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Primary and secondary apportionment of overheads
The
overhead apportionment process is in two stages, namely primary and secondary
apportionments.
The primary apportionment stage is when
overheads are apportioned to all departments in the organization (both
production and service departments) without considering any reciprocal transfer
of benefits. The objective at this stage is to allot common overheads to all
cost centres that have benefited from that cost, using fair or equitable bases.
The secondary apportionment stage
reapportions service department overhead to production departments. The objective
of this stage is to ensure that only production departments bear all overhead
costs, and which will eventually be charged to products. This is because while
there is a direct link between the product produced and the production
departments, there is no such link between the products and service
departments. The absence of a direct link between service cost centres and
products will make it difficult to charge service cost centre overheads to
products. The stage is also called
overhead redistribution.
Service departments are
those departments such as canteen, administration, stores, maintenance, etc
that do not take direct part in the production process. They provide support
work for the production departments.
Methods of Secondary Apportionment
The
following are the methods to be considered:
i.
The reciprocal or repeated distribution
method
ii.
The direct distribution method or
substitution method
iii.
The elimination or step-wise method
iv.
The algebraic or simultaneous equation
method.
1. The Reciprocal Method
This
method reapportions service department overhead to production department in a
continuous manner until the amount is exhausted. The method is also called the
repeated distribution or continuous reapportionment method. It recognises fully
any interdepartmental transfers of benefits. This method can be explained well
with an example.
Exercise
1
The data below relates to the
overhead cost of Power Enterprise, a manufacturing organisation with two
production and two service cost centres.
Production
Cost Centres
|
Service
Cost Centres
|
Total
|
|||
Mixing
|
Boiling
|
Administration
|
Canteen
|
||
Indirect material and labour ($)
|
500,000
|
400,000
|
250,000
|
320,000
|
1,470,00
|
Rent and rates ($)
|
750,000
|
||||
Lighting and air conditioning ($)
|
650,000
|
||||
Welfare cost ($)
|
800,000
|
||||
Depreciation of machinery ($)
|
950,000
|
||||
Other relevant information:
|
|||||
Number of employees
|
20
|
30
|
15
|
10
|
75
|
Book values of machinery ($000)
|
50,000
|
45,000
|
25,000
|
22,000
|
142,000
|
Floor space occupied (square
metre)
|
5,000
|
6,000
|
4,000
|
4,500
|
19,500
|
Number of light bulbs
|
40
|
30
|
50
|
10
|
130
|
Working hours of machinery
|
20,000
|
35,000
|
30,000
|
28,000
|
113,00
1
|
Usage of service department:
|
|||||
Administration (%)
|
44
|
48
|
-
|
8
|
100
|
Canteen (%)
|
45
|
50
|
5
|
-
|
100
|
You are required to ascertain the
total overhead cost of each of the production cost centres using the reciprocal
method. Show clearly primary and secondary apportionment as well as the basis
of apportioning each overhead cost. All calculations must be made to the
nearest whole number.
Exercise 1
Mersin
Ltd, a jobbing engineering company, has two production and two service
departments. The company incurred the following overhead costs for the period.
Production
|
Department
|
Service
|
Department
|
YJ
|
|
A
|
B
|
1
|
2
|
Total
|
|
$
|
$
|
$
|
$
|
$
|
|
Indirect
wages
|
60,000
|
76,000
|
90,000
|
70,000
|
296,000
|
Indirect
materials
|
100,000
|
150,000
|
-
|
-
|
250,000
|
Building Rent & Rates
|
600,000
|
||||
Factory
power
|
200,000
|
||||
Depreciation
& Insurance of plant
|
150,000
|
||||
$
|
|||||
Salaries
|
300,000
|
||||
Factory
lighting
|
300,000
|
The
following information is also relevant:
Production
|
Department
|
Service
|
Department
|
|
A
|
B
|
1
|
2
|
|
Area occupied
(sq. m)
|
3,000
|
2,000
|
500
|
500
|
No. of
employees
|
20
|
30
|
6
|
4
|
No. of light
bulbs
|
300
|
150
|
30
|
20
|
Value of plant
($)
|
2,400,000
|
2,000,000
|
800,000
|
800,000
|
Effective
house power (KW/hr)
|
50,000
|
50,000
|
-
|
-
|
GF
The
overhead of the service cost centres in are charged out on a percentage basis
as follows:
Production
|
Department
|
Service
|
Department
|
|
A
|
B
|
1
|
2
|
|
Service
Dept. 1 (%)
|
50
|
40
|
-
|
10
|
Service
Dept. 2 (%)
|
45
|
40
|
15
|
-
|
You
are required to apportion the overheads of the service cost centres to the
production cost centres using the reciprocal method.
2.
The
Direct Distribution Method
This
method reapportions service department overheads to production departments
only. It ignores totally any intra-service department transfers of overheads.
Exercise 1
Lean
Ltd has two production and three service department. It needs to apportionment
budgeted monthly fixed overhead cost between the department. The costs are as
follows;
$000
|
|
Rent
|
2,000
|
Rates
|
1,000
|
Plant
insurance
|
4,000
|
Plant
depreciation
|
5,000
|
Supervisors
salary
|
7,000
|
The
following additional information is available
Production
department
|
Service
department
|
||||
A
|
B
|
X
|
Y
|
Z
|
|
No.
of employee
|
10
|
8
|
48
|
5
|
4
|
Value
of plant ($000)
|
3,800
|
3,500
|
700
|
1,200
|
800
|
Area
occupied (sq. feet)
|
2,000
|
2,500
|
1,500
|
1,000
|
1,000
|
Hours
worked
|
10,000
|
8,000
|
12,000
|
10,000
|
1,000
|
Usage
of service department
|
|||||
X
(%)
|
50
|
25
|
-
|
15
|
10
|
Y
(%)
|
35
|
40
|
10
|
-
|
15
|
Z
(%)
|
20
|
50
|
25
|
5
|
-
|
Ascertain
the total overhead cost of the production departments using the direct
distribution method.
3.
The Elimination
Method
This
method gives partial recognition to the reciprocal transfer of benefits between
service departments. The reapportionment process starts with all service
departments. Each service department is omitted from the reapportionment
process after its overhead has been reapportioned.
The
following is the order in which the overhead must be reapportioned under this method:
a. Start
with the service department that does work for the highest number of other service departments;
b. Where
the above (a) above does apply, start the reapportionment with the service
department having the highest overhead after the primary apportionment.
Note
that the above order must be followed so as to minimize the inequitable effect
of the elimination method in allotting overhead to production cost centres.
Exercise 1
Nimrud
Plc is preparing its budget for the forth coming quarter and has provided you
with the information below to assist in the process. It has two production cost
centres and two service cost centres.
Production
Cost Centre
|
Service Cost
Centre
|
|||
Mixing
|
Bottling
|
Reception
|
Canteen
|
|
$
|
$
|
$
|
$
|
|
Direct
material
|
230,000
|
220,000
|
-
|
-
|
Direct
labour
|
690,000
|
875,000
|
-
|
-
|
Indirect
material
|
200,000
|
180,000
|
453,000
|
856,980
|
Indirect
labour
|
349,500
|
342,200
|
450,000
|
680,000
|
Other
overhead:
|
||||
Stores
cost
|
400,000
|
|||
Depreciation
of buildings
|
500,000
|
|||
Depreciation
of equipment
|
450,000
|
|||
Rent,
rates and electricity
|
720,000
|
|||
Other
relevant information is as follows:
Production
Cost Centre
|
Service Cost
Centre
|
|||
Mixing
|
Bottling
|
Reception
|
Canteen
|
|
Number
of employee
|
10
|
5
|
4
|
5
|
Floor
area occupied (m2)
|
2,000
|
2,000
|
500
|
1,200
|
Cost of building ($000)
|
20,000
|
18,000
|
6,000
|
8,500
|
Cost
of equipment ($000)
|
14,000
|
16,000
|
4,000
|
5,000
|
Number
of requisitions
|
20
|
15
|
10
|
12
|
Working
hours
|
10,000
|
10,000
|
10,000
|
8,000
|
Usage
of service departments:
|
||||
Reception
(%)
|
50
|
40
|
-
|
10
|
Canteen
(%)
|
30
|
45
|
25
|
-
|
You
are required to ascertain the total overhead cost of each production cost
centre using the elimination or step-wise method.
Exercise 2
Withington
Enterprise has two production departments and three service departments. The
cost accountant is seeking your assistance for the new budget to be prepared.
He has provided the following data to you.
Production
departments
|
Service
Departments
|
Total
|
||||
Cutting
|
Finishing
|
Canteen
|
Admin.
|
Stores
|
||
$
|
$
|
$
|
$
|
$
|
$
|
|
Direct
labour and material
|
50,000
|
80,000
|
-
|
-
|
-
|
130,000
|
Indirect
labour and material
|
30,000
|
45,000
|
60,000
|
20,000
|
50,000
|
205,000
|
Rent
and rates
|
100,000
|
|||||
Depreciation
of assets
|
120,000
|
|||||
Welfare
cost
|
105,000
|
|||||
Lighting
and air conditioning
|
110,000
|
|||||
The
following information has also been provided:
Production
departments
|
Service
Departments
|
Total
|
||||
Cutting
|
Finishing
|
Canteen
|
Admin.
|
Stores
|
||
Number
of workers
|
20
|
15
|
10
|
4
|
6
|
55
|
Floor
space occupied in metre sq.
|
3,000
|
2,500
|
2,000
|
500
|
1,800
|
9,800
|
Cost
of assets ($000)
|
300,000
|
400,000
|
150,000
|
80,000
|
120,000
|
1,050,000
|
Cutting
|
Finishing
|
Canteen
|
Admin.
|
Stores
|
Total
|
|
Working
hours
|
5,000
|
5,000
|
5,000
|
5,000
|
5,000
|
25,000
|
Number
of light sockets
|
30
|
40
|
20
|
10
|
15
|
115
|
Utilisation
of service departments:
|
||||||
Canteen %
|
40
|
50
|
-
|
10
|
-
|
100
|
Admin %
|
35
|
45
|
5
|
-
|
15
|
100
|
Store %
|
60
|
20
|
8
|
12
|
-
|
100
|
Using
the elimination method, determine the total overhead for each production
department. Show the bases of apportionment and leave all answers to nearest
dollar.
Exercise 3
Adulki
Enterprise has two production cost centres and three service cost centres. The
following data have been collected from the business.
$
Lighting
and air conditioning 4,000
Insurance
of building 5,000
Cost
of indirect material issues 2,400
Other
relevant information is as follows:
Production Departments
|
Service
Departments
|
||||
Mixing
|
Boiling
|
Admin.
|
Maintenance
|
Canteen
|
|
Area
occupied(m2)
|
5000
|
4000
|
3000
|
2000
|
2000
|
Metre
reading(kw/h)
|
10,000
|
12000
|
8000
|
5000
|
6000
|
No.
of material requisitions
|
20
|
22
|
10
|
18
|
15
|
Cost
of building($000)
|
15000
|
20000
|
9000
|
18000
|
10000
|
Number
of employees
|
10
|
8
|
5
|
4
|
3
|
Usage
of service cost centre:
|
|||||
Admin %
|
40
|
50
|
-
|
10
|
-
|
Maintenance %
|
35
|
25
|
40
|
-
|
-
|
Canteen
%
|
30
|
20
|
22
|
28
|
-
|
Determine
the total overhead cost of the production cost centres using the step-wise
method.
4.
The
Algebraic or Simultaneous Equation Method
This
method uses algebra in determining the overhead cost for each service
department before apportioning to production departments. For example, where
two production and two service departments are involved the following equations
can be used to determent the total overhead of each service department.
Assuming the service departments are X and Y.
x
= own cost + P1y → equation
(1)
y
= own cost + P2x → equation
(2)
Where
‘x’ is the total overhead of service department X;
‘y’ is the total overhead of service
department Y;
‘P1’ is the proportion of
benefit department X enjoys form department Y;
‘P2’ is the proportion of
benefit department Y enjoys form department X;
‘own cost’ means overhead of service
department after primary apportionment.
The
overhead obtainable from the above is shared to the production departments
according to the proportion of benefits enjoyed by the production departments
from the service departments.
Exercise 1
The
following summarized overhead information was collected from the records of a
manufacturing organization. Using the information provided and the algebraic
method of overhead apportionment, determine for each production department, the
total overhead cost.
Production
Cost Centre
|
Service Cost
Centre
|
|||
Mixing
|
Bottling
|
Reception
|
Canteen
|
|
Overhead
allotted
|
69,000
|
70,000
|
65,000
|
50,000
|
Usage
of service departments:
|
||||
Reception
(%)
|
50
|
40
|
-
|
10
|
Canteen
(%)
|
30
|
45
|
25
|
-
|
You
are required to ascertain the total overhead cost of the production departments
using the simultaneous equation or algebraic method.
Example2
The
following represent the overhead cost incurred by APP. Enterprise in respect of
its three production Department and two service depts.
Production
Department
|
Service
Department
|
||||
Mixing
|
Boiling
|
Bottling
|
Administration
|
Canteen
|
|
$
|
$
|
$
|
$
|
$
|
|
Indirect
Material and Labour
|
50000
|
30000
|
40000
|
20000
|
30000
|
Other
Overheads:
|
|||||
Rent
and Rates
|
60000
|
||||
Lighting
and Heating
|
45000
|
||||
Insurance
of building
|
50000
|
||||
Other
information:
Production
Department
|
Service
Department
|
||||
Mixing
|
Boiling
|
Bottling
|
Administration
|
Canteen
|
|
$
|
$
|
$
|
$
|
$
|
|
Number
of Employees
|
20
|
25
|
22
|
10
|
8
|
Floor
Area occupied(m2)
|
1000
|
800
|
500
|
500
|
400
|
Value
of machinery($000)
|
10000
|
15000
|
20000
|
120000
|
8000
|
Overhead
Absorption: This is the final stage of the overhead analysis
process where the overhead of the production departments are charged to the
final product.
The
following is the general formula for calculating overhead absorption rate:
Overhead
Absorption Rate =
Activity
level maybe measured using any of the following
1. Cost
basis
2. Production
hours
3. Output
Overhead absorption rates are
based on budgeted overhead rather than actual overhead so as to avoid
i.
Delay in the inclusion of overhead into the cost of a product or
service
ii.
Frequent fluctuations in the prices of
product.
1.
Absorption
on Cost Basis
The three main methods under this
are;
a.
Direct
Material Cost Percentage Method
This method absorbs overhead on
the basis of direct material cost incurred. The rate is calculated as
Direct material cost percentage =
x 100
This
is applicable where
i.
direct material cost forms a significant
proportion of production cost
ii.
most firms in the industry use this
method
b.
Direct
Labour Cost Percentage Method
This method calculates overhead
cost using the formula below
Direct Labour cost percentage =
x 100
This method is used where
i.
Direct labour cost forms a significant
proportion of production cost
ii.
Most forms in the industry use this
method
c.
Prime
Cost Percentage Method
This
method absorbs overhead cost on the bases of prime cost. The rate is calculated
as
Prime
cost percentage =
x 100
This
method is applicable where
i.
Prime cost forms a significant
proportion of production cost
ii.
Most firms in the industry use this
method.
2.
Absorption
on Production Hour Basis
Production hours
maybe measured in teams of
a. Machine
hours
b. Labour
hours
The
absorption rates under this are
a.
Machine
hour rate:
This
method absorbs overhead on the basis of machine hours. The rate is calculated
as
Machine
hours =
This
method is used where
i.
The work undertaken is capital intensive
ii.
Most firms in the industry use this
method
b.
Direct
labour hour rate:
This
method absorbs overhead cost on the basis of direct labour hours. The rate is
calculated as
Direct
Labour hour rate =
This
method is used where
i.
The work undertaken is labour intensive
ii.
Most firms in the industry use this method
Note:
Machine hour rate and direct labour hour rate are the most popular absorption
rates. However machine hour rate is gaining more popularity with the increase
in technology.
3.
Absorption
on Output Basis
This
method absorbs overhead on the basis of output units. The rate is calculated as
Rate
per unit=
This
method is capable where
i.
Standard or homogeneous products are
produced(i.e. identical, similar etc products are produced)
ii.
Most firms in the industry use this
method
Non-production
overheads, such as administrative overhead, etc. can be absorbed on the basis
of total factory cost while selling and distribution overhead may be absorbed
on the basis of sales revenue.
Exercise3
The
following data relates to the three production departments of Biggs Enterprise:
Production
|
Polishing
|
Packaging
|
|
Budgeted
Overhead ($)
|
400000
|
350000
|
420000
|
Budgeted
D Material Cost ($)
|
150000
|
100000
|
180000
|
Budgeted
D Labour Cost ($)
|
80000
|
70000
|
80000
|
Budgeted
Machine Hours
|
5000
|
6000
|
4000
|
Budgeted
D. Labour Hours
|
2000
|
5000
|
5000
|
Budgeted
Output
|
10000
|
10000
|
10000
|
You
are required to calculate the following;
a. Production
Department:
i.
Direct material cost percentage rate
ii.
Direct Labour hour rate
b. Polishing
Department;
i.
Prime cost percentage
ii.
rate per unit
c. Packaging
Department;
i.
Direct Labour Cost percentage
ii.
machine hour rate
Blanket
Absorption Rate versus Departmental Absorption Rate
Blanket overhead
absorption,
a single absorption rate is calculated for the whole factory or organisation
that is used for absorbing overhead. This method is appropriate where all
products or jobs are identical and consume the same amount of resources.
Departmental overhead
absorption
rate refers to a situation where different overhead absorption rates are used
for different departments. This method is suitable when non-standard products
are produced.
Over Absorption
and Under Absorption of Overhead
Over
absorption occurs when the overhead absorbed is greater than the actual
overhead incurred. Over absorbed overheads represent gains and are therefore
credited to the profit and loss account.
Under
absorption occurs when actual overhead cost incurred is greater than the
overhead absorbed. Under-absorbed overhead represents a loss and is therefore
debited to the profit and loss account.
Exercise 4
BBC
Enterprise uses machine hour rate for overhead absorption. The data below relates to the business
$
|
|
Budgeted
Overhead
|
48,000
|
Actual
Overhead Incurred
|
38,000
|
Budgeted
machine hours
|
1,200
|
Actual machine
hours
|
1,250
|
Determine
a) The
overhead absorption rate for the period
b) The
overhead absorbed
c) Any
under or over absorption of overhead
d) Analysis
of under or over absorbed overhead into expenditure variance and volume
variance
Exercise 5
The
overhead of two production cost centres were
Production
Cost Centres
|
||
X
|
Y
|
|
Budgeted($)
|
161,820
|
97,110
|
Actual ($)
|
163,190
|
96,330
|
Overheads
are absorbed using predetermined rates. Machine hour rate is used in production
cost centre X and direct labour hour rate in production cost centre Y.
Machine
and direct labour activity in each production cost centre are;
X
|
Y
|
|
Machine
hours
|
||
Budgeted
|
8,700
|
1,760
|
Actual
|
8,960
|
1,725
|
Direct
Labour hours
|
||
Budgeted
|
6,220
|
8,300
|
Actual
|
6,276
|
7,870
|
Required:
Calculate
for each production cost centre
a) The
predetermined production overhead absorption rate
b) The
production overhead absorbed
c) The
over or under-absorption of production overhead
d) zany over or under-absorbed overhead in each cost centre into volume variance
and expenditure variance.
