ACCOUNTING FOR OVERHEADS

5.1            Introduction
Overheads are the expenditure which cannot be conveniently traced to or identified with any
particular cost unit. Such expenses are incurred for output generally and not for a particular work
order. Overheads are also very important cost element along with direct materials and direct
labour. Often in a manufacturing concern, overheads exceed direct wages or direct materials and
at times even both put together. On this account, it would be a grave mistake to ignore overheads
either for the purpose of arriving at the cost of a job or a product or for controlling total
expenditure.
Overheads also represent expenses that have been incurred in providing certain ancillary
facilities or services which facilitate or make possible the carrying out of the production process;
by themselves these services are not of any use. For instance, a boiler house produces steam so
that machines may run and, without the generation of steam, production would be seriously
hampered. But if machines do not run or do not require steam, the boiler house would be useless
and the expenses incurred would be a waste.
Overheads are incurred not only in the factory of production but also on administration, selling
and distribution.

5.2            Meaning and Definition

According to Wheldon, Overhead may be defined as "the cost of indirect material, indirect
labour and such other expenses including services as cannot conveniently be charged to a
specific unit."
Blocker and WeItmer define overhead as follows:
"Overhead costs are operating cost of a business enterprise which cannot be traced directly to a
particular unit of output. Further such costs are invisible or unaccountable."

5.3            Importance of Overhead Cost

Nowadays business is a dynamic organism. Advancement of technological development and
innovation, economic situations and social considerations are the important factors for
modernization of industries at mass production to meet its more demand. The overhead charges
are heavily increased and they represent major portion of total cost. Therefore, it assumes greater
importance for cost control and cost reduction.
5.4            Classification of Overheads
Classification of overheads is the process of grouping of costs based on the features and
objectives of the business organization. The following are the important methods on which the
overheads are classified:
a)      On the basis of Nature
b)      On the basis of Function
c)      On the basis of Variability
d)      On the basis of Normality
e)      On the basis of Control.

5.4.1                On the Basis of Nature

 One of the important classifications is on the basis of nature or elements. Based on nature the
aggregate of all indirect material cost, indirect labour cost and indirect other expenses are known
as overheads. Accordingly, overheads are grouped into (a) Indirect Material Cost (b) Indirect
Labour Cost and (c) Indirect Expenses.

(a) Indirect Material Cost: Indirect materials do not form part of the finished products. Indirect
materials are indirectly or generally used for production which cannot be identified directly. For
example, oil, lubricants, cotton waste, tools for repairs and maintenance etc. are indirect
materials.
(b) Indirect Labour Cost: Indirect labour is for work in general. The importance of the
distribution lies in the fact that whereas direct labour can be identified with and charged to the
job, indirect labour cannot be so charged and has, therefore, to be treated as part of the factory
overheads to be included in the cost of production. Examples are salaries and wages of
supervisors, storekeepers, maintenance labour etc.
(c) Indirect Expenses: Any expenses that are not specifically incurred for or can be readily
charged to or identified with a specific job. These are the expenses incurred in general for more
than one cost centre. Examples of indirect expenses are rent, insurance, lighting, telephone,
stationery expenses ·etc.

5.4.2                On the Basis of Function

The classification overheads on the basis of the various function of the business concern is
known as function wise overheads. Here there are four important functional overheads such as
a)      Production Overhead
b)      Administration Overhead
c)      Selling Overhead
d)      Distribution Overhead

(a) Production Overhead: Production overhead is also termed as manufacturing overhead or

works overhead or factory overhead. It is the aggregate of all indirect expenses which are
incurred for work in operation or factory. These costs are normally incurred during the period
when the production process is carried on. For example, factory rent, factory light, power,
factory employees' salary, oil, lubrication of plant & machinery, etc.

(b) Administrative Overhead: Administrative expenses are incurred in general for management

to discharge its functions of planning organizing, controlling, co-ordination and directing. These
expenses are not specifically incurred and cannot be identified with the specific job. It is also
termed as office cost. For example, office rent, rates, printing, stationery, postage, telegram, legal
expenses etc. are the office and administrative costs.
(c) Selling Overheads: Selling expenses are overheads which are incurred for promoting sales,
securing orders, creating demand and retaining customers. For example, salesmen's salaries,
advertisement, rent and rates of show room, samples, commission etc.
(d) Distribution Overhead: Distribution overhead are incurred for distribution of products or
output from producers to the ultimate consumers. For example, warehouse staff salaries,
expenses of delivery van, storage expenses, packing etc.
 5.4.3                On the Basis of Variability
One of the important classifications is on the basis of variability. According to this, the expenses
can be grouped into (a) Fixed Overhead (b) Variable Overhead and (c) Semi-Variable Overhead.

(a) Fixed Overhead: Fixed cost or overhead incurred remain constant due to change in the
volume output or change in the volume of sales. For example, rent and rates of buildings,
depreciation of plant, salaries of supervisors etc.

(b) Variable Overhead: Variable overhead may be defined as "they tend to increase or decrease
in total amount with changes in the volume of output or volume of sales." Accordingly the
change is in direct proportion to output. Indirect materials, Indirect labour, repair and
maintenance, power, fuel, lubricants etc. are examples of variable overhead costs.

(c) Semi-Variable Overheads: Semi-variable overheads are incurred with a change in the
volume of output or turnover. They neither remain fixed nor do they tend to vary directly with
the output. These costs remain fixed up to a certain volume of output but they will vary at other
part of activity. Semi-variable overheads are mixed cost, i.e., partly fixed and partly variable. For
example, power, repairs and maintenance, depreciation of plant and machinery telephone etc.

5.4.4                On the Basis of Normality

Overheads are classified into normal overheads and abnormal overheads on the basis of
normality features. According to this normal overheads are incurred in achieving the target
output or fixed plan. On the other hand, abnormal overhead costs are not expected to be incurred
at a given level of output in the conditions in which the level of output is normally produced. For
example, abnormal idle time, abnormal wastage etc. Such expenses are transferred to Profit and
Loss Account.

5.4.5                On the Basis of Control

It is one of important classifications of overhead on the basis of control. Based on control it is
grouped into controllable overhead and uncontrollable overhead. Controllable overhead which
can be controlled by the action of a specified number of undertaking. For example, idle time,
wastages etc. can be controlled. Uncontrollable overheads cannot be controlled by the action of
the executive heading the responsibility centre. For example, rent and rates of building cannot be
controlled

5.5            Usefulness of Overhead classification

i)        It ensures effective cost control.
ii)       It helps the management for effective decision making.
iii)     The application of marginal costing is essentially for profit planning, cost control, decision
making etc. are based on the classification of overheads.
iv)     On the basis of classification of fixed and variable cost, flexible budgets are prepared at
different levels of activity.
v)      It facilitates fixing of selling price.
 vi)     Cost classification is useful for break-even analysis. Break-even analysis mainly depends on
overall cost and profit which can be useful for making or buying decision.
vii)   It helps to find out the unit cost of production

5.6            Accounting and Control of Manufacturing Overheads

Generally manufacturing overheads form a substantial portion of the total overheads. It is
important, that such overheads should be properly absorbed over the cost of production. We have
to find out a way by which the overheads can be distributed over the various units of production.
One method of working out the distribution of overheads over the various products could be to
ascertain the amount of actual overheads and distribute them over the products.
This however, creates a problem since the actual amount of overheads can be known only after
the financial accounts are closed. If we wait that long, the cost sheets lose their main advantages
and utility to the management. All the decisions for which cost sheets are prepared are immediate
decisions and cannot be postponed till the actual overheads are known. Therefore, some method
has to be found by which overheads can be included in the cost of the products, as soon as prime
cost, the cost of raw materials, labour and other direct expenses, is ascertained.
5.7            Allocation and Apportionment of Overhead to Cost Centres
The first step of overhead analysis is distribution of overhead to production department and
service department. Before analysing overhead, we should know the concept of Allocation,
Absorption and Apportionment, Re-apportionment:

5.7.1        Cost allocation
The term ‘allocation’ refers to assignment or allotment of an entire item of cost to a particular
cost center or cost unit. It implies relating overheads directly to the various departments. The
estimated amount of various items of manufacturing overheads should be allocated to various
cost centres or departments. For example- if a separate power meter has been installed for a
department, the entire power cost ascertained from the meter is allocated to that department. The
salary of the works manager cannot be directly allocated to any one department since he looks
after the whole factory. It is, therefore, obvious that many overhead items will remain
unallocated after this step.
5.7.2        Cost apportionment
There are some items of estimated overheads (like the salary of
the works manager) which cannot be directly allocated to the various departments and cost
centres. Such un-allocable expenses are to be spread over the various departments or cost
centres on an appropriate basis. This is called apportionment. Thus apportionment implies
“the allotment of proportions of items of cost to cost centres or departments”. After this stage,
all the overhead costs would have been either allocated to or apportioned over the various
departments. Apportionment is done by using some of the suitable basis. Example of the
commonly used basis are shown in the table below

Item Basis of Apportionment

Factory rent Floor space
 Factory lighting Floor space
 Power KWH, power consumption KHW
 Depreciation of plant and machinery Value of plant and machinery
  Insurance of the building Value of building/ floor space
Indirect material Direct material cost
  Indirect wages Direct labour hours or cost
Supervision No of personnel
  Repairs to plant Value of plant
   Canteen expenses No of personnel

5.7.3        Re-apportionment
 Up to the last stage all overheads are allocated and apportioned to
all the departments- both production and service departments. Service departments are those
departments which do not directly take part in the production of goods. Such departments
provide ancillary services. Examples of such departments are boiler house, canteen, stores,
time office, dispensary etc. The overheads of these departments are to be shared by the
production departments since service departments operate primarily for the purpose of
providing services to production departments. The process of assigning service department
overheads to production departments is called reassignment or re-apportionment. At this stage,
all the factory overheads are collected under production departments.
5.7.4        Absorption
After completing the distribution as stated above the overheads charged to
department are to be recovered from the output produced in respective departments. This
process of recovering overheads of a department or any other cost center from its output is
called recovery or absorption. The overhead expenses can be absorbed by estimating the
overhead expenses and then working out an absorption rate. When overheads are estimated,
their absorption is carried out by adopting a pre-determined overhead absorption rate.
As the actual accounting period begins, each unit of production automatically absorbs a
certain amount of factory overheads through pre-determined rates. During the year a certain
amount will be absorbed over the various products. This is known as the total amount of
absorbed overheads.
v Difference between Allocation and Apportionment
The difference between the allocation and apportionment is important to understand because the
purpose of these two methods is the identification of the items of cost to cost units or centers.
However, the main difference between the above methods is given below.
1.      Allocation deals with the whole items of cost, which are identifiable with any one department.
For example, indirect wages of three departments are separately obtained and hence each
department will be charged by the respective amount of wages individually. On the other hand
apportionment deals with the proportions of an item of cost for example; the cost of the benefit
of a service department will be divided between those departments which has availed those
benefits.
2.      Allocation is a direct process of charging expenses to different cost centres
whereas apportionment is an indirect process because there is a need for the identification of
the appropriate portion of an expense to be born by the different departments benefited.
3.      The allocation or apportionment of an expense is not dependent on its nature, but the
relationship between the expense and the cost centre decides that whether it is to be allocated or
apportioned.
4.       Allocation is a much wider term than apportionment
5.8            Methods of Absorbing Overheads to Various Products or Jobs
The method selected for charging overheads to products or jobs should be such as will ensure:
i)        That the total amount charged (or recovered) in a period does not differ materially from the
actual expenses incurred in the period. And
ii)       That the amount charged to individual jobs or products is equitable. In case of
factory overhead, this means:
a)    That the time spent on completion of each job should be taken into consideration;
b)    That a distinction should be made between jobs done by skilled workers and those done by
unskilled workers. and
c)    That jobs done by manual labour and those  done  by  machines  should  be distinguished.
In addition, the methods should be capable of being used conveniently; and yield uniform result
from period to period as far as possible; any change that is apparent should reflect a change in
the underlying situation such as substitution of human labour by machines.
Several methods are commonly employed either individually or jointly for computing
the appropriate overhead rate. The more common of these are:
(1)    Percentage of direct materials,
(2)    Percentage of prime cost,
(3)    Percentage of direct labour cost,
(4)    Labour hour rate,
(5) Machine hour rate  and
(6) Rate per unit of Output

To summarise, the predetermined overhead rate will be computed as follows:

Predetermined overhead rate = Estimated manufacturing overhead
Estimated activity (material cost, labour
cost, labour hours or machine hours)
Overhead application: The process of assigning overhead cost to jobs is called overhead
application.
Example 5.1
You are required to find out (1) Direct Material Cost Rate (2) Direct Labour Cost Rate (3) Direct
Labour Hours and (4) Prime Cost Rate from the following particulars:

Total overhead for the period                            Tshs. 25,000

Total direct labour cost (Direct wages)  Tshs. 8,000
Total materials used or Direct material cost        Tshs. 10,000
Total direct labour hours                                   Tshs. 2,000

5.8.1                Under- and over-applied overhead

Since the predetermined overhead rate is established before a period begins and is based on
estimated data, there will be a difference between the amount of overhead cost applied and the
amount of overhead cost actually incurred during a period.  The difference between the applied
overhead cost and actual overhead cost is termed either underapplied or overapplied
overhead. 
What is the cause of underapplied or overapplied overhead?  Generally, the cause can be either
one of two factors.  Firstly, the cost of inputs may change from what was estimated at the
beginning of the period because of external market forces.  Secondly, the actual level of activity
which is the activity realised during a specific period and known as actual direct labour hours /
machine hours / completed units, may be different from what was estimated at the beginning of
the period.  To summarise, the under- or overapplied overhead can be computed by the following
formula:
Under- or overapplied            =          Actual overhead less overhead applied overhead
An allocation base should be used that acts as cost driver in the incurrence of overhead cost. 
A cost driver is a factor, such as machine hours, computer hours, flight hours, beds occupied
etc. that causes overhead costs.
If a base is used to compute overhead rates that does not “drive” overhead cost, then the result
will be inaccurate overhead rates and inaccurate product costs If there exists no causal
relationship between the product and the cost driver and another “wrong” cost driver is used to
allocate overhead, products will be over- or undercosted.
In the changing manufacturing environment (from manual labour to machine labour) direct
labour is becoming less of a factor and overhead is becoming more of a factor in the cost of
products.  In organisations where direct labour and overhead cost have been moving in opposite
directions, it would be difficult to argue that direct labour “drives” overhead cost.

5.8.2                Accounting entries
In the general ledger the transactions will be recorded as follows:
·               Actual manufacturing overhead incurred:
          Debit Manufacturing Overhead Control
          Credit Accounts payable or Bank depending if the amount has already been paid.
·               Applied manufacturing overhead:
          Debit Work in Process Control
          Credit Manufacturing Overhead Control
The balance on the Manufacturing Overhead Control Account is the under- or overapplied
manufacturing overhead.  Please note that:
          Actual > Applied = Underapplied overhead
          Actual < Applied = Overapplied overhead
Under-applied overhead is a loss and will decrease profits which means an under-applied
overhead will be debited. 
 Vice versa: Over-applied overhead is favourable and will increase profit which means over-
applied overhead will be credited.
Non-manufacturing overhead: This cost should not go into the Manufacturing Overhead
Control Account and should be recorded separately in a Non-manufacturing Overhead Control
account.  The transaction for expenses incurred for sales and administrative activities will be
entered in the general ledger as follows:
Debit Sales and Administrative expenses
Credit Accounts payable or Bank depending if the accounts have been paid.
Example 5.2
The following is the budget of superb engineering works for the year 2013 :
Tshs.
Factory overheads                    62,000
Direct labour cost                     98,000
Direct labour hours                   155,000,
Machine hours              50,000
(a) From the above figures prepare the overhead application rate using the following methods
(i) Direct Labour Hour (ii) Direct Labour Cost (iii) Machine hour
(b) Prepare a comparative statement of cost, showing the result of application of each of the
above rates to Job No. 555 from the undermentioned data.
Direct material cost Tshs. 45
Direct labour: wages Tshs. 40
Direct labour: hours 40
                                                                                                                            Machine hours 30
5.9            Multiple predetermined overhead rate
Until now the discussion was on a single overhead rate for an entire factory which is called
a plant wide overhead rate or blanket overhead rate.  In larger organisations multiple
predetermined overhead rates or departmental overhead rates are often used.  In a multiple
predetermined overhead rate system there is a different overhead rate for each production
department.  This system is more complex but more accurate. Then for departments which are
relatively labour intensive, overhead can be based on direct labour hours.  In departments which
are relatively machine intensive, machine hours can be used as allocation base.
This multiple predetermined overhead rate method of assigning overhead cost is called a level-
two approach as the plant wide overhead rate method is called a level-one approach.
The level-two approach works on a basis of two stages, namely, the first stage of assigning
manufacturing overhead to departments or cost centres and the second stage where the cost of
the departments will be assigned to products

 The manufacturing overhead costs attributable to each production department must therefore be
determined (budgeted). This is referred to as the departmentalization of manufacturing
overheads.
 Treatment of manufacturing overheads where separate departments exist should be dealt with as
follows:
1.      Primary allocation/apportionment, where ALL overhead expenses (eg rent, salaries, insurance
etc) are divided among ALL the departments in the organisation, including the service
departments (ie maintenance, scheduling) and non-production departments (ie administration and
sales, where necessary). Accumulation of a department’s overhead cost either occurs directly (eg
depreciation on plant in department A will only reside in department A’s costs) or by
apportionment (eg total rent paid, common to all departments, will be apportioned amongst the
various departments).

2.      Secondary allocation (reapportioning), where the accumulated overhead costs (from step 1
above) of service departments are allocated to the production and non-production departments
for which they (the service/support department) render services. This is carried out by means of
an allocation rate or service charge. An example: the maintenance department reallocates its total
accumulated manufacturing overheads to the respective production departments (maintenance of
production plant and equipment) and the dispatch department (maintenance of delivery vehicles).
In this way, all production-related overheads are finally accumulated solely in the various
production departments.

3.       A recovery rate (as explained before) is determined for each respective production department
depending on its own overhead and allocated service costs, and using a basis suitable to its
activities. Each production department will therefore have its own recovery rate.

4.       Each departmental overhead rate is then applied to actual activity data for each product type it
processes in order to calculate the total applied manufacturing overheads.

Steps 1 and 2 are referred to as the first-stage allocations. These allocations involve the
allocation of manufacturing related overheads to production departments (also called cost
centres). Steps 3 and 4 are referred to as second stage allocations. These allocations involve
allocating manufacturing overhead costs to products and other cost objects.

5.9.1                Primary allocation of overheads

In the primary allocation stage, every overhead item (eg depreciation, salaries, rent, electricity
etc) are assigned directly/apportioned to the organisation’s production, service (support) and
non-manufacturing departments on appropriate bases. Each of these departments is referred to as
a cost centre, because each department is mainly controlled and managed on the basis of the
costs it incurs.
Production departments are identified based on the type of goods they produce or the activities
they perform.

Examples are production departments for cutting, assembling, drilling and finishing.

In a production environment, a number of service departments provide support functions to the

production departments and, at times, to other service departments as well. A service department
might also render services to non-production departments.
 Examples of service departments are production scheduling, maintenance, quality control,
information technology and HR. Service departments play a vital role in the overall
manufacturing process and provide auxiliary support to production departments and the rest of
the organisation. In highly technical production environments, these departments may contribute
a substantial amount to the total manufacturing overhead costs.

For the primary allocation of overheads (as well as secondary allocation), it is necessary to find a
suitable basis for the apportionment of individual cost items among the various departments. The
basis will be determined by the causal relationship between the cost and the ultimate allocation
activity. The allocation basis used to allocate a particular department’s costs should drive these
costs. For example, the area utilised (m2) by each department would be the most appropriate
basis for the apportionment of the rental cost for a factory building to the various departments.

Example 5.3
Kuntakite Ltd. has a production, service and administration department; the following budgeted
information is available:

Production Service Administration

Number of employees                 53 5 2
Number of copies made (Xerox)           3000 1250 5100
Value of machines and equipment          Tshs.70 000     Tshs.20 000 Tshs.10 000
Floor area (m2)                                    1 150               100 50

The following budgeted overhead costs are applicable: Tshs

Buildings insurance                                23 600
Machinery insurance                             12 400
Cafeteria                                              11 400
Maintenance of copy machines 16 000
Protective overalls                                  3 600
Indirect material:
Production                                            14 000
Service                                                   2 400
Administration                              1 500

5.9.2                Re-apportioning service department overheads over production department

The re-apportionment of the service department cost to the production department is known as
secondary distribution. The re-apportionment of service department expenses over the
production departments may be carried out by using any one of the following methods:
(i)    Direct re-distribution method.
(ii)   Step method of secondary distribution or non-reciprocal method.
(iii)   Reciprocal Service method.

(i) Direct re-distribution method

Service department costs under this method are apportioned over the production departments
only, ignoring the services rendered by one service department to the other. To understand the
applications of this method go through the illustration which follows.

Illustration 1: (Re-apportionment of costs under Direct re-distribution method)

XL Ltd., has three production departments and four service departments. The expenses for these
departments as per Primary Distribution Summary are as follows:
Production Department:                                                  Tshs                 Tshs
A                                                                                            30,000
B                                                                                            26,000
C                                                                                            24,000              80,000
Service Departments:                                                    Tshs                      Tshs
Stores                                                                                  4,000
Time-keeping and Accounts                                         3,000
Power                                                                                  1,600
Canteen                                                                              1,000                9,600
The following information is also available in respect of the production departments:
Dept. A         Dept. B Dept. C
Horse power of Machine 300 300 200
Number of workers 20 15 15
Value of stores requisition in 2500 1500 1000

Apportion the costs of service departments over the production departments.

Solution
Secondary Overhead Distribution Statement
Item of cost                             Basis of                    Total                 Production Depts
(as per primary                    apportionment
distribution                                                                                     A                     
B                                 C
summary)                                                                   Tshs         Tshs               Tshs                
   Tshs
Cost as per primary                                      80,000       30,000               26,000                   24,000
distribution  summary
Stores                               Value of
(5:3:2)                               Store requisition    4,000         
2,000                  1,200                        800
Time-keeping                No. of
and Accounts                 workers
(4:3:3)                                                                3,000          1,200                900                         900
Power                               H.P. of
(3:3:2)                              Machine                 1,600             600                     600                      400
Canteen                           No. of
(4:3:3)                              workers                   1,000             400                     300                     300
89,600       34,200               29,000                   26,400

(ii)     Step Method or Non-reciprocal method:

This method gives cognizance to the services rendered by service department to another service
department. Therefore, as compared to previous method, this method is more complicated
because a sequence of apportionments has to be selected here. The sequence here begins with the
department that renders service to the maximum number of other service departments. In other
words the cost of the service department which serves the largest number of other service and
production departments is distributed first. After this, the cost of
service department serving the next largest number of departments is apportioned.
This process continues till the cost of last service department is apportioned. The cost of
last service department is apportioned among production departments only.
Some authors are of the view that the cost of service department with largest amount of
cost should be distributed first. Refer to the illustration which follows to understand this method.

Illustration 2: (Re-apportionment of costs under non-reciprocal method)

Suppose the expenses of two production departments A and B and two service departments X
and Y are as under:
Amount                                        Tshs                                Apportionment Basis
Y                           A                                 B
X                                                  2,000                              25%                     
40%                                                 35%
Y                                                 1,500                                   —                    
40%                                                 60%
A                                                  3,000
B                                                 3,200
Solution
Summary of Overhead Distribution
Departments                                            X                             Y                           
A                              B
Tshs                  Tshs                  Tshs                  Tshs
Amount as given above                            2,000                      1,500                     
3,000                      3,200
Expenses of X Dept.
apportioned over Y, A and
B Dept. in the ratio (5:8:7)                    —2,000                         500                        
800                         700
Expenses of Y Dept.
apportioned over A and
B Dept. in the ratio (2:3)                                    -                  —2,000                        
800                      1,200
Total                                                                 Nil                             
Nil                            4,600                      5,100
(iii)   Reciprocal Service Method: This method recognises the fact that where there are two or
more service departments they may render services to each other and, therefore, these inter-
departmental services are to be given due weight while re-distributing the expenses of the service
departments.
The methods available for dealing with reciprocal services are:
(a)   Simultaneous equation method;
(b)   Repeated distribution method;
(c)   Trial and error method.   
(a)    Simultaneous equation method: According to this method firstly, the costs of
service departments are ascertained. These costs are then re-distributed to production
departments on the basis of given percentages. (Refer to the following illustration to understand
the method)
Illustration 3: (Re-apportionment of costs under Simultaneous equation method)
Service departments’ expenses
Tshs
Boiler House                                                                                                         
3,000
Pump Room                                                                                                              
600
3,600

The allocation is :
Production Departments                       Boiler House          Pump
Room
A                          B
Boiler House                                     60%                     
35%                                                           -                              5%
Pump Room                                       10%                     
40%                                                    50%                                 -
Solution
The total expenses of the two service departments will be determined as follows:
Let B stand for Boiler House expenses and P for Pump Room expenses.
Then
B= 3,000 + 1/2 P
P = 600 + 1/20 B
Substituting the value of B,
P= 600 + 1/20 (3,000 + 1/2 P) = 600 + 150 + 1/40 P
= 750 + 1/40 P
40 P= 30,000 + P
39 P= 30,000
P= Tshs. 769 (approx.)
The total of expenses of the Pump Room are ` 769 and that of the Boiler House
is Tshs 3,385 i.e., Tshs 3,000 + 1/2 × Tshs 769.
The expenses will be allocated to the production departments as under:
Production departments:                                                                           
A                                     B
Tshs                Tshs
Boiler House (60% and 35% of Tshs 3,385)                        2,031                      1,185
Pump Room (10% and 40% of Tshs 769)                                 77                         307
Total                                                                                               2,108                      1,492
The total of expenses apportioned to A and B is Tshs 3,600.

(b)    Repeated  distribution  method:  Under  this  method,  service  departments’  costs 
are distributed to other service and production departments on agreed percentages and
this process continues to be repeated, till the figures of service departments are either
exhausted or reduced to too small a figure. (Refer to the following illustration to understand this
method)

Illustration 4: (Re-apportionment of costs under Repeated distribution method)

PH Ltd., is a manufacturing company having three production departments, ‘A’, ‘B’ and ‘C’ and
two service departments ‘X’ and ‘Y’. The following is the budget for December 2011:
Total                        A                       B               
C                           X                       Y
Tshs          Tshs          Tshs     Tshs          Tshs        Tshs
Direct material                                                          1,000                2,000       
4,000                 2,000              1,000
Direct wages                                                              5,000               2,000        
8,000                 1,000              2,000
Factory rent                                      4,000
Power                                                  2,500
Depreciation                                   1,000
Other overheads                           9,000
Additional information:
Area (Sq. ft.) Capital value                                       500                  250           
500                       250                 500
(x100,000) of assets                                                 20                     40             
20                         10                    10
Machine hours                                                          1,000                2,000       
4,000                 1,000              1,000
Horse power of machines                                          50                     40             
20                         15                    25
A technical assessment of the apportionment of expenses of service departments is as under:
A                                B                               
C                           X                         Y
Service Dept. ‘X’ (%)                           45                             15                             
30                            -                       10
Service Dept. ‘Y’ (%)                          60                             35                                 
-                              5                          -
Required:
(i)      A statement showing distribution of overheads to various departments.
(ii)     A statement showing re-distribution of service departments expenses to
production   departments.
(iii)    Machine hour rates of the production departments ‘A’, ‘B’ and ‘C’.
Solution
(i)      Overhead Distribution Summary
Basis             Total                    A              B                  
C                    X                  Y
Tshs         Tshs      Tshs         Tshs       Tshs   Tshs
Direct materials              Direct                     -                   -               -                   -        
2,000        1,000
Direct wages                   Direct                     -                   -               -                   -        
1,000        2,000
Factory rent                        Area           4,000          1,000         500          1,000          
500        1,000
Power                   H.P. × M/c Hrs.        2,500             500         800             800          
150           250
Depreciation       Cap. value               1,000             200         400             200          
100           100
Other overheads         M/c hrs.             9,000          1,000      2,000          4,000       
1,000        1,000
16,500          2,700      3,700          6,000        4,750        5,350

(ii)     Redistribution of Service Department’s expenses:

A                       B                  C                    
X                         Y
Tshs            Tshs         Tshs          Tshs    Tshs
Total overheads                                      2,700              3,700          6,000            4,750           
5,350
Dept. X overhead apportioned
in the ratio (45:15:30:—:10)                   2,138                 712          1,425         -4,750               
475
Dept. Y overhead apportioned
in the ratio (60: 35:—:5 :—)                    3,495              2,039                 −           291         -5,825
Dept. X overhead apportioned
in the ratio (45:15:30:—:10)                      131                   44               87             -291                 
29
Dept. Y overhead apportioned
in the ratio (60:35:—:5:—)                           17                   10                 −               2               -29
Dept. X overhead apportioned
in the ratio (45:15:30:—:10)                           1                     −             1                 -2                    −
8,482              6,505          7,513                   −              −
(iii)  Machine hour rate:
Machine hours                                        1,000                                 
2,000                                  4,000
Machine hour rate (`)                               8.48                                   
3.25                                    1.88
(` 8,482/ 1,000 hrs)        (` 6,505/ 2,000 hrs.)        (` 7,513/ 4,000 hrs.)

(c)    Trial and error method: According to this method the cost of one service Cost Centre is
apportioned to another service Cost Centre. The cost of another service centre plus the share
received from the first Cost Centre is again apportioned to the first cost centre. This process
is repeated till the amount to be apportioned becomes negligible. (Refer to the
following illustration to understand this method.)
Illustration 5: (Re-apportionment of costs under Trial and error method)
The ABC Company has the following account balances and distribution of direct charges
on  31st March, 2011.
Total                    Production Depts.                               Service
Depts.
Machine              Packing                  Gen.                      
Store &
Shop                                                  Plant          
Maintenance
Allocated Overheads:                    
Tshs            Tshs               Tshs               Tshs                  Tshs
Indirect labour                              14,650               4,000                    3,000                    
2,000                          5,650
Maintenance material                5,020               1,800                       700                   
1,020                          1,500
Misc. supplies                                 1,750                   400                  
1,000                         150                              200
Superintendent’s salary             4,000                        -                            
-                         4,000                                   -
Cost & payroll salary                 10,000                        -                             -                  
10,000                                    -
Overheads to be apportioned :
Power                                                  8,000
Rent                                                    12,000
Fuel and heat                                 6,000
Insurance                                            1,000
Taxes                                                   2,000
Depreciation                            1,00,000
1,64,420               6,200                    4,700               
17,170                          7,350
The following data were compiled by means of the factory survey made in the previous year:
Floor                              Radiator                No. of        
Investment                               H.P
 Space                             Sections 
Employees                                   `                 hours
Machine Shop             2,000  Sq. ft.                           45                       20             
640,000                          3,500
Packing                               800    ” ”                                 90                      
10                  200,000                              500
General Plant                   400    ” ”                                 30                         
3                    10,000                                  -
Store & Maint.              1,600     ” ”                                 60                          
5                  150,000                          1,000
4,800     ” ”                             225                        38         
1,000,000                          5,000

Expenses charged to the stores and maintenance departments are to be distributed to the other
departments by the following percentages: Machine shop 50%; Packing 20%; General Plant
30%; General Plant overheads is distributed on the basis of number of employees:
(a)    Prepare  an  overhead  distribution  statement  with  supporting  schedules  to  show
              computations and basis of distribution including distribution of the service department
              expenses to producing department.
(b)    Determine the service department distribution by the method of continued distribution.
Carry through 3 cycles. Show all calculations to the nearest Shilling

                                        Solution

(a)   Overhead Distribution Statement
Production Departments                   Service Departments
Machine                   Packing              General                     
Stores &
Allocated Expenses:                           Shop                                                       
Plant               Maintenance
Indirect labour                                  4,000                      3,000                  2,000                         
5,650
Maintenance material                    1,800                         700                  1,020                         
1,500
Superintendent’s salary                         −                      −             4,000                                 −
Misc. supplies                                     400                      1,000                     150                            
200
Cost & payroll salaries                           −                      −           10,000                                 −
Total                                                  6,200                      4,700               17,170                         
7,350
Apportioned expenses
(See schedule below)                  77,720                   25,800                  2,830                       22,650
Total                                                83,920                   30,500               20,000                      
30,000
Schedule of Apportioned Expenses
Item                            Basis                         Machine                     Packing       
General                   Stores &
Shop                                                   Plant       
Maintenance
(`)                      (`)             (`)                     (`)
Power                   Horse Power Hrs.      5,600                           800                    -                      
1,600
Rent                      Floor Space               5,000                        2,000            1,000                     
4,000
Fuel & Heat         Radiator Secs.           1,200                        2,400               800                     
1,600
Insurance            Investment                     640                           200                 10                        
150
Taxes                   Investment                  1,280                           400                 20                        
300
Depreciation       Investment                64,000                     20,000            1,000                   15,000
Total                                                       77,720                     25,800            2,830                  
22,650
(b)      Distribution of Service Department Expenses
Production Departments                       Service Departments
Machine                  Packing                   General                  
Stores &
Plant                                                    
Maintenance
(`)                     (`)                     (`)                     (`)
Total Expense [as per (a)]           83,920                   30,500                   20,000                  
30,000
Transfer from Stores &
Maintenance                                 15,000                      6,000                      9,000                
-30,000
Transfer from General Plant      16,571                      8,286                 -29,000                      
4,143
Transfer from Stores &
Maintenance                                    2,072                         829                      1,242                  
-4,143
Transfer from General Plant            710                         355                   -1,242                         
177
Transfer from Stores &
Maintenance                                         88                           36                          
53                       -177
Transfer from General Plant              35                           18                        
-53                             —
Total                                            1,18,396                    46,024                           
—                            —