀valuations฀and฀so฀on. Random
 Machine฀hour฀(machine฀intensive) fluctuations฀in฀overheads฀would฀create
variable฀OARs฀from฀month฀to฀month.

Departmental OARs
Budgeted฀overheads฀allocated฀and
 Used฀instead฀of฀blanket฀(single฀factory)฀OARs apportioned฀to฀production฀cost฀centres
____________________________________
 Reflect฀different฀times฀spent฀by฀different Budgeted฀activity฀levels฀(hours,฀units฀etc) on
products฀in฀production฀cost฀centres which฀rate฀to฀be฀based

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Cost฀allocation Overhead Overhead


apportionment absorption

Over-/under-absorbed overheads Accounting for over/under absorption of overheads


These฀arise฀because฀the฀OAR฀is
STATEMENT฀OF PROFIT฀OR฀LOSS
predetermined฀from฀budget฀estimates.
When฀actual฀overheads฀incurred฀and
overheads฀absorbed฀using฀predetermined Under-absorbed overhead Over-absorbed overhead
OARs,฀there฀will฀be฀an฀over฀or฀under
absorption฀of฀overheads. DR฀(expense) CR฀(expense฀reduction)

Reasons INSUFFICIENT absorbed TOO MUCH฀absorbed


overhead overhead
1 Actual฀OH฀≠ budgeted฀OH
2 Actual฀activity฀level฀≠ budgeted
activity฀level
3 1฀and฀2฀above฀(together)

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