Virtual Kollage: Primary and secondary apportionment of overheads

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Primary and secondary apportionment of overheads



PRIMARY AND SECONDARY APPORTIONMENT OF OVERHEAD
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.
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