Overhead allocation and absorption rates
Overheads are shared out to cost centres; the totals give the rates used to cost products.
Formulas
- Allocate overheads by a fair basis (area, staff, kWh …)
- Reapportion service centres by the service they provide
- Material rate = material overhead / direct materials × 100
- Administration and selling rates = overhead / production cost × 100
Your turn
Three problems on this topic. Amounts with or without thousands separators, a point for pence.
Task
In the overhead analysis sheet, building costs of £22,000.00 are to be allocated to the cost centres by floor area.
| Cost centre | Area (m²) |
|---|---|
| Materials | 140 |
| Production | 390 |
| Administration | 280 |
| Selling | 70 |
Share of production in £
Share of administration in £
Amounts like 12,500 or 12500.50; percentages as a number (12.5). Round to the penny or 2 decimal places.
Worked example
In the overhead analysis sheet, building costs of £7,840.00 are to be allocated to the cost centres by floor area.
| Cost centre | Area (m²) |
|---|---|
| Materials | 160 |
| Production | 70 |
| Administration | 360 |
| Selling | 390 |
Worked solution
- 1.Total area = 160 + 70 + 360 + 390 = 980 m²
- 2.Cost per m² = £7,840.00 / 980 = £8.00
- 3.Production: 70 × £8.00 = £560.00; administration: 360 × £8.00 = £2,880.00
Typical mistake: Splitting the costs equally instead of by the allocation key.
After the overhead analysis these totals are known. There are no changes in stock. Work out the four overhead rates (2 decimal places).
| Item | Amount |
|---|---|
| Direct materials | £95,000.00 |
| Direct labour | £187,000.00 |
| Material overheads | £22,800.00 |
| Production overheads | £280,500.00 |
| Administration overheads | £79,015.50 |
| Selling overheads | £49,750.50 |
Worked solution
- 1.Material rate = £22,800.00 / £95,000.00 × 100 = 24.00%
- 2.Production rate = £280,500.00 / £187,000.00 × 100 = 150.00%
- 3.Production cost = £95,000.00 + £22,800.00 + £187,000.00 + £280,500.00 = £585,300.00
- 4.Administration rate = £79,015.50 / £585,300.00 × 100 = 13.50%; selling rate = £49,750.50 / £585,300.00 × 100 = 8.50%
Typical mistake: Basing the administration and selling rates on direct costs instead of production cost.
Frequently asked questions
What is a service cost centre?
A centre such as the vehicle fleet or canteen that works for other centres; its costs are passed on to them.