Example

ABC Co. Ltd has four production departments P1, P2, P3 and P4 and three service departments S1, S2 and S3.

S1 –stores

S2 –production control section

S3 –maintenance department

Calculate for each production department an appropriate overhead absorption rate per machine hour.

Calculate the total cost of each department.

The annual overheads are as follows:

120Depreciation -Plant

240Depreciation -Building

100Insurance -Plant

160Insurance -Building

80Rent

600Power

200Supervision

2,000Indirect labour

Total (Rs.’000)Cost

Information

Indirect Labour Costs

Cost centres Actual costs

Rs.’000

P1 300

P2 200

P3 500

P4 100

S1 200

S2 300

S3 400

Information

P1 P2 P3 P4 S1 S2 S3 Total

No. of employee 400 400 500 600 30 20 50 2,000

Floor Area (Sq.M) 3,000 9,000 8,000 8,000 1,000 1,000 2,000 32,000

Power (KWHrs) 7,000 5,000 3,000 2,000 1,500 500 1,000 20,000

Pro.Cntrl Hours 4,000 5,000 5,000 3,000 - - 1,000 18,000

Stores Requisitions 600 300 250 150 - 400 300 2,000

Maint. Dept Hours 6,000 8,000 5,000 6,000 - - - 25,000

Plant Hrs (‘000) 120 80 200 100 - - - 500

Book value of plant

(Rs.’000)

300 200 100 80 120 50 150 1,000

Information

498343289.4357.

6

7825696613500Total

18614.49.6122436120Book valueDepreciation

Plant

157.57.5606067.522.5240Floor areaDepreciation

Building

152128102030100Book valueInsurance

Plant

105540404515160Floor areaInsurance

Building

52.52.5202022.57.580Floor areaRent &

Rates

3015456090150210600KWHrPower

52360504040200No. of

employee

Supervision

4003002001005002003002000ActualInd. Labour

S3S2S1P4P3P2P1Total Basis Item

Allocation of costs to Production and Service Departments

CalculationItem Basis Total P1

Ind. Labour Actual 2000 300.0

Supervision No. of

Employee

200 (200/2,000)*400 = 40.0

Power KWHr 600 (600/20,000)*7000 = 210.0

Rent & rates Floor area 80 (80/32,000)*3000 = 7.5

Insurance -B Floor area 160 (160/32,000)*3000 = 15.0

Insurance-P Book value 100 (100/1,000)*300 = 30.0

Depreciation-B Floor area 240 (240/32,000)*3000 = 22.5

Depreciation-P Book value 120 (120/1,000)*300 = 36.0

Total 3500 661.0

Reallocation of Service Department Overheads to

Production Departments

Item Basis Total P1 P2 P3 P4 S1 S2 S3

Total

costs

3500 661.0 569.0 782.0 357.6 289.4 343.0 498.0

S1-

stores

Store

req

- 86.8 43.4 36.2 21.7 -

289.4

57.9 43.4

S2-Pro

Control

Prodn

control

3500 748.8

89.1

612.4

111.35

818.2

111.35

379.3

66.8

-

-

400.9

-400.9

541.4

22.3

S3-

Maint

Main

Hrs

3500 837.9

135.3

723.75

180.4

929.55

112.7

446.1

135.3

-

-

-

-

563.7

-

563.7

Total 3500 973.2 904.15 1042.25 581.4 - - -

S1-

stores

Store

req

- 87.8 43.4 36.2 21.7 (289.4) 57.9 43.4

• S1 P1 (289.4/2000)*600 = 86.82 ≈ 86.8

P2 (289.4/2000)*300 = 43.41 ≈ 43.4

P3 (289.4/2000)*250 = 36.18 ≈ 36.2

P4 (289.4/2000)*150 = 21.71 ≈ 21.7

S2 (289.4/2000)*400 = 57.88 ≈ 57.9

S3 (289.4/2000)*300 = 43.41 ≈ 43.4

Total 289.4

S2-Pro

Control

Prodn

control

3500 748.8

89.1

612.4

111.35

818.2

111.35

379.3

66.8

-

-

400.9

(400.9)

541.4

22.3

• S2 P1 (400.9/18,000)* 4000= 89.08 ≈ 89.1

P2 (400.9/18,000)* 5000=111.35

P3 (400.9/18,000)* 5000=111.35

P4 (400.9/18,000)* 3000=66.81 ≈ 66.8

S3 (400.9/18,000)* 1000=22.27 ≈ 22.3

S3-

Maint

Plant

Hrs

3500 837.9

135.3

723.75

180.4

929.55

112.7

446.1

135.3

-

-

-

-

563.7

(563.7)

S3 P1 (563.7/25,000)*6000 =135.288 ≈ 135.3

P2(563.7/25,000)*8000 =180.384 ≈ 180.4

P3(563.7/25,000)*5000 =112.74 ≈ 112.7

P4 (563.7/25,000)*6000 =135.288 ≈ 135.3

Total 563.7

Calculation of appropriate departmental

overhead rates

• Based on machine hours

P1 = 973.3/120 = 8.11 per M/C hour

P2 = 904.15/80 = 11.30 per M/C hour

P3 =1042.25/200 = 5.21 per M/C hour

P4 = 581.4/100 = 5.81 per M/C hour

Charging Overhead Rates to Products

Overhead costs in each cost centre should be

absorbed by the products, at an absorption rate

of each product.

Pro.Dep. Job1(hours) Job2(hours) Job3(hours)

P1 3 12 1.5

P2 2.5 0 4

P3 0 5 10

P4 5 0 3

• Then, based on the production hours the

overhead costs chargeable are as follows:

• Job 1 = 3*8.11+2.5*11.3+5*5.81 = 81.63

• Job 2 = 12*8.11+5*5.21 = 123.37

• Job 3 = 1.5*8.11+4*11.3+10*5.21+3*5.81 =

Allocation service department costs

Example

A manufacturing firm has three production departments, P1, P2 and P3, and two service departments, S1and S2. the following costs are shown in the overhead distribution sheet.

production dep. P1 = Rs. 5000

production dep. P2 = Rs. 8000

production dep. P3 = Rs. 6000

service dep. S1 = Rs. 1280

service dep. S2 = Rs. 3000

Total = Rs.23,280

• The costs of the two service departments S1 and S2 are to be re-apportioned to production departments using the following basis.

S1 S2

P1 20% 30%

P2 40% 30%

P3 10% 20%

S1 - 20%

S2 30% -

Total 100% 100%

• There are 3 basic methods of allocating

service department costs.

1. Continuous Allotment

2. Simultaneous Equation method

3. Specified order of Re-Allocation

Continuous Allotment

Costs of service departments are re-allocated to other departments repeatedly until the amount remaining is too insignificant.

s1 s2

P1 20% 30%

P2 40% 30%

P3 10% 20%

S1 - 20%

S2 30% -

Total 100% 100%

Total P1 P2 P3 S1 S2

Cost before

re-allocation

Dept S1

Dept. S2

Total

23280

2380

5000

256

1015

135

61

8

3.6

4

6479

8000

512

1015

271

62

16

3.6

4

9880

6000

128

677

68

40

4

2.4

3

6920

1280

(1280)

677

(677)

40

(40)

2.4

-

3000

384

(3384)

203

(203)

12

(12)

-

Simultaneous equation method

X=total cost of S1 after receiving 20% cost of S2

Y=total cost of S2 after receiving 30% cost of S1

X=1280+0.2Y

Y=3000+0.3X

By solving two equation above,

X=2000 and Y=3600

As above Total P1 P2 P3

Cost before

re-allocation

19000 5000 8000 6000

Dept S1 2000 1400* 400* 800* 200*

Dept S2 3600 2880 1080 1080 720

Total 23280 6480 9880 6920

(2000/100)*70

=1400

(1400/70)*20

=400

(1400/70)*40

=800

(1400/70)*10

=200

Specified order of Re-allocation

• Assume that service dept. costs are first allocated to S1 and then to

S2.

S1 S2

P1 20% 37.5%

P2 40% 37.5%

P3 10% 25.0%

S1 - -

S2 30% -

Total 100% 100%

30*(100/80)

30*(100/80)

20*(100/80)

Total P1 P2 P3 S1 S2

Cost before

re-allocation

23280 5000 8000 6000 1280 3000

Dept S1 256 512 128 (1280) 384

Dept. S2 1269 1269 846 - (3384)

Total 2380 6525 9781 6974 - -

(1280/100)*20

=256

(1280/100)*40

=512

(1280/100)*10

=128

(1280) (1280/100)*30

=384