CA Intermediate · Cost and Management Accounting

Overheads - Absorption Costing Method: formula sheet

Full chapter guide

Key formulas

Overheads: Overheads = Indirect materials + Indirect employee cost + Indirect expenses; Total of all indirect costs. Direct costs are excluded.
Prime cost and overheads: Total cost = Prime cost + Overheads; Prime cost = direct materials + direct employee cost + direct expenses.
Semi-variable cost: Total cost = Fixed part + (Variable rate × Activity); Use this to split a semi-variable cost into its two parts.
High-low split of variable rate: Variable rate per unit = (Cost at high activity − Cost at low activity) ÷ (High activity − Low activity); Fixed part = Total cost at either level − (Variable rate × activity at that level).
Fixed overhead per unit: Fixed overhead per unit = Total fixed overhead ÷ Units produced; Falls as output rises. Variable overhead per unit stays constant.
Classification by function: Factory (production) | Administration | Selling | Distribution; Research and development and similar heads may be shown separately where relevant.
Allocation: Allocated overhead = full amount of the cost identified with one cost centre; No basis or ratio is needed. Use it when the cost is incurred solely for that centre.
Apportionment (for contrast): Share of a centre = Total shared cost × (Centre's basis quantity ÷ Total basis quantity); Used for shared costs. For example, rent is shared on floor area and power on units consumed or kWh.
Test for treatment: One centre only → allocate; several centres → apportion; Write this test before you start any overhead distribution problem.
Check total: Sum of allocated items + Sum of shared items (before apportionment) = Total overhead collected. Sum of all centre totals after apportionment = Total overhead collected.; Count each shared item once, at its full amount, before it is split. After apportionment, its shares sit inside the centre totals, so never add the full shared cost and its shares together. Any difference means you missed or double-counted an item.
Apportionment to a department: Share of department = (Total overhead ÷ Total units of base) × Department's units of base; Same as Total overhead × Department's base ÷ Total base. Use the total of the base across all departments, including service departments.
Ratio method: Share = Total overhead × (Department's ratio ÷ Sum of ratios); Use when the base is given as a ratio, such as 4 : 3 : 2 : 1.
Check total: Sum of all department amounts = Total overhead for that item; Check every row and the grand total of the summary.
Common bases: Rent, rates, depreciation of building, repairs of building = floor area or volume; Lighting = light points or area; Power = kWh or HP × machine hours; Insurance of machinery, depreciation of machinery = value of machinery; Insurance of stock = value of stock; Canteen, ESI, PF contribution = number of employees or wages; Supervision = number of workers; Personnel/HR = number of employees; If the question gives a base, always use it, even if you would choose another.
Reapportioned share: Share to a department = Service cost to be distributed × (its percentage or ratio ÷ total of the ratios used); In the direct method the ratios used are only those of production departments, so re-base the percentages to 100.
Step method order: Close first the department that serves the most departments or has the largest cost; Follow the order given in the question if it is stated. Once closed, a department gets no further cost.
Simultaneous equation for reciprocal services: S1 = own primary cost of S1 + (% of S2 service to S1) × S2 and S2 = own primary cost of S2 + (% of S1 service to S2) × S1; S1 and S2 are the total costs of the service departments after receiving each other's share. Solve, then distribute these totals.
Closing check: Σ (production department overheads after secondary distribution) = Σ (all primary overheads); Always verify this before moving to absorption rates.
Predetermined overhead absorption rate: Rate = Budgeted overheads ÷ Budgeted base (units, hours or cost); Use budgeted figures for the same period in numerator and denominator. Apply the rate to the actual base.
Percentage of direct material: Rate = (Overheads ÷ Direct material cost) × 100; Use only when overheads vary with material cost.
Percentage of direct wages: Rate = (Overheads ÷ Direct wages) × 100; Suits labour-intensive work with similar wage rates.
Percentage of prime cost: Rate = (Overheads ÷ Prime cost) × 100; Prime cost = direct material + direct labour + direct expenses.
Direct labour hour rate: Rate per hour = Overheads ÷ Direct labour hours; Better than the wage percentage when wage rates differ.
Machine hour rate: Rate per hour = Machine overheads ÷ Machine hours; Compute fixed and variable parts separately when normal hours differ from actual hours.
Absorbed overhead: Absorbed = Rate × Actual base; Compare with actual overhead to find under- or over-absorption.
Blanket rate: Total factory overheads ÷ Total factory base; One rate for all jobs.
Predetermined overhead rate: Budgeted overheads ÷ Budgeted base (hours, units, etc.); Fixed before the period starts. Use the same base for budget and actual.
Absorbed overhead: Predetermined rate × Actual base; Use actual hours or units, not budgeted ones.
Under- or over-absorption: Actual overheads − Absorbed overheads; Positive = under-absorbed. Negative = over-absorbed.
Supplementary rate: Under- or over-absorbed amount ÷ Actual base of cost of sales, WIP and finished stock; Used when the difference is spread over stock and cost of sales.
Fixed overhead rate per unit: Budgeted fixed overhead ÷ Capacity chosen (normal or practical); A higher base gives a lower rate. Use the base the question names.
Idle capacity (units): Capacity base − Actual output; Use the same base as the rate.
Idle capacity cost: Idle units × Fixed overhead rate per unit; Equals fixed overhead not absorbed by production.
Capacity utilisation %: Actual output ÷ Capacity base × 100; Check which base is asked for.
Treatment of idle capacity: Normal idle → production cost. Abnormal idle → Costing P&L; Decide by the cause of the idleness.
Treatment of special overheads: Administration: separate or on works cost. Selling and distribution: on sales or sales units. R&D: process-related to production overhead, unsuccessful to Costing P&L; State the base you use and why.

Quick revision

Overheads are indirect costs, split into factory, administration, selling and distribution.
Allocation assigns a whole cost item to one cost centre. Apportionment shares it across several.
Primary distribution spreads all overheads over production and service departments.
Secondary distribution moves service department costs to production departments.
Direct method ignores service-to-service transfers. Step-ladder allows one-way transfers. Reciprocal allows two-way transfers.
Reciprocal method: set up equations such as S1 = own cost + share of S2, and solve them together.
Absorption rate = Budgeted overhead ÷ Budgeted base (units, labour hours or machine hours).
Under-absorption = Actual overhead − Absorbed overhead, when actual is higher.
Over-absorption = Absorbed overhead − Actual overhead, when absorbed is higher.
Idle capacity cost is usually treated as abnormal and not loaded to product cost.
Check that total overhead after secondary distribution equals total before it.

Common mistakes

Treating small items such as nails or thread as direct materials because they are physically part of the product. Fix: Use the economic traceability test. Small items such as nails or thread are indirect even though they are in the product.
Saying fixed overhead per unit is fixed. Fix: Fixed means fixed in total within the relevant range. Per unit it falls as output rises. Variable is constant per unit.
Treating allocation and apportionment as the same thing. Fix: Remember that allocation is the whole cost to one centre and apportionment is a share to many. Use the one-centre or many-centres test.
Apportioning an item that is clearly for one department. Fix: Read the wording of each item first. If it names one department, allocate the full amount.
Using the wrong base for an item, such as floor area for power. Fix: Ask what drives the cost. Use the base the question gives. If none is given, pick the one linked to usage or benefit and state it.
Leaving out service departments when finding the total base. Fix: In primary distribution, every department, production and service, receives its share. Include all in the base total.
Using the original percentages in the direct method without re-basing to 100. Fix: Add only the production department percentages and divide each by that sum. For example 50 and 30 become 5/8 and 3/8.
Passing cost back to a department already closed in the step method. Fix: Once a department is closed, ignore its percentage in later steps. Re-base the remaining percentages among departments still open.
Using actual overheads instead of budgeted overheads to find the rate Fix: Use budgeted overheads and budgeted base unless the question asks for an actual rate.
Dividing overheads by the wrong base, such as total hours instead of machine hours Fix: Underline the base asked for and use only that column of data.

Exam tips

Expect MCQs asking you to pick the correct classification of an item, or how a cost behaves per unit. Learn the per-unit behaviour of fixed and variable costs cold.
In written answers always give a one-line reason for each classification. It protects marks when the examiner's class differs.
If a question gives two activity levels for a semi-variable cost, use the high-low method and show the check step.
Name the basis of classification before listing classes. Keep function, behaviour and controllability separate and do not mix them in one list.
Write a short definition of overheads first in theory questions, then the classes with one example each.
Write a one-line definition of allocation and apportionment together in theory answers, and state the difference in your own words.
In numericals, always show the basis and the ratio for each apportioned item. Marks are given for them even if arithmetic slips.
Underline words like 'solely', 'only' and 'common' in the question. They tell you how each item is treated.