Management Accounting · Accounting for material, labour and overheads

Overheads: Allocation, Apportionment and Absorption Explained

Updated 11 October 2026 · Fact-checked

Overhead costing shares indirect production costs among units. You allocate costs that belong wholly to one cost centre, apportion shared costs using a fair basis, reapportion service centre costs to production centres, then absorb them into units using a predetermined rate: budgeted overheads ÷ budgeted activity.

Understand Overheads: Allocation, Apportionment and Absorption

Overheads are indirect costs. You cannot trace them to a single unit, such as factory rent, supervisor pay or machine maintenance. Yet each unit made should carry a fair share, so the business can set prices and value inventory.

The process has three stages. Allocation means charging a whole cost to the one cost centre that caused it. For example, a supervisor who works only in the assembly department is allocated to assembly. Apportionment means splitting a shared cost across several cost centres using a fair basis, such as floor area for rent or number of employees for canteen costs.

Some cost centres are service cost centres, such as stores or maintenance. They do not make products, so their costs are reapportioned to the production cost centres that use their services. Methods are direct, step-down (sequential) and reciprocal. Use the reciprocal method when service centres serve each other. It needs simultaneous equations.

Finally, absorption charges overheads to units. Because actual costs are known only after the period ends, you use a predetermined overhead absorption rate (OAR), based on budgeted overheads and budgeted activity. The activity base should reflect what drives the cost. Use machine hours in a machine-intensive department and labour hours in a labour-intensive one. Use units only when products are identical.

The actual overhead usually differs from the amount absorbed. That gives over- or under-absorption, which is covered in a separate topic.

Key formulas to remember

Predetermined OAR: OAR = budgeted overheads ÷ budgeted activity level; Use budgeted figures for the production centre. The activity is labour hours, machine hours or units.
Overhead absorbed: Overhead absorbed = OAR × actual activity; Use actual hours or units for the period, not the budget.
Reciprocal method equations: S1 = own costs + x% of S2; S2 = own costs + y% of S1; Solve for S1 and S2, then share each total to all other centres by the stated percentages.
Allocation versus apportionment: Allocate whole cost to one centre; apportion shared cost across centres; Apportionment needs a fair basis, such as floor area or headcount.
Absorption rate per unit: Overhead per unit = OAR × hours per unit; Use this to build the overhead part of a unit cost.

How to solve Overheads: Allocation, Apportionment and Absorption questions

Follow these steps for any overhead question. Draw a small table with one column per cost centre.

1List each overhead cost and decide whether it is allocated to one centre or apportioned across several.
2Allocate directly traceable costs to their centre, then apportion shared costs using the stated basis, such as area or headcount.
3Add across each row. Check the column totals equal the total overhead given.
4Reapportion service centre costs to production centres using the stated method: direct, step-down or reciprocal.
5Check that all overhead now sits in production centres only and that the total is unchanged.
6Calculate each OAR as budgeted overhead ÷ budgeted activity for that centre. Keep the units of activity consistent.
7Multiply the OAR by the actual or per-unit activity to find overhead absorbed or overhead in a unit cost.
8Read the question again to check what was asked, such as the rate, the absorbed amount or the unit cost.

Quickest way: Table-first shortcut

When to use it: Use this for number entry questions on a single OAR or a simple reapportionment where time is short.

Identify the budgeted overhead and budgeted activity for the right department. Ignore actual figures for the rate.
Divide to get the OAR and keep full decimals until the end.
For a reciprocal question, write the two equations at once and substitute. Do not redraw the full table.
Do a sense check. The total overhead shared out must equal the total you started with.

Common mistakes in Overheads: Allocation, Apportionment and Absorption

Using actual hours or actual overheads to calculate the OAR.
Students see several figures and pick the wrong ones.
Fix: The rate is always budgeted overheads ÷ budgeted activity. Actual activity is used only when you absorb.
Confusing allocation with apportionment.
Both words describe assigning costs to centres.
Fix: Ask whether the cost belongs wholly to one centre. If yes, allocate. If shared, apportion.
Leaving service centre costs unabsorbed.
Students stop after the primary apportionment.
Fix: Always reapportion service centre costs so that only production centres remain.
Using the wrong percentage in the reciprocal equations.
Students mix up which centre gives and which receives the service.
Fix: Write each centre's equation as its own cost plus the share it receives from the other centre.
Using the wrong activity base for the department.
Students use a single rate for the whole factory.
Fix: Use the base given for each department, such as machine hours for machining and labour hours for assembly.

Worked examples

Example 1

A factory has two production centres, Cutting and Finishing, and one service centre, Stores. Allocated overheads are Cutting $40,000, Finishing $30,000 and Stores $20,000. Stores costs are reapportioned 60% to Cutting and 40% to Finishing. Budgeted machine hours in Cutting are 10,000. Calculate the OAR for Cutting.

Show the solution

Reapportion Stores: 60% × $20,000 = $12,000 to Cutting.
Cutting total overhead = $40,000 + $12,000 = $52,000.
OAR = $52,000 ÷ 10,000 machine hours = $5.20 per machine hour.

Answer: $5.20 per machine hour

Example 2

Service centre S1 has costs of $50,000 and S2 has $30,000. S1 gives 20% of its output to S2. S2 gives 10% of its output to S1. Using the reciprocal method, find the total cost of S1.

Show the solution

Let S1 = total cost of S1 and S2 = total cost of S2.
S1 = 50,000 + 0.1 S2.
S2 = 30,000 + 0.2 S1.
Substitute: S1 = 50,000 + 0.1(30,000 + 0.2 S1) = 50,000 + 3,000 + 0.02 S1.
S1 − 0.02 S1 = 53,000, so 0.98 S1 = 53,000.
S1 = 53,000 ÷ 0.98 = $54,082 (to the nearest dollar).

Answer: $54,082 (to the nearest dollar)

Exam tips

Read which method the question requires. Direct and step-down questions cannot be solved with simultaneous equations.
For number entry, check the rounding instruction and the units, such as per hour or per unit.
In multiple response questions, check each statement separately. Allocation applies to a cost wholly belonging to one centre.
Always check that your reapportioned totals add back to the original total overhead.
Look for which department the question asks about. A wrong department gives a wrong rate.

Practice questions from Accounting for material, labour and overheads

Overheads: Allocation, Apportionment and Absorption in other exams

The same ground in other exams, if you are preparing for more than one or want another angle on it.

Overheads: Allocation, Apportionment and Absorption: frequently asked questions

What is the difference between allocation and apportionment of overheads?

Allocation charges a whole cost to the one cost centre that incurred it. Apportionment splits a shared cost across several cost centres using a fair basis, such as floor area or number of employees.

How do I calculate a predetermined overhead absorption rate?

Divide the budgeted overheads of the cost centre by its budgeted activity, such as labour hours or machine hours. Then multiply that rate by the actual activity to find the overhead absorbed.

When do I use the reciprocal method?

Use it when service cost centres provide services to each other. You write simultaneous equations for each service centre's total cost, solve them, and then share the totals to the production centres.

Why is a predetermined rate used rather than actual costs?

Actual overheads are known only after the period ends. A predetermined rate lets you cost units and quote prices during the period. Any difference is dealt with as over- or under-absorption.