UNIT 5
Manufacturing Overheads
Learning Outcomes
2
At the end of this unit, you should be
able to:
Define overhead cost and distinguish
between manufacturing and non-
manufacturing overhead cost.
Allocate overheads using appropriate basis.
Compute predetermined overhead rates and
explain why estimated overhead cost (rather
than actual overhead cost) is used in the
costing process
Learning Outcomes
3
Compute applied overhead as well as the
under or over-applied overhead cost
Close the balance of under or over-applied
overhead cost into the appropriate accounts
Prepare journal entries of all transactions
regarding overhead cost
Explain why multiple overhead rates are
needed in many organisations
Introduction
4
Direct material and direct labour can be traced
easily and conveniently to a product
Other costs that can not be directly traced are
indirect and thus overhead
Overhead classified as manufacturing or non-
manufacturing
Manufacturing Overhead
5
Manufacturing overhead included in the
calculation of the cost of production
Difficult to allocate manufacturing overhead to
production units
Thus an allocation process is used
Apportionment of Overhead
6
Apportionment of overhead is distribution of
overheads to more than one cost centre on some
equitable basis.
When the indirect costs are common to different
cost centres, these are to be apportioned to the
cost centres on an equitable basis.
For example, the expenditure on general repair
and maintenance pertaining to a department can
be allocated to that department but has to be
apportioned to various machines (Cost Centres) in
the department.
If the department is involved in the production of a
single product, the whole repair & maintenance of
the department may be allocated to the product.
Bases of Apportionment
7
Basis of Apportionment-Service Cost Centres
8
Primary and Secondary Distribution of Overheads
9
In case of multi-product environment, there are
common service cost centres which are providing
services to the various production cost centres and
other service cost centres.
The costs of services are required to be
apportioned to the relevant cost centres.
First step to be followed is to apportion the
overheads to different cost centres and then
second step is to apportion the costs of service cost
centres to production cost centres on an equitable
basis.
The first step is termed as primary distribution and
the second step is termed as secondary distribution
of overheads.
Allocation of Overhead
10
Use an allocation base – measure of activity
Allocation base is a cost driver – there has to be a
relationship between the allocation base and the
manufacturing overhead
For example, the following cost will be charged to the
following cost centres via the process of allocation:
Direct labour will be charged to the production cost
centre
The cost of warehouse security will be charged to the
warehouse cost centre
Costs such as canteen are charged direct to the
various overhead cost centres.
Budgeted Manufacturing Overheads
11
Estimated amount of what future manufacturing
overheads should be, based on the normal activity
(expected capacity under normal conditions);
Calculated to ensure that they are as close as
possible to the actual overheads;
Serve as a guideline for expenditure without
concealing wastage or spillage; and
Used to determine the absorption rate for costing
purposes and for pricing decisions.
Applied Manufacturing Overheads
12
Overheads allocated to the production process or
products according to the pre-determined
overhead rate (absorption rate).
If the budgeted capacity for the budget period
differs significantly from the normal capacity, the
budgeted capacity is used to determine the
absorption rate.
Various bases are used to calculate the
Predetermined Overhead Rate (POR)
Allocation bases
13
Production units
Labour hours
Machine hours
Direct material costs
Direct labour costs
Prime (primary) costs
POR = Estimated manufacturing overhead
Estimated activity
POR = Budgeted manufacturing overhead
Budgeted allocation base
Example
14
Using the following information collected relating to
Cost Centre 60 for July, calculate the
absorption/applied overhead rates
Feedback
15
Feedback
16
Feedback
17
Absorbing Overhead Costs to Production
18
Absorption of overhead is the process of allocating
overhead to different tasks
1. Select a cost driver (allocation base).
2. Estimate the manufacturing overhead cost and the
activity level for the period.
3. Calculate POR= Budgeted manufacturing overhead
Budgeted allocation base
4. Multiply the POR by the actual activity level to apply
(allocate) manufacturing overheads to production.
Allocated overhead = Predetermined overhead rate x
actual activity
Example
19
In the previous year, mega builders total variable
manufacturing overhead cost was N$200 000 and
the activity level was 100 000 direct labour hours.
The company estimates the same level of activity
and costs for this year.
Calculate the Predetermined Overhead Rate
(POR) of the company
Feedback
20
Feedback
21
Example
22
A company provides the following information:
Actual manufacturing overhead N$295 000
Budgeted manufacturing overhead N$300 000
Budgeted activity 30 000 labour hours
60 000 machine hrs
Actual activity 29 000 labour hours
62 000 machine hrs
Machine hours are used as an allocation base
Required
23
Calculate the following:
1. Predetermined overhead rate
2. Allocated overhead
3. Actual overhead
4. Under- or overapplied overhead rate
Feedback
24
POR = Budgeted manufacturing overhead
Budgeted allocation base
= N$300 000
60 000 machine hours
= N$5 / machine hour
Allocated overhead =
Predetermined overhead rate x actual activity
= N$5/mh x 62 000 machine hours
= N$310 000 (Allocated overhead)
Under and Over-Applied Overhead
25
This is the difference between the applied and the
actual manufacturing overheads caused by:
Incorrect predetermined overhead rates.
Actual overheads more/less than budgeted.
Activity higher/lower than estimated
When applied manufacturing overheads are
more than actual, the difference is over-
applied.
When applied manufacturing overheads is less
than actual, the difference is under-applied
Feedback
26
Under-applied Over-applied
Overhead Overhead
Actual overhead Allocated overhead
exceeds allocated exceeds actual
overhead. overhead.
Allocated overhead N$310 000
Actual overhead N$295 000
Over-applied overhead N$15 000
Budgeted Quantity and Volume
27
Two reasons for the over or under applied
overhead
A variance from the budgeted amount – the
budget variance and
A variance caused by a change in volume – the
volume variance
Budget variance = Budgeted overhead -
actual overhead
Volume variance = (Actual activity –
budgeted activity) x predetermined
overhead rate
Feedback-Previous Example
28
Budget variance = Budgeted overhead -
actual overhead
= N$300 000 – N$295 000
= N$5 000 favourable
Volume variance = (Actual activity –
budgeted activity) x POR
= (62 000 – 60 000) x N$5/mh
= N$10 000 favourable
