OVERHEADS ALLOCATION AND

APPORTIONMENT - PRIMARY
1. INTRODUCTION
2. DEFINE OVERHEAD.
3. CLASSIFY OVERHEADS INTO FIXED AND VARIABLE OVERHEADS.
4. ALLOCATE OVERHEADS USING VARIOUS METHODS.
5. DEFINE OVERHEAD APPORTIONMENT AND COST CENTRES.
6. STATE BASES USED TO APPORTION OVERHEADS TO ALL COST
CENTRES.
7. REVIEW QUESTION
1. INTRODUCTION

• In the manufacture of any product, incurring indirect costs is as

inevitable as incurring direct costs. While preparing cookies, the
dough and the labour of the baker are as essential as is the electricity
(consumed by the oven), which is not a direct ingredient in cookies,
but is indispensable for baking the cookies.
• You would not pay much for uncooked cookies!
• Hence assigning indirect costs to the final product is as important as
charging the direct costs. Indirect costs are known as overheads.
• This Study Guide explains various methods of accurately assigning
the overheads to the final products.
2. DEFINE OVERHEAD.

• Direct costs i.e. direct material, direct labour and direct expenses are those
that can be easily traced to the physical units produced. On the contrary, by
their very nature, indirect (overhead) costs cannot be specifically traced to
physical units produced. However, the making of goods would be impossible
without incurring such overhead costs.
Example
In the production of an exercise book, the amount of paper used can be easily
traced to the product from the material requisitions. The cost of paper is hence
a traceable cost. The machine that is used to bind the exercise book undergoes
wear and tear each day. The depreciation of the machine is also a cost involved
in the manufacture of notebooks. This cost however, cannot be easily traced to
the product. Therefore this will be an indirect (overhead) cost of the product
2. DEFINE OVERHEAD.
• Overhead (i.e. indirect) costs include depreciation, fuel, heating,
lighting, material handling, repairs, property taxes, cost of services
facilitating the day to day operations etc. that are essential for any
production activity. Since these costs are not easily traceable to the
products, they need to be assigned to the products on a suitable, pre-
determined basis.
• The rates for assigning the indirect costs to the products are
determined on the basis of the budgeted figures that are calculated at
the start of an accounting period. This assignment of the indirect
costs to the products is known as the allocation and apportionment
of overheads.
3. CLASSIFY OVERHEADS INTO FIXED AND VARIABLE OVERHEADS.

Example
Considering the above example of producing an exercise book, the paper cost (the direct
material cost) will be directly charged to the product; the printed material or book. The
depreciation of the printing machine will be assigned to the book using a suitable basis.
• According to their function and on the basis of their origin, overheads are classified as:
1. Production, manufacturing, or factory overheads
2. Non-manufacturing overheads:
(a) Administrative overheads
(b) Selling and distribution overheads
(c) Research and development overheads
3. CLASSIFY OVERHEADS INTO
FIXED AND VARIABLE OVERHEADS.
Fixed and variable overheads
The abovementioned overheads can be further classified as fixed and
variable overheads based on their behaviour.
4. ALLOCATE OVERHEADS USING VARIOUS METHODS.

• There are two types of cost centres where overheads are incurred: the production cost
centre and the service cost centre. The actual processing and manufacture of the product
takes place in the production cost centre whereas service cost centres provide services to
the production cost centres.
• The first stage is where the accumulation of overheads occurs, according to the
department. The total overheads are allocated and apportioned to the production and
service cost centres. Thereafter, in the second stage, these costs are applied to the products
that are processed in these cost centres.
• The overhead costs are collected from various records such as financial accounts, cost
records and so on.
• Costs are accumulated for each cost centre. The costs are either allocated or apportioned to
the cost centres. Whenever the overhead costs can be assigned to the cost centres on an
accurate basis, the costs are allocated to the cost centres. Allocation is performed only
when we can precisely assign the costs to a cost centre.
4. ALLOCATE OVERHEADS USING
VARIOUS METHODS.
Example
Large organisations provide canteen facilities for their employees. If the
organisation has a system of coupons against which food is served, then the costs
of the canteen can be allocated to the various departments / cost centres on the
basis of the coupons submitted by the workers in each department.
• This is a case of allocation of canteen costs as we have an accurate basis on
which to allocate the costs. Coupons are an accurate basis as each coupon has a
value that can give us a clear idea of the cost of food consumed by each
department.
• Apportionment of costs to the cost centres is performed when we do not have
a precise basis to assign the overheads to the cost centres. In this case we
generally apportion the costs using the most suitable basis available.
4. ALLOCATE OVERHEADS USING
VARIOUS METHODS.
Example
Consider the canteen example above. If the organisation does not have a coupon
system, then it will not be in a position to accurately calculate the cost of food
consumed by each department. In this case, we will take the most suitable basis for
assigning the canteen costs to various departments. We will take the number of people
in each department as the basis to assign the canteen costs to each department.
• The method of apportionment of costs is used when the basis is not accurate. This is
the most suitable method available that can give us reasonable assurance that the
costs are not apportioned wrongly.
• Cost allocation refers to the charging of identifiable /traceable indirect cost items to
either cost centres or cost units. Cost apportionment involves division of costs
amongst two or more cost centres or cost units in proportion of the expected benefit
gained.
4. ALLOCATE OVERHEADS USING
VARIOUS METHODS.
• Allocation and apportionment of overheads assigns the entire overheads to
production and service cost centres.
• We still need to re-distribute the service cost centre overheads to the production cost
centres. This is because service centres provide services to the production cost
centres. Hence the production cost centres have to bear the cost of these services.
This is called re-apportionment of overheads, since the overheads once apportioned
to the service cost centres are again re-apportioned to the production cost centres in
this stage.
Example
In a factory which makes plastic goods, the production department is involved in the
actual moulding and finishing of the plastic goods. The stores department does the
work of receiving material requisitions and satisfying them. This is a service provided by
the stores department to the production department
4. ALLOCATE OVERHEADS USING
VARIOUS METHODS.
• If, in the first stage of apportionment, the stores department is apportioned a
Tshs400,000 electricity cost then this cost will be again re-apportioned on a
suitable basis to the production department. One may take as a basis the number
of requisitions received from the production department.
Calculation of overhead absorption rates
• Once the apportionment and the re-apportionment of the overheads are
complete in the first stage, all the overheads are allocated and apportioned to the
production departments. These are now to be assigned to the products. This is
the stage where the overhead absorption rates are calculated.
• Once we have the pool of overheads allocated and apportioned to the production
departments, we need to divide these by the total number of a suitable unit. The
most commonly used unit is a machine hour or a labour hour.
4. ALLOCATE OVERHEADS USING
VARIOUS METHODS.
• The above procedure provides us with the rate per machine hour /
labour hour (or any other unit used). When this rate is multiplied by the
number of machine hours or labour hours consumed by each product,
the amount of overheads to be assigned to each product is obtained.
Example
Suppose the total machine maintenance cost allocated to a production
department is Tshs120 million and the machine hours recorded in the
department are 6,000. The machine maintenance will be assigned to the
products on the basis of machine hours required per product as this is
the most suitable basis.
4. ALLOCATE OVERHEADS USING
VARIOUS METHODS.
• The overhead absorption rate will be calculated as = Tshs120
million/6,000 machine hours
• = Tshs20,000 per machine hour.
• If one unit of a product processed requires 5 machine hours then the
overheads to be assigned to the product will be calculated as
• Overhead absorption rate x number of machine hours consumed by
the product = Tshs20,000 x 5 hours = Tshs100,000
• In conclusion, the amount of overheads assigned to the product will
be Tshs100,000. This represents all the indirect costs which have gone
into making that product
4. ALLOCATE OVERHEADS USING
VARIOUS METHODS.
• The detailed procedure for determining the individual rates of
absorption of overheads for each department can be summarised as
follows:
(a) Allocate and apportion the total amount of overhead expenses
incurred to the production and service cost centres.
(b) Reapportion the service cost centre overheads to the production
cost centres.
(c) Calculate separate overhead rates for each production cost centre.
(d) Assign cost-centre overheads to products
4. ALLOCATE OVERHEADS USING
VARIOUS METHODS.
Review question
Assuming the total machine maintenance cost incurred and allocated
to a production department as Tshs36 million and Tshs48 million
respectively, and the recorded machine hours in that department as
12,000, calculate the overhead absorption rate.
A. Tshs4,000
B. Tshs2,500 ( )
C. Tshs3,000
D. Tshs3,333
6. STATE BASES USED TO APPORTION OVERHEADS TO ALL COST
CENTRES.

• Assigning specific overheads to a production/service cost centre or cost unit

on an appropriate basis is known as the allocation of overheads.
• When costs can be easily identified with a particular cost centre they are
allocated to the cost centre.
Example
The cost of tools issued to the maintenance department will be an overhead
cost as these are not direct material items but items of indirect material. This is
a specific cost that can be identified only with the maintenance department
and hence this cost will be allocated to the maintenance department.
• When specific overheads are incurred for a particular cost centre, those
overheads are allocated to it.
6. STATE BASES USED TO APPORTION OVERHEADS TO ALL COST CENTRES.

Example
A special repair cost is incurred in the machine shop (a cost centre where part processing of
the product takes place) due to break down of a machine in the shop. This cost is incurred
only in the machine shop and hence this overhead will be allocated only to the machine shop.
• Allocation of common costs or general overheads becomes difficult at times as the basis for
allocation is imprecise or arbitrary. In such cases, computation of the exact amount of
overheads to be allocated to a cost centre becomes difficult. These can only be allocated to
cost centres using an appropriate basis.
Example
In a big manufacturing unit that requires a continuous supply of electricity, the electricity is
normally generated in-house. This ensures an uninterrupted supply of electricity. In this case,
electricity generation is a secondary activity to the main production activity and hence the
cost incurred on this activity will be an overhead cost.
6. STATE BASES USED TO APPORTION
OVERHEADS TO ALL COST CENTRES.
• To keep track of the electricity consumption by each department, sub-meters are fitted in
each of the departments. The electricity cost, in this case, will be assigned to each
department on the basis of the submeter readings. Here the allocation of electricity cost
is done as the basis of assigning this cost is accurate.
• Overheads are always allocated to cost centres. When an organisation is divided into
various departments according to their function, it may happen that such division is not
suitable for cost allocation. Typically, cost centres are departments, but in some instances
a department may contain several cost centres. This helps in the assignment of costs.
Example
An organisation is divided into various departments, one of which is the production
department. This department consists of three machines; the melting machine, the
moulding machine and the finishing machine. The overheads incurred on each machine
can be separately identified.
6. STATE BASES USED TO APPORTION
OVERHEADS TO ALL COST CENTRES.
• For costing purposes, instead of considering the entire production department as one
single cost centre, we will consider each of the three machines installed as individual
cost centres.
Apportionment of overheads
• Certain costs cannot be traced to a particular cost unit or cost centre. Apportionment
refers to the proportionate allotment of such overheads to two or more departments or
cost centres on an equitable (most suitable) basis. This is done in the case of those
overheads which cannot be wholly allocated to a particular department or cost centre.
Example
Consider the above example of the ‘in-house electricity generation unit’. If the sub-
meters are not fitted in each department then it can pose a problem for the allocation of
the electricity costs to the departments.
6. STATE BASES USED TO APPORTION
OVERHEADS TO ALL COST CENTRES.
• In this case we will use the most appropriate basis, such as the light
points in each department. This will give us a fair amount of accuracy.
As the capacity of each light point or power point is given in kilowatts
this gives us a nearly accurate estimation of the power consumption in
each department. This will now be a case of apportionment of
overheads and not allocation.
• Although the basis used in the above example does not seem to be
accurate we still use it as it gives a greater accuracy than any other
basis. It can be argued that all the light points are not in use at all times.
However, apportionment is to assign overheads to the departments
using a somewhat arbitrary basis as no accurate basis is available.
6. STATE BASES USED TO APPORTION
OVERHEADS TO ALL COST CENTRES.
• The salary of a cleaner (for all departments) is a common cost incurred by all
departments. In this case, we do not have any precise basis on which we can
assign this cost accurately to the various cost centres. We will therefore take
the most suitable basis such as the floor area of each department / cost centre.
• This will give a fairly accurate cost apportionment. The larger the area of the
department, the greater is the amount of cost apportioned. This is because the
cleaner will need more time and effort to clean the department.
• The main difference between cost allocation and cost apportionment is that
allocation is the tracing of the whole of a cost to a cost centre while
apportionment is the distribution of common costs over the cost centres on
some suitable basis. In other words, cost allocation is direct, but apportionment
needs a suitable basis
6. STATE BASES USED TO APPORTION
OVERHEADS TO ALL COST CENTRES.
Selection of an appropriate basis
• The selection of an appropriate basis for the apportionment of overheads to
cost centres is a critical decision. If the basis is not reasonable, it might lead to
over- or under-assignment of overheads to the products. One of the criteria is
to apportion the overheads on the basis of the benefit received by the
department.
Example
The salary of the supervisor supervising more than one department/cost centre
will be apportioned on the basis of the time spent by him in each department.
This is a fair basis as he gets paid on the basis of the hours of work completed by
him. In this case, each department should bear the supervision costs in the ratio
of the time spent by the supervisor in each department
6. STATE BASES USED TO APPORTION
OVERHEADS TO ALL COST CENTRES.
• One may also apportion the overheads on the basis of the factor that
is the most responsible for the costs incurred.
• The commonly used bases for the apportionment of overhead costs
to the cost centres are:
Overhead cost Basis of distribution
1. All labour related expenses e.g. time keeping, Number of employees or wages paid for each department.
expenses, staff welfare expenses, canteen Direct labour hours are used as a basis for indirect labour
expenses and indirect labour
2. Lighting costs Number of light points, floor space area occupied
3. Supervising costs Time spent in each department or number of employees in the
department
4. Rent, rates and property taxes, heat, light, air Area occupied
conditioning
5. Depreciation of plant and machinery Capital value / book value of the machinery or plant will form
the basis to apportion depreciation to the machine
7. REVIEW QUESTION
QUESTION
Genilia Plc has incurred the following overhead costs during 2013.
Factory rent 20,000,000
Depreciation on factory building 10,000,000
Canteen expenses 5,000,000
Lighting 10,000,000
The following information relates to the production and service
department.
7. REVIEW QUESTION

DEPARTMENTS PRODUCTION PRODUCTION SERVICE SERVICE

DEPARTMENT A DEPARTMENT B DEPARTMENT X DEPARTMENT Y
1. Floor area occupied (square 3 4 2 1
metres)
2. Number of employees 30 40 25 5
7. REVIEW QUESTION
• In this case the overheads cannot be identified specifically with a cost
centre for allocation and therefore need to be apportioned. The
manner of apportionment of the overheads is given below.
DETAILS BASIS OF TOTAL COST PROD. PROD,DEPART SERVICE SERVICE
APPORTIONM DEPRTMENT MENT B DEPARTMENT DEPSRTMENT
ENT A X Y
Factory rent Floor area 20,000,000 6,000,000 8,000,000 4,000,000 2,000,000
Depreciation Floor area 10,000,000 3,000,000 4,000,000 2,000,000 1,000,000
on factory
building
Canteen Number of 5,000,000 1,500,000 2,000,000 1,250,000 250,000
expenses employees
Lighting Floor area 10,000,000 3,000,000 4,000,000 2,000,000 1,000,000

TOTAL 45,000,000 13,500,000 18,000,000 9,250,000 4,250,000

7. REVIEW QUESTION
Workings
W1 -Proportion to allocate costs using the suitable cost unit
Details Total Dept A Dept B Service dept X Service dept Y
Floor area 3+4+2+1=10 3/10 4/10 2/10 1/10
Number of 30+40+25+5=100 30/100 40/100 25/100 5/100
employee
7. REVIEW QUESTION
• Show the apportionment of the following costs:
Costs at the end of the year.
DETAILS0 AMOUNT IN TSH
Fixed costs
Rent and rates 4,000,000
Insurance 20,000,000
Depreciation on plant and machinery 25,000,000
General department expenses 37,500,000
Variable costs
Indirect wages 15,000,000
Fuel and power 20,000,000
Maintenance expenses 10,000,000
7. REVIEW QUESTION
Additional cost related data (Amounts in Tshs’000).
Details Dept A Dept B Dept C Dept D Total
Floor area (sq.ft.) 2,000 2,000 4,000 2,000 10,000
Cost of plant and 100,000 250,000 50,000 100,000 500,000
machinery
Horsepower 16 24 20 20 80
Labour hours 5,000 10,000 15,000 20,000 50,000
Machine hours 12,000 9,000 6,0000 3,000 30,000
Direct expenses 25,000 25,000 20,000 5,000 75,000
Direct wages 30,000 30,000 26,000 15,000 101,000
Direct materials 27,000 19,500 15,500 - 62,000
7. REVIEW QUESTION
• Department D is a service department and all other departments are
production departments