Overheads: Classification, Allocation, Apportionment and Absorption
What this domain tests
Overheads are indirect costs. Questions demand classification by function and behaviour, the distinction between allocation and apportionment, primary and secondary distribution (repeated distribution, step-ladder, reciprocal or algebraic method), and absorption rates with over- and under-absorption.
Core rules
- Allocation assigns a whole cost to one department where it is wholly identifiable; apportionment splits a common cost on a suitable basis - floor area for rent, machine hours for power, number of employees for canteen and welfare.
- Secondary distribution reallocates service department costs to production departments. Use repeated distribution where one service department serves others, step-ladder where reciprocal service is limited, and the algebraic (simultaneous equation) method for full reciprocity.
- Absorption rate = budgeted overhead ÷ budgeted base (direct labour hours, machine hours, direct wages or units). A machine hour rate is used where machines dominate production.
- Over-absorption arises when absorbed overhead exceeds actual overhead; under-absorption is the reverse. The difference is written off to costing profit and loss or carried forward using supplementary rates.
Worked example
Budgeted factory overhead ₹1,20,000 and budgeted machine hours 8,000 give a rate of ₹15 per machine hour. Actual machine hours are 8,400 and actual overhead is ₹1,30,000. Absorbed overhead = 8,400 × 15 = ₹1,26,000. Overhead is under-absorbed by ₹4,000 (1,30,000 − 1,26,000), which is debited to the costing profit and loss account.
Traps
- Computing the absorption rate with actual rather than budgeted figures.
- Apportioning a cost that could have been allocated directly to one department.
- Ignoring reciprocal services between service departments.
- Reversing the over-absorption and under-absorption signs.