Group 4

LECTURE 4

Overhead Analysis
 Introduction
 Direct Costs
These are costs that can be identified or traced to
a cost object or cost center.
 Indirect Costs
These are costs that cannot be traced to a cost
object or cost center.
Indirect costs are collectively termed overheads.
Indirect costs comprise of indirect materials,
indirect labour and indirect expenses

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 Components of Overhead

Cost

Material Cost Labour Cost Expenses

Direct Material Indirect Material Direct Labour Indirect Labour Direct Expenses Indirect Expenses

Overheads

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 Components of Overhead Contd.
 Indirect Cost/ Overhead Components

A. Indirect Material Costs

This would include all other material costs not directly used or consumed in
production or service. Examples include lubricants and fuel for Plant &
Machinery, spare parts and loose tools for repairs and maintenance etc.
B. Indirect Labour Costs
This would include wages and salaries to paid to workers not directly involved
in production or service delivery. These may include cost of workers engaged
in supervision, quality control, selling and distribution, administration, research
and development etc.
C. Indirect Expenses
This would also include expenses not specifically incurred in the production of
a cost object or service delivery. These may include establishment costs such
as pre-operational expenses, interest expenses, electricity expenses, taxes of
all forms, research expenses, permits etc.

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 Cost Assignment
 Cost Assignment
Cost assignment is the process by which direct or indirect costs
are charged to or made the responsibility of particular cost
centres, and ultimately charged to a cost object or services.
 Cost Allocation
Allocation is the process by which whole cost items are charged
direct to a cost unit or cost centre.
 Cost Apportionment
Apportionment is a procedure whereby indirect costs are spread
fairly between cost centres.
 Cost Absorption
This is the process of including overhead cost into cost object.

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 Cost Assignment

Allocation
Direct Costs

Cost Object

Allocation (Apportionment) Allocation (Absorption)

Indirect Costs Cost Centres

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 Overhead Allocation
 Overhead Allocation
Allocation of overhead is the process of assigning cost to a cost object. The basis of
allocation of overheads to cost objects is called allocation base or cost driver. Two
types of systems can be used to assign indirect (overhead) costs to cost objects.
They are;
a. Traditional Costing Systems
b. Activity Based Cost (ABC) systems.
The objective of allocating overheads to cost objects is to include in the total cost of
the product or service an appropriate share of the organization’s total overhead
costs.
Overheads are to be apportioned to different cost centres based on following two
principles:
 Cause and Effect - Cause is the process or operation or activity and effect is
the incurrence of cost. Apportionment of overheads based on this criterion
ensures better rationality as it is guided by the relationship between cost object
and cost.
 Benefits received – overheads are to be apportioned to the various cost
centres in proportion to the benefits received by them.
Group 4 Participants. Memba 7. Lagos Business School 2-7
 Overhead Allocation Contd.
 Cost Centres
CIMA defines Cost Centre as “a production or service, function, activity
or item of equipment whose costs may be attributed to cost units. A
cost centre is the smallest organizational sub-unit for which separate
cost allocation is attempted.”
 Production and Service Cost Centres
i. Production Cost Centre
Production cost centres’ are engaged in production activity by
conversion of raw material into finished production.
ii. Service Cost Centre
Service cost centres are those which are ancillary to and render service
to other production and service cost centres

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 Overhead Allocation Contd.

 Process of Allocating Overheads

1. Apportioning/assigning all manufacturing overheads to
production and service cost centres. This is called primary
allocation;
2. Reapportioning/reassining the costs assigned to service cost
centres to production cost centres. This is called secondary
allocation;
3. Computing separate overhead rates for each production cost
centre;
4. Assigning cost centre overheads to products or other chosen
cost objects.
The above process is often referred to as the two-stage process of
allocating overheads under the traditional costing system.
Group 4 Participants. Memba 7. Lagos Business School 2-9
 Overhead Allocation Contd.
 Bases of apportionment
It is considered important that overhead costs should be shared out
on a fair basis. Due to the complexity of items of cost it is rarely
possible to use only one method of apportioning costs to the
various departments of an organisation. The bases of
apportionment for the most usual cases are given below.
Overhead to which the basis applies Basis

Rent, rates, heating and light, repairs and Floor area occupied by each cost centre
depreciation of buildings

Depreciation, insurance of equipment/plant Cost or book value of equipment/plant

Personnel office, canteen, welfare, wages Number of employees, or labour hours
and cost offices, first aid worked in each cost centre

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 Overhead Allocation Contd.


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 Overhead Allocation Contd.
 Methods of Absorbing Overhead
1. percentage of direct materials cost
2. percentage of direct labour cost
3. percentage of prime cost
4. rate per machine hour
5. rate per direct labour hour
6. rate per unit
7. percentage of factory cost (for
administration overhead)

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 Overhead Allocation Contd.


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 Overhead Allocation Contd.


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 Overhead Allocation Contd.
 Blanket Rates & Departmental Absorption Rates
a. Blanket/ Plant – Wide Overhead Rates: this is used to describe where an
organization uses one single overhead rate for the entire organization as a
whole.
b. Departmental Overhead Rates: this is used to describe where an organization
uses separate overhead rates for cost centers/cost pools within the organization.
 Over/Under Absorption
Over and under absorption of overheads occurs because the predetermined
overhead absorption rates are based on estimates.
The rate of overhead absorption is based on estimates (of both numerator and
denominator) and it is quite likely that either one or both of the estimates will not
agree with what actually occurs.
a. Over absorption: means that the overheads charged to the cost of sales are
greater than the overheads actually incurred.
b. Under absorption: means that insufficient overheads have been included in the
cost of sales.

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 Overhead Allocation Contd.
 Reapportioning Service Department Costs
Only production departments produce goods that will ultimately be
sold. In order to calculate a correct price for these goods, we must
determine the total cost of producing each unit – that is, not just the
cost of the labour and materials that are directly used in production,
but also the indirect costs of services provided by such
departments as maintenance, stores and canteen.
 Methods of allocating the service department costs:
1. repeated distribution (reciprocal) method;
2. simultaneous equation method;
3. specified order of closing method;
4. direct allocation method

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 Questions
 Question 1
ELEKURU LTD has two production departments (A and B) and two
service departments (maintenance and stores). Details of next
year's budgeted overheads are shown below.
Total
($)
Heat and light 19,200
Repair costs 9,600
Machinery depreciation 54,000
Rent and rates 38,400
Canteen 9,000
Machinery insurance 25,000
Total 155,200
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 Questions Contd.
A B Maintenance Stores Total

Floor area (m2) 6,000 4,000 3,000 2,000 15,000

Machinery book value ($) 48,000 20,000 8,000 4,000 80,000

Number of employees 50 40 20 10 120

Allocated overheads ($) 15,000 20,000 12,000 5,000 50,00

Service departments' services were used as follows.

A B Maintenance Stores Total

Maintenance hours worked 5,000 4,000 ---- 1,000 10,000

Number of stores requisitions 3,000 1,000 ---- ---- 4,000

Required;
Prepare an overhead analysis sheet for Elekuru Limited

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 Questions Contd.
Question 2
The following table shows the overheads apportioned to the five
departments in AMUZUNGU CO.
Total Machine Machine Assembly Canteen Maintena
Shop A Shop B nce
$ $ $ $ $ $

Indirect wages 78,560 8,586 9,190 15,674 29,650 15,460

Consumable materials 16,900 6,400 8,700 1,200 600 -

Rent and rates 16,700 3,711 4,453 5,567 2,227 742

Insurance 2,400 533 640 800 320 107

Power 8,600 4,730 3,440 258 - 172

Heat & Lighting 3,400 756 907 1,133 453 151

Depreciation 40,200 20,100 17,900 2,200 - -

Total 166,760 44,816 45,230 26,832 33,250 16,632

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 Questions Contd.
Total Machine Machine Assembl Canteen Maintena
Shop A Shop B y nce
Power usage – technical 100 55 40 3 - 2
estimates (%)
Direct labour (hours) 35,000 8,000 6,200 20,800 - -
Machine usage (hours) 25,200 7,200 18,000 - - -
Area (square metres) 45,000 10,000 12,000 15,000 6,000 2,000

Required;
Using the bases which you consider to be the most appropriate, calculate
overhead totals for Amuzungu Co's three production departments, Machine
shop A, Machine shop B and Assembly.

Group 4 Participants. Memba 7. Lagos Business School 2-20

 Questions Contd.
Question 3
Zangalanga Limited has two production departments, for which the
following budgeted information is available.
Department A Department B
Budgeted Overheads $360,000 $200,000
Budgeted Direct Labour Hours 200,000 hrs 40,000 hrs
Budgeted Machine Hours 170,000 hrs 30,000 hrs

As the cost accountant to Zangalanga Limited, you are required to

calculate;
a. A single factory rate of overhead recovery using Labour Hours
b. A single factory rate of overhead recovery using Machine Hours
c. Separate departmental rates of overhead recovery using Labour
Hours
d. Separate departmental rates of overhead recovery using Labour
Hours
Group 4 Participants. Memba 7. Lagos Business School 2-21
 Questions Contd.
Assuming that Job X has a prime cost of $100, takes 30
hours in department B and does not involve any work in
department A.
Job Y has a prime cost of $100, takes 28 hours in
department A and 2 hours in department B.
What would be the factory cost of each job, using the
following rates of overhead recovery?
a. A single factory rate of overhead recovery
b. Separate departmental rates of overhead recovery

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 Questions Contd.
Question 4
Given below is data relating to Cost Centre 52 for period 9 for ABAMI
Total Overhead for period ₦6,000
Total Direct Labour Hours for period 800
Total Direct Wages ₦1,600
Total Direct Material used ₦3,000
Total Machine Hours 1,200
Total Units Produced 45
Required:
Using the above data compute overhead absorption rates using;
1. Percentage of Direct Material Cost
2. Percentage of Direct Labour Cost
3. Percentage of Prime Cost
4. Rate per machine hour
5. Rate per direct labour hour
6. Rate per unit

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 Questions Contd.
Job X has a material cost of $100, and labour cost of $40, it takes 7
hours in cost centre 52.
a. What will be the production cost using each of the above methods

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 Group 4

END

LECTURE 4