Overheads: classification, apportionment, service department distribution, absorption and machine hour rate
Cost and Management Accounting · Foundations · Topic 6 of 18 · 4 min read
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1. Meaning and classification
Overheads are the aggregate of indirect material, indirect labour and indirect expenses: costs that cannot be traced to a cost unit and must be shared out. They are classified:
- By function: factory (production), office and administration, selling, and distribution overheads.
- By element: indirect material, indirect labour, indirect expenses.
- By behaviour: fixed, variable and semi-variable.
- By control: controllable and uncontrollable.
- By normality: normal (absorbed into cost) and abnormal (to costing profit and loss).
2. Allocation, apportionment and bases
Allocation charges a whole item to one cost centre (the wages of a department’s foreman). Apportionment shares a common item between centres on a fair base. This first sharing among all departments is the primary distribution.
| Overhead | Usual base |
|---|---|
| Rent, rates, building insurance, lighting of building | Floor area |
| Lighting | Number of light points |
| Power | Horse power × machine hours, or HP |
| Depreciation and insurance of machinery | Value of machinery |
| Indirect wages, canteen, welfare | Direct wages or number of workers |
| Supervision | Direct labour hours or number of workers |
3. Secondary distribution: service departments
Service departments (stores, maintenance, power house) do not make products, so their totals are re-apportioned to production departments. Methods: direct redistribution (ignore services rendered between service departments), step method, repeated distribution (keep re-apportioning until the figures are negligible), and simultaneous equations.
Solved (January 2026, B.Com). Primary totals: A 13,600, B 14,700, C 12,800, service X 9,000, service Y 3,000. X serves A 40%, B 30%, C 20%, Y 10%; Y serves A 30%, B 30%, C 20%, X 20%.
(a) Direct redistribution. X’s 9,000 in 40 : 30 : 20 = 4,000, 3,000, 2,000. Y’s 3,000 in 30 : 30 : 20 = 1,125, 1,125, 750. Totals: A 18,725, B 18,825, C 15,550 (sum 53,100).
(b) Repeated distribution.
| Step | A | B | C | X | Y |
|---|---|---|---|---|---|
| Primary | 13,600 | 14,700 | 12,800 | 9,000 | 3,000 |
| X | 3,600 | 2,700 | 1,800 | (9,000) | 900 |
| Y | 1,170 | 1,170 | 780 | 780 | (3,900) |
| X | 312 | 234 | 156 | (780) | 78 |
| Y | 23.40 | 23.40 | 15.60 | 15.60 | (78) |
| X | 6.24 | 4.68 | 3.12 | (15.60) | 1.56 |
| Y | 0.47 | 0.47 | 0.31 | 0.31 | (1.56) |
| X (4:3:2) | 0.14 | 0.10 | 0.07 | (0.31) | |
| Total | 18,712.25 | 18,832.65 | 15,555.10 | – | – |
(c) Check by simultaneous equations. X = 9,000 + 0.2Y; Y = 3,000 + 0.1X. So X = 9,000 + 600 + 0.02X, X = 9,600 / 0.98 = 9,795.92 and Y = 3,979.59. A = 13,600 + 0.4(9,795.92) + 0.3(3,979.59) = 18,712.24; B = 18,832.65; C = 15,555.10. The one-paisa difference in A is rounding. For the 100-mark problem, first do the primary distribution with the bases in the table above, then use these equations.
4. Absorption and under- or over-absorption
Absorption charges production-department overheads to units by a predetermined rate = budgeted overheads / budgeted base. Methods: percentage of direct material, of direct wages, or of prime cost; direct labour hour rate; machine hour rate; rate per unit of output. Labour hour and machine hour rates are the most accurate because overheads mostly accrue with time.
Actual overheads rarely equal absorbed overheads. Under-absorption (absorbed less than actual) arises from output or hours below budget, idle capacity, rise in overhead prices, breakdowns, or a wrong estimate. Treatment: small differences by a supplementary rate on cost of sales and stocks, or carried forward; large abnormal ones written off to costing profit and loss.
5. Machine hour rate
The cost of running one machine for one hour: standing charges (rent, lighting, insurance, supervision) apportioned to the machine and divided by its working hours, plus machine expenses (depreciation, repairs, power) per hour.
Solved (January 2025, B.Com). Machine 1,00,000 + installation 10,000, scrap 5,000 after 15 years; shop rent 200 and lighting 300 a month, machine occupies one-fourth; insurance 960 and repairs 1,000 a year; power 10 units an hour at Rs. 20 per 100 units; supervisor 600 a month, one-third of his time; 1,000 hours a year.
| Item | Per year Rs. | Per hour Rs. |
|---|---|---|
| Rent (200 × 12 × ¼) | 600 | 0.60 |
| Lighting (300 × 12 × ¼) | 900 | 0.90 |
| Insurance | 960 | 0.96 |
| Supervisor (600 × 12 × ⅓) | 2,400 | 2.40 |
| Standing charges | 4,860 | 4.86 |
| Depreciation ((1,10,000 − 5,000) / 15) | 7,000 | 7.00 |
| Repairs | 1,000 | 1.00 |
| Power (10 × 20/100) | 2.00 | |
| Machine hour rate | 14.86 |
The January 2026 machine (1,00,000 including freight, 10-year life, 2,000 hours a year) gives depreciation 5.00, repairs 2.50, power 1.00, oil 0.25, stores 1.25 and operator 0.50: a rate of Rs. 10.50 an hour. Operator’s wages may be kept out if the paper treats them as direct labour; say which way you go.
How this is examined
The 10-mark slot alternates between the classification essay and the distribution problem; the 6-mark slot between machine hour rate and the absorption note. In distribution problems show the percentages, a ruled table and a total that agrees with the primary total (53,100 here).
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