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F2 MANAGEMENT
ACCOUNTING
TOPIC: OVERHEADS &
ABSORPTION COSTING
TUTOR: MR
KANYONGANISE
+263 782487521
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F2 MANAGEMENT ACCOUNTING
OVERHEADS
Production and
Non-production.
Production overheads are indirect costs that are directly related to the production. These include
items such as:
Power
Maintenance of machinery.
Non-production overheads are necessary expenses of the business, which are notdirectly related to
production. These can be classified into:
Administration overheads
Selling and distribution overheads
Finance overheads.
Absorption costing is used to calculate the production overhead cost per unit.
OVERHEAD ALLOCATION
Some costs can be easily identified with a unit or units of production such as labour and
material costs. These are said to be ‘allocated to the product’. Often they are allocated to
the cost centre or department before being shared among the units of production.
Overheads can also be allocated to a cost centre if they are specifically identifiable with that
cost centre, such as the salary of the cost centre supervisor.
OVERHEAD APPORTIONMENT
Some costs relate to the business as a whole. These costs then have to be shared between
the various departments or cost centres. This is done by ‘apportioning the costs’.
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F2 MANAGEMENT ACCOUNTING
“The division of costs amongst two or more cost centres is in proportion to the estimated
benefit received, by using a proxy.Eg,area, headcount, capital value etc.
These overheads then have to be included into the cost of the products which are produced
in that department. It would be easy to just divide the cost by the number of units made.
This would be fine if only one product was made or if all products took exactly the same time
to be made. As this is not the case we have to find a way of sharing the overhead costs
between the products.
Exercise 1
JOB Co Ltd is preparing its departmental budgets and product cost estimates for the year ended 31
December. The company has three manufacturing departments – Machining, Assembly, and
Finishing – together with a production maintenance department.
The following costs and related data have been estimated for the year to 31 December:
Prepare an overhead analysis sheet for ABC Ltd for its year ended 31 December.
SECONDARY APPORTIONMENT
Not all departments are production based. Some act as a service to the production
departments. Eg, canteen, stores, maintenance.The costs of these have to be included into
the total overheads of the production departments. Secondary apportionment is a means of
apportioning overheads from service cost centres to production cost centres by means of
relevant usage factors.
A canteen – on basis of number of employees.
A stores – on the number of stores issues.
Sometimes both service cost centres provide services to each other (reciprocal servicing).
This has to be taken into account before the final apportionments are made.
1) Elimination
2) Algebraic
1. Elimination
This method is used where one service centre does not use the services of another. For
instance it is unlikely that the stores would provide a service to the canteen while the
canteen would provide a service to the stores. In this case the canteen costs would be
apportioned first followed by the stores.
The ABC washing machine Co. produces a standard washing machine in three production
departments (Machining, Assembly, and Finishing) and two service departments (Materials handling
and Production control). Costs for last year, when 2,000 machines were produced were as follows:
Prepare a statement showing the overhead allocated and apportioned to each of the production
departments.
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F2 MANAGEMENT ACCOUNTING
3. Algebraic
Using simultaneous equations to arrive at the total used in the repeated distribution method.
Required:
Reapportion the service centre costs to the production centres using Algebraic method.
OVERHEAD ABSORPTION
An absorption rate can be thought of as a charge out rate for overheads. Absorption rates
can be calculated in a number of ways but the most common ways for exam questions are:
A rate per unit.
A rate per labour hour.
A rate per machine hour.
It is worth remembering that absorption rates are always calculated using BUDGETED
figures. Rates have to be available at the start of a period so it is possible to cost output as
the period progresses. Actual figures are only available at the end of a period. Absorption
rates are calculated as:
Budgeted overheads / budgeted activity = OAR
A single absorption rate can be calculated for a company as a whole, known as a blanket
rate. Equally, separate absorption rates can be calculated for individual departments, known
as departmental rates.
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F2 MANAGEMENT ACCOUNTING
Razor Ltd makes two products, each with a prime cost of $20.The following budgeted information is
available for the factory.
Bulb 1 3 20,000
Petal 2 5 20,000
Budgeted Overhead $120,000
D) What will the total production cost for each product be using each absorption rate?
Bulb - - -
Petal - - -
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F2 MANAGEMENT ACCOUNTING
It may be more accurate to calculate separate absorption rates for different departments.
Would it be fair or meaningful to use labour hours, for instance, to charge out overheads in a
machine intensive department?
Cutting Finishing
Budgeted
Overheads $100,000 $50,000
Machine Hours 50,000 3,000
Labour Hours 20,000 12,500
Actual
Overheads $132,000 $38,000
Machine Hours 40,000 4,200
Labour Hours 28,000 12,000
The following information is also available about one of the company's products
Machine Hours 6 1
Labour Hours 2 4
Exercise 6
A company manufactures two products P1 and P2 in a factory divided into two cost centres, X and Y.
The following budgeted data are available:
Cost Centre
X Y
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F2 MANAGEMENT ACCOUNTING
Budgeted output is 8,000 units of each product. Fixed overhead costs are absorbed on a direct
labour hour bases.
What is the budgeted fixed overhead cost per unit for Product P2?
A $10
B $11
C $12
D $13
Calculation of the overhead absorption rate (OAR) is done by using budgeted figures. We
cannot use actual figures because we do not know these until after the event. This means
that for every item we make we absorb a certain amount of overheads into the unit. The
total amount absorbed will depend upon the number of units made.
It is highly unlikely that the budgeted production will agree exactly with the actual or that
the budgeted overhead will agree with the actual spend. Because of this we need to
calculate how much overhead has been absorbed into our production, compare this with the
actual amount and make an adjustment to our P&L account.
If we have absorbed too much (over absorption) we will have to add back the difference into
our P&L. This will increase the reported profit. If we have not absorbed enough (under
absorption) we will have to take more out of our P&L. This will decrease the reported profit.
Wix Ltd uses absorption costing. The following information for its one production department is as
follows:
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F2 MANAGEMENT ACCOUNTING
Shredding
Budgeted
Overhead $200,000
Actual
Overheads $208,000
Required:
Overheads were - by $ -
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F2 MANAGEMENT ACCOUNTING