Week 6 – Chapter 5 OVERHEAD ALLOCATION

FNSACC507A Provide Management Accounting Information

By the end of this part of the lesson you will have learnt how to…

Calculate and apply two (2) types of factory overhead recovery rates; �  a DEPARTMENTAL overhead rate; and �  a PLANT-WIDE overhead rate.

Overhead allocation

Factory overhead is allocated to units of production using what is called a

predetermined overhead rate (POR)

(also known as a factory overhead recovery rate).

Overhead allocation This rate is calculated using the

following formula:

Overhead allocation The predetermined overhead rate may be determined for:

�  each productive department in the factory (this is known as a departmental overhead rate); or

�  the factory as a whole (this is known as a plant-wide overhead rate).

Both these options will now be discussed.

a. Departmental overhead rates Departmental overhead rates are calculated by: Step 1: Allocating budgeted overhead costs to service and production departments. Step 2: Re-distributing service department costs to producing departments. Step 3: Using the following formula to calculate an overhead rate for each producing department.

a. Departmental overhead rates Step 1: Allocate budgeted overhead costs to service and production departments. e.g. Service department:

Storeroom; Repairs & Maintenance e.g. Production department:

Machining; Assembly

a. Departmental overhead rates Step 2: Re-distribute service department costs to producing departments. Why re-distribute service department costs? �  Producing departments are the only departments through

which products being manufactured actually flow. �  If overhead rates are to be reasonable estimates of the

amount of factory overhead applicable to units produced they must include both producing department costs and service department costs.

a. Departmental overhead rates Step 2: Redistribute service department costs to producing departments.

DIRECT METHOD The direct method can be used to redistribute service department costs to producing departments. � Service department costs are allocated to producing departments only using each service department’s cost driver as the basis for re-allocation. � No service department costs are allocated to any other service department.

a. Departmental overhead rates Applying overhead recovery rates �  Involves allocating costs from producing

departments to units of production. � After working out a predetermined overhead rate for

each producing department, use this rate to allocate overhead costs from these producing departments to individual units of production.

b. Plant-wide overhead rates �  This is a single overhead rate for the entire

factory.

�  It is used in certain situations such as: �  where the factory produces only one product. �  where production is characterised by only one

process.

Worked Example

DEPARTMENTAL and PLANT-WIDE overhead recovery rates

Rainbow Pty Ltd

Worked Examples  NOTE TO STUDENTS:

Before moving on to the next slide, please open and work through the following document now:

WEEK 6_FNSACC507A_Management

Accounting_WORKED EXAMPLES_Overhead Allocation

This week’s homework � Read chapter 5 à Overhead allocation

(p.255 to p.266) � Complete homework questions (chapter 5)

(ref. STUDENT ONLINE STUDY GUIDE)

You are now ready to start the next part of this lesson on:

CHAPTER 7

Overhead Variance Analysis