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In a traditional costing system, we calculate one plant-wide allocation rate. A three-step process is
typically used:
Step 1: Determine the basis for allocating overhead (or indirect costs). In this case, it is the direct
labour hours.
Step 2: Calculated a predetermined overhead rate using estimates. Typically calculated at the end of
the year to be used during the following year.
The formula we use for this is:
Estimated Overhead
Predetermine Overhead Rate ( POHR ) =
Estimated Base (cost driver)
Step 3: Apply overhead throughout the period using the actual amount of our base and the
predetermined overhead rate (POAR) calculated in step 2. The calculation is as follows:
Applied Overhead=Actual amount of base × POAR
EXAMPLE 1:
XYZ Limited makes two products, A and B. Product A is a high-volume line, while Product B is a low-
volume, specialized product. 10 000 units of products A and 15 000 units of product B were
manufactured during January.
XYZ Limited allocated manufacturing overhead costs to the two products for the month of January.
Department X had estimated overhead of R2 000 000 and used 20 000 machine hours. XYZ Limited
has decided to allocate overhead on the basis of machine hours. At the end of January, XYZ Limited
had used 1,500 machine hours for product A and 500 machine hours for product B.
Direct costs of Products A and B are:
Product Product B
A
Direct labour cost per unit, R 20 10
Direct materials cost per unit, R 25 16
Required:
Calculate the unit cost of product A and B
SOLUTION
Step 1: The basis for allocating overhead is machine hours.
,Step 2: Calculated a predetermined overhead allocation rate using estimates.
Estimated ManufacturingOverhead
Predetermine Overhead Rate ( POAR )=
Estimated Base ( cost driver )
Step 3: Apply overhead throughout the period using the actual amount of our base and the
predetermined allocation overhead rate (POAR) calculated in step 2. The calculation is as follows:
Applied Overhead=Actual amount of base × POAR
Product A Product B
Machine hours per unit 1 500 500
Overheads costs per unit R150 000 (=1 500 x R100) R50 000 (=500 x R100)
Units produced 10 000 15 000
Overhead cost per unit R15 (=R150 000/10 000) R3.33 (=R50 000/15 000)
Product A Product B
Direct labour cost per unit, R 20 10
Direct materials cost per unit, R 25 16
Overhead cost per unit, R 15 3.33
Unit cost of product, R 60 29.33
EXAMPLE 2
A manufacturing entity, DJK Inc., operates 3 manufacturing departments: P1, P2, and P3, and a service department,
S1.
The actual costs for a period are as follows:
R
Rent 1 000 000
Repairs to plant 600 000
Depreciation of plant 450 000
Employer’s liability for insurance 150 000
Supervision 1 500 000
Fire insurance in respect of inventory 500 000
Diesel used power operations during loadshedding (power cuts) 900 000
, Electricity 120 000
The following information is available in respect of the four departments of DJK Inc:
P1 P2 P3 S1
Floor area (m2) 1 500 1 100 900 500
Number of Employees 20 15 10 5
Total wages (R) 6 000 000 4 000 000 3 000 000 2 000 000
Value of plant (R) 24 000 000 18 000 000 12 000 000 6 000 000
Value of inventory (R) 15 000 000 9 000 000 6 000 000 -
Production runs of plant 24 18 12 6
Required:
Apportion the costs to the various department on the most equitable basis.
Step 1:
P1 P2 P3 S1 Total
Floor area (m2) 1 500 1 100 900 500 4 000
Number of Employees 20 15 10 5 50
Total wages (R) 6 000 000 4 000 000 3 000 000 2 000 000 15 000 000
Value of plant (R) 24 000 000 18 000 000 12 000 000 6 000 000 60 000 000
Value of inventory (R) 15 000 000 9 000 000 6 000 000 - 30 000 000
Production runs of plant 24 18 12 6 60
SOLUTION:
Basis of Total P1 P2 P3
Cost item
Apportionment Amount, R
Rent Floor area 1 000 000 375 000 275 000 225 000
Repairs to plant Value of plant 600 000 240 000 180 000 120 000
Depreciation of plant Value of plant 450 000 180 000 135 000 90 000
Employer’s liability for insurance No. of employees 150 000 60 000 45 000 30 000
Supervision No. of employees 1 500 000 600 000 450 000 300 000
Fire insurance i.r.o inventory Value of inventory 500 000 250 000 150 000 100 000
Diesel used to power generators (power cuts) H.P. of plant 900 000 360 000 270 000 180 000
Electricity Floor area 120 000 45 000 33 000 27 000
Total 5 220 000 2 110 000 1 538 000 1 072 000
What is shown here is the primary allocation overheads.
EXAMPLE 3
REQUIRED
, 1.1 Prepare an overhead allocation statement (using traditional costing). (12)
1.2 Calculate the allocation rate for each of the production centres, based on machine hours for
Machine centres A and B and direct labour hours for assembly.
(3)
1.3 Calculate the overheads applied to each batch of Product X. (5)
INFORMATION
Gumtree Limited has 3 production centres (Machine centre A, Machine centre B and an Assembly
centre) it also has 2 service centres (Materials procurement, S1 and General manufacturing support,
S2). The annual overhead costs are as follows:
R
Indirect materials:
Machine centre A 250 000
Machine centre B 402 500
Assembly 52 500
Materials procurement 0
General manufacturing support 5 000
Indirect labour:
Machine centre A 500 000
Machine centre B 500 000
Assembly 750 000
Materials procurement 550 000
General manufacturing support 740 000
Heating and lighting 250 000
Property tax 500 000
Insurance of machinery 75 000
Depreciation of machinery 750 000
Insurance of buildings 125 000
Salaries of works management 400 000
The following information is also provided:
Carrying value of Area Number of Direct labour Machine
machinery occupied employee hours hours
(m2) s
Machine centre R4 000 000 5 000 150 500 000 1 000 000
A
Machine centre 2 500 000 2 500 100 500 000 500 000
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