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Apportion and Re Apportion

Absorption costing aims to allocate an appropriate share of total overhead costs to products, which is essential for inventory valuation, pricing decisions, and assessing product profitability. The process involves three stages: allocation, apportionment, and absorption, where costs are assigned to cost centers and then distributed among products based on various factors. Over/under absorption of overheads is calculated using budgeted figures, and adjustments are made to the profit and loss account based on the difference between absorbed and actual overheads.

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23 views10 pages

Apportion and Re Apportion

Absorption costing aims to allocate an appropriate share of total overhead costs to products, which is essential for inventory valuation, pricing decisions, and assessing product profitability. The process involves three stages: allocation, apportionment, and absorption, where costs are assigned to cost centers and then distributed among products based on various factors. Over/under absorption of overheads is calculated using budgeted figures, and adjustments are made to the profit and loss account based on the difference between absorbed and actual overheads.

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mirzatahrema
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Absorption costing

• The objective of absorption costing is to include in the total cost of a product an


appropriate share of the organization's total overhead. An appropriate share is generally
taken to mean an amount which reflects the amount of time and effort that has gone
into producing a unit or completing a job.

• The main reasons for using absorption costing are for inventory valuations, pricing
decisions, and establishing the profitability of different products.

• Absorption costing is recommended in financial accounting by IAS 2 Inventories. IAS 2


deals with financial accounting systems

Absorption costing stages


• The three stages of absorption costing are:

� Allocation

� Absorption

� Apportionments

1. OVERHEAD ALLOCATION
• Some costs can be easily identified with a unit or units of production such as
labour and material costs. These are said to be ‘allocated to the product’.
Often they are allocated to the cost centre or department before being
shared among the units of production. Overheads can also be allocated to a
cost centre if they are specifically identifiable with that cost centre, such as
the salary of the cost centre supervisor.

• Allocation is the process by which whole cost items are charged direct to a
cost unit or cost centre.

• Consider the following costs of a company.


• Wages of the foreman of department A $200

• Wages of the foreman of department B $150

• Indirect materials consumed in department A $50

• Rent of the premises shared by departments A and B $300

• The cost accounting system might include three overhead cost centers.

• Cost centre: 101 Department A

• 102 Department B

• 201 Rent

• Overhead costs would be allocated directly to each cost centre, ie $200 + $50
to cost centre 101, $150 to cost centre 102 and $300 to cost centre 201. The
rent of the factory will be subsequently shared between the two production
departments, but for the purpose of day to day cost recording, the rent will
first of all be charged in full to a separate cost centre.

2. OVERHEAD APPORTIONMENT
Apportionment is a procedure whereby indirect costs are spread fairly
between cost centres. Service cost centre costs may be re-apportioned to
production cost centres by using the reciprocal method

Some costs relate to the business as a whole. These costs then have to be
shared between the various departments or cost centers. This is done by
‘apportioning the costs’.

The division of costs amongst two or more cost centers is in proportion to the
estimated benefit received, by using a proxy. E.g., area, headcount, capital
value etc.
These overheads then have to be included into the cost of the products which
are produced in that department. It would be easy to just divide the cost by
the number of units made. This would be fine if only one product was made or
if all products took exactly the same time to be made. As this is not the case
we have to find a way of sharing the overhead costs between the products.

SECONDARY or RE-APPORTIONMENT
Not all departments are production based. Some act as a service to the
production departments. E.g., canteen, stores, maintenance. The costs of
these have to be included into the total overheads of the production
departments. Secondary apportionment is a means of apportioning
overheads from service cost centres to production cost centres by means of
relevant usage factors.
• A canteen – on basis of number of employees.
• A stores – on the number of stores issues.
Sometimes both service cost centres provide services to each other
(reciprocal servicing). This has to be taken into account before the final
apportionments are made.

3. OVERHEAD ABSORPTION
Overhead absorption is the process whereby overhead costs
allocated and apportioned to production cost centres are added to
unit, job or batch costs. Overhead absorption is sometimes called
overhead recovery.
An absorption rate can be thought of as a charge out rate for
overheads. Absorption rates can be calculated in a number of ways
but the most common ways for exam questions are:
• A rate per unit.
• A rate per labour hour.
• A rate per machine hour.
It is worth remembering that absorption rates are always
calculated using BUDGETED figures. Rates have to be available at
the start of a period so it is possible to cost output as the period
progresses. Actual figures are only available at the end of a period.
Absorption rates are calculated as:
• OAR = Budgeted overheads / budgeted activity
A single absorption rate can be calculated for a company as a
whole, known as a blanket rate. Equally, separate absorption rates
can be calculated for individual departments, known as
departmental rates.

OVER/UNDER ABSORPTION OF OVERHEADS


Calculation of the overhead absorption rate (OAR) is done by using
budgeted figures. We cannot use actual figures because we do not
know these until after the event. This means that for every item
we make we absorb a certain amount of overheads into the unit.
The total amount absorbed will depend upon the number of units
made.
It is highly unlikely that the budgeted production will agree exactly
with the actual or that the budgeted overhead will agree with the
actual spend. Because of this we need to calculate how much
overhead has been absorbed into our production, compare this
with the actual amount and make an adjustment to our P&L
account.
If we have absorbed too much (over absorption) we will have to
add back the difference into our P&L. This will increase the
reported profit.
If we have not absorbed enough (under absorption) we will have
to take more out of our P&L. This will decrease the reported profit.
9000 6000 3000 18,000

7500 3750 1250 12,500


Working – Apportion
1. Rent = 18,000 basis- Area
Prodn Dept 1 4500 18,000 x 4500/9000 = 9000
Prodn Dept 2 3000 18000 x 3000 /9000 = 6000
Service dept 1500 18000 x 1500 / 9000 = 3000
9000 18000

2. Heating & lighting 12500 basis – electricity used


Prodn Dept 1 60,000 12,500 x 60,000/100,000 = 7500
Prodn Dept 2 30,000 12,500 x 30,000/100,000 = 3750
Service dept 10,000 12,500 x 10,000/100,000 = 1250
100,000 12500

3. Service dep re apportion- 5550 basis – electricity used


Prodn Dept 1 60,000 5,550 x 60,000/90,000 = 3700
Prodn Dept 2 30,000 5,550 x 30,000/90,000 = 1850
90,000 5550

Depreciation - 11200, Basis - NCA

Prodution dEpt 1 75000 11200 x 75000 / 120000 = 7000


Production Dept 2 45000 11200 x 45000 / 120000 = 4200
120000 11200
OAR = Budgeted overheads
Budgeted labour/machine hours

Dept 1 = 31700 / 4000 = $ 7.93 per labour hour

Dept 2 = 18300 / 2000 = $9.15 per machine hour

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