Production overhead absorption rates

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Allocation and Apportionment

Cost Card
Direct Materials These specifically go into making the product
Direct Labour
Direct Expenses
Prime cost The total of Direct costs
Production Overheads (e.g. Factory Electricity and Rent) These must be allocated, apportioned and absorbed
Total Production Cost

Absorption Costing

Basically absorbs the fixed production overheads into the product cost

Absorption costing involves 3 stages:

  1. Allocation and Apportionment of overheads

  2. Reapportionment of service (non-production) cost centre overheads to production cost centres

  3. Absorption of Overheads (after allocation and apportionment)

Stage 1: Allocation and apportionment of overheads

Allocation means charging overheads directly to specific departments

Eg. Supervisor salary of the packaging department will be entirely allocated to the packaging department

Apportionment
If the overheads relate to more than one department, then they must be apportioned / shared between these departments using a fair basis. 

Eg. Factory rent apportioned between all departments that use the factory (using a suitable basis of apportionment)

Possible bases of apportionment include:

  1. Floor Area

    for overheads such as  rent, rates, heat and light overheads

  2. Cost or NBV of non-current assets

    for overheads such as depreciation and insurance

  3. Number of Employees

    for overheads such as canteen costs; personnel office, welfare, wages, first aid

Illustration

Which basis should factory rent be apportioned on?

a) Area
b) Number of employees

Solution

Area

  • Let us go further and try this with numbers

    Rental cost $600

    There are 2 factories in the department:

    Factory 1 occupies 100m² of space
    Factory 2 occupies 200m² of space

    How much of the rental cost should be apportioned to Factory 1 and Factory 2?

    Solution

    Factory 1 = $600 x 100²/300² = $200
    Factory 2 $600 x 200²/300² = $400

Illustration - Apportionment and Allocation

General overhead
$
Rent 100,000
Machinery Insurance 40,000
Stores wages 20,000
Heating costs 60,000
Total 220,000
Mixing Department Storing Department Stores Department Canteen Total
Floor Space 10,000 3,000 1,000 6,000 20,000
Machinery NBV 2,000 1,000 600 400 4,000
Rent apportionment =10,000/20,000 x 100,000 = 50,000 15,000 5,000 30,000 100,000
Machine insurance apportionment =2,000/4,000 x 40,000 = 20,000 10,000 6,000 4,000 40,000
Stores wages - allocation 60,000 20,000
Heating cost apportionment =10,000/20,000 x 60,000 = 30,000 9,000 3,000 18,000 60,000
Total for each department 100,000 34,000 34,000 52,000

Stage 2: Reapportionment of service cost centre overheads to production cost centres

  • Since service cost centres/departments are not directly involved in making the products, the fixed production overheads of these service cost centres must be shared out between the production departments. 

    Examples of service cost centres include:  stores, canteen, maintenance and payroll departments.

Illustration

A factory consists of 2 production centres ( A and B ) and one service centre ( C )

The overheads of each centre are:

A $71,000
B $69,000
C $42,000

The overheads of the service centre are re-apportioned to the production centres on the basis of number of employees.

Number of employees:

A - 40
B -  32
C - 17

What is the total overhead for production centre A?

Solution

40/(40+32) x $42,000+$71,000= $94,333

Note that when apportioning the overheads on the basis of employees, we did not add the service centre employees, this is because we want all of the overheads apportioned between the production centres.

Now that all of the overheads are correctly allocated and apportioned into the production departments, they can be absorbed into the cost of a product being produced.

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