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CMA Intermediate · Cost Accounting

Overheads in Cost Accounting for CMA Inter

Overheads are indirect costs that cannot be traced to one unit of product. You classify them, collect them, allocate or apportion them to cost centres, re-apportion service department costs, and absorb them into products using a rate. Any difference between absorbed and actual overhead is under or over absorption.

What this chapter covers

This chapter shows how a business turns a pile of indirect costs into a cost per unit. Materials and labour are often traceable to a job. Rent, power, supervision, depreciation and maintenance are not. Overheads give you a step-by-step method to share these costs fairly across products.

The flow is fixed. First you classify and codify costs. Then you collect them, allocate whole items to the cost centre that caused them, and apportion shared items on a sensible basis. Service department costs are then re-apportioned to production departments. Finally you compute an absorption rate and charge overheads to products or jobs. Any gap between what you absorbed and what was actually spent is dealt with as under or over absorption.

This chapter feeds directly into cost sheets, job and batch costing, process costing, and later into marginal costing and variance analysis in Management Accounting. If your overhead rates are wrong, every product cost you compute afterwards will be wrong too.

Overheads is a numerical chapter with a clear, repeatable method, so it rewards practice. A typical question asks for a primary distribution statement, secondary distribution, rates and an under/over absorption figure in one sum, and each stage carries step marks even if a later figure goes wrong. The same logic also appears in MCQs on rate formulas, bases and treatment of special items, so the chapter pays off in both Section A and the written section.

Overheads: topics in the order to study them

  1. 1Overheads: Meaning, Classification and CodificationYou need the vocabulary (fixed, variable, factory, administration, selling) before any calculation makes sense.
  2. 2Collection and Allocation of OverheadsAllocation is the simplest step, where a cost belongs wholly to one cost centre, and it sets up the idea of cost centres.
  3. 3Apportionment of Overheads to Cost CentresShared costs need a basis such as floor area, horsepower or number of workers, so this comes after allocation.
  4. 4Re-apportionment of Service Department CostsOnce primary distribution is done, you move service costs to production departments, using direct, step or reciprocal methods.
  5. 5Absorption of Overheads and Overhead RatesRates can only be computed after each production department holds its full overhead total.
  6. 6Under and Over Absorption of OverheadsYou compare absorbed overhead with actual overhead, so you must know how absorption works first.
  7. 7Treatment of Special OverheadsItems like research and development, packing, bad debts and idle time are easier once the main flow is clear.

How to prepare Overheads

Treat this chapter as one process you can draw on a page. Learn the flow first, then drill the numbers.

  1. Write the full flow on one sheet: classify, collect, allocate, apportion, re-apportion, absorb, adjust. Keep it as your map.
  2. Learn the common apportionment bases and which cost goes with which basis, for example rent with floor area and power with horsepower or kWh.
  3. Practise primary distribution statements until the layout is automatic: costs in rows, departments in columns, totals checked.
  4. Do secondary distribution using the direct, step and reciprocal methods. For reciprocal, set up simultaneous equations and check that the totals tally with the original.
  5. Compute absorption rates on different bases such as direct labour hour, machine hour and percentage of prime cost, and know when each suits.
  6. Solve under and over absorption questions, then state the treatment: write off to costing profit and loss, or use a supplementary rate where the question asks.
  7. Finish with MCQs on definitions and special overheads, then attempt one full written question in exam time.

Common mistakes in Overheads

  • Using the wrong apportionment basis for a cost

    Fix: Ask what drives the cost. Rent follows area, power follows consumption, supervision follows number of workers. Write the basis next to each item.

  • Losing marks in reciprocal method equations

    Fix: Write each service department's total as its own primary cost plus its share from the other. Solve, then verify that the distributed total equals the original total.

  • Dividing by actual base instead of budgeted base for the rate

    Fix: A predetermined rate uses budgeted overhead and budgeted base. Actual base is used only to find absorbed overhead.

  • Reversing under and over absorption

    Fix: Absorbed less than actual means under absorbed. Absorbed more than actual means over absorbed. Write the comparison before naming it.

  • Including abnormal items in the overhead rate

    Fix: Read for words like abnormal, idle or unusual. Exclude such items from the rate and charge them to costing profit and loss.

  • Skipping the layout and totals check

    Fix: Present a neat statement with headings and totals. It earns step marks and lets you spot errors quickly.

Last-day revision: Overheads

  • Overheads are indirect costs: indirect materials, indirect labour and indirect expenses.
  • Allocation charges a whole cost item to one cost centre; apportionment shares it on a basis.
  • Primary distribution covers all costs to all departments; secondary distribution moves service costs to production departments.
  • Match the basis to the cost: rent to floor area, lighting to number of light points, power to horsepower or units used.
  • Direct method ignores service-to-service services; step method recognises them one way; reciprocal method recognises them both ways.
  • Predetermined overhead rate = budgeted overheads ÷ budgeted base (hours, units or cost).
  • Machine hour rate suits machine-intensive departments; direct labour hour rate suits labour-intensive ones.
  • Absorbed overhead = actual base × predetermined rate.
  • Under absorption = actual overhead more than absorbed overhead; over absorption = absorbed more than actual.
  • Always check that the total after re-apportionment equals the total before it.
  • Treat abnormal idle time cost as a loss, not as part of the overhead rate.
  • Where an overhead is a normal, recurring item, include it in cost; abnormal items go to costing profit and loss.

Overheads practice questions

Overheads in other exams

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

Overheads: frequently asked questions

What is the difference between allocation and apportionment?

Allocation charges a whole item of cost to a single cost centre because it clearly belongs there. Apportionment divides an item shared by several cost centres on a fair basis, such as area or number of employees.

Which re-apportionment method should I use in the exam?

Use the method the question names. If none is named, state your choice, but the reciprocal method is the most accurate when service departments serve each other. Always show your working and a totals check.

Is Overheads important for MCQs?

Yes. Section A can ask about definitions, bases of apportionment, rate formulas and the treatment of under or over absorption. These are quick marks if you have revised the rules, and there is no negative marking, so attempt every question.

How should I treat under or over absorbed overhead?

Compare actual overhead with absorbed overhead. If the amount is small and arises from normal causes, it is usually written off to the costing profit and loss account. If the question asks, you may instead use a supplementary rate to adjust product costs.