Question 3.6: You can use the following short example to practise the tech...

The first step is to prepare an overhead analysis sheet which shows the apportionment of the overheads, using the most appropriate basis for each.

Notes
1. The rent and rates cost is apportioned as follows. Total area occupied is 18,564 square  metres. Therefore, rent and rates cost £4,641/18,564 = £0.25 per square metre.
All of the other apportionments are calculated in the same way.

2. Since the canteen serves all other departments, its costs must be apportioned first, over the 970 employees in the other departments

3. Once the stores have received a charge from the canteen, the total stores costs can be apportioned to the production departments.

Looking at the data for machine hours and direct labour hours in each of the departments, it appears that the most appropriate absorption base for department A is machine hours and for department B is direct labour hours. The absorption rates can now be calculated.

Production department A = £71,327/27,200 = £2.62 per machine hour

Production department B = £50,756/18,000 = £2.82 per direct labour hour

We can now extend the example a little further to practise using the calculated absorption rates. What is the total production cost of the following job ?

                                                                                   Job 847
Direct material cost                                                 £487
Direct labour cost                                                    £317
Machine hours in department A                           195
Direct labour hours in department B                   102

The overhead absorption rates can be applied as follows:

                                                                               Job 847
                                                                                      £
Direct material cost *                                          487.00
Direct labour cost *                                              317.00
Prime cost                                                              804.00
Production overhead:
Department A 195 hours ×£2.62                         510.90
Department B 102 hours × £2.82                        287.64
Total production cost                                           1602.54

Remember that direct costs are not affected by the overhead absorption rate selected.

See if you can calculate the under- or over-absorbed overhead in each of the departments using the following data. The actual overhead incurred would have been determined by the allocation and apportionment of the actual overhead costs.

                                                                      Department A         Department B
Actual results
Overhead incurred                                         £70,483                     £52,874
Direct labour hours                                       6,740                           18,300
Machine hours                                                27,900                         850

The first step is to calculate how much overhead would have been absorbed, based on the actual hours and the predetermined overhead absorption rate for each department. This total can then be compared with the actual overhead incurred

                                                                     Department A          Department B
                                                                               £                                  £
Overhead absorbed
27,900 × £2.62                                                73,098
18,300 × £2.82                                                                                    51,606
Overhead incurred                                         70,483                        52,874
(Under-)/over-absorption                             2,615                          (1,268)