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Calculating Budgeted Overhead Absorption Rates: A Step-by-Step Guide, Lecture notes of Auditing

An in-depth explanation of the methods and processes involved in calculating a company's budgeted overhead absorption rates. It covers primary and secondary apportionment, using examples from the aat qualification's crs sample paper. Understanding these concepts is crucial for candidates in unit 6 (recording and evaluating costs and revenues) and the new costs and revenues unit.

What you will learn

  • How is the secondary apportionment process different when there is reciprocal servicing between support cost centres?
  • What is the primary apportionment process for calculating budgeted overhead absorption rates?
  • What is the difference between the direct and step down methods in the secondary apportionment process?

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Calculating budgeted overhead absorption rates – AT Online, June 2010 1
Calculating budgeted overhead absorption rates
There are several possible methods for calculating a company’s budgeted overhead
absorption rates. Les Nightingale takes you though them
Both the current Unit 6 (Recording and Evaluating Costs and Revenues) and the new Costs
and Revenues (CRS) unit within the Revised AAT Qualification require candidates to be able
to calculate budgeted overhead absorption rates.
There are three steps in this process:
1. Firstly, all relevant overhead costs have to be allocated or apportioned to production
and support centres, or departments. Production centres – also referred to as profit centres –
are where the production takes place. Support centres are there to support the production
centres, and are also referred to as service cost centres. This first step is called the primary
apportionment.
2. Next, the support centres have to be reapportioned to the production centres on either
the direct or step down method. The direct method is used where there is no reciprocal
servicing between the support centres, and the step down method is used where there is. This
is called the secondary apportionment.
3. Finally, the budgeted overhead absorption rate (BOAR) is calculated for each
production centre by dividing the total budgeted overheads in each by an appropriate basis of
absorption, such as budgeted direct labour or machine hours.
Let us now look in detail at the first two steps, using task 1.4 from the CRS sample paper as
an example.
Broadsword Ltd’s budgeted overheads for the next financial year are:
£ £
Depreciation of plant and
equipment 804,150
Power for production machinery 715,000
Rent and rates 104,500
Light and heat 23,100
Indirect labour costs:
Maintenance 101,150
Stores 36,050
General Administration 240,100
Total indirect labour cost 377,300
The following information is also available:
Department Net book value
of plant and
equipment
Production
machinery
power usage
(KwH)
Floor space
(square
metres)
Number of
employees
Production centres:
Plastic moulding 5,600,000 2,145,000 14
Plastic extrusion 2,400,000 1,430,000 10
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Calculating budgeted overhead absorption rates

There are several possible methods for calculating a company’s budgeted overhead absorption rates. Les Nightingale takes you though them

Both the current Unit 6 (Recording and Evaluating Costs and Revenues) and the new Costs and Revenues (CRS) unit within the Revised AAT Qualification require candidates to be able to calculate budgeted overhead absorption rates.

There are three steps in this process:

  1. Firstly, all relevant overhead costs have to be allocated or apportioned to production and support centres, or departments. Production centres – also referred to as profit centres – are where the production takes place. Support centres are there to support the production centres, and are also referred to as service cost centres. This first step is called the primary apportionment.
  2. Next, the support centres have to be reapportioned to the production centres on either the direct or step down method. The direct method is used where there is no reciprocal servicing between the support centres, and the step down method is used where there is. This is called the secondary apportionment.
  3. Finally, the budgeted overhead absorption rate (BOAR) is calculated for each production centre by dividing the total budgeted overheads in each by an appropriate basis of absorption, such as budgeted direct labour or machine hours.

Let us now look in detail at the first two steps, using task 1.4 from the CRS sample paper as an example.

Broadsword Ltd’s budgeted overheads for the next financial year are:

Depreciation of plant and equipment

Power for production machinery 715,

Rent and rates 104,

Light and heat 23,

Indirect labour costs:

Maintenance 101,

Stores 36,

General Administration 240,

Total indirect labour cost 377,

The following information is also available:

Department

Net book value of plant and equipment

Production machinery power usage (KwH)

Floor space (square metres)

Number of employees

Production centres:

Plastic moulding 5,600,000 2,145,000 14

Plastic extrusion 2,400,000 1,430,000 10

Support cost centres:

Maintenance 14,000 5

Stores 8,400 2

General administration

Total 8,000,000 3,575,000 28,000 38

Overheads are allocated or apportioned on the most appropriate basis. The total overheads of the support cost centres are then reapportioned to the two production centres using the direct method.

  • 76% of the Maintenance cost centre’s time is spent maintaining production machinery in the Plastic moulding production centre and the remainder in the Plastic extrusion production centre.
  • The Stores cost centre makes 60% of its issues to the Plastic moulding production centre, and 40% to the Plastic extrusion production centre.
  • General Administration supports the two production centres equally.
  • There is no reciprocal servicing between the three support cost centres.

Step 1

We simply allocate some of the overheads to the department where they are incurred. This is the case with the indirect labour costs. We then share, or apportion, the remaining overheads across the various departments on the most reasonable basis. Rent and rates, for example, are spread based on the floor area of each department.

The primary apportionments are, therefore:

Basis of apportionment

Plastic moulding £

Plastic extrusion £

Maintenance £

Stores £

General Admin £

Totals £

Depreciation of plant and equipment

NBV of plant and equipment

Power for production machinery

Production machinery power usage (KwH)

Rent and rates

Floor space 52,250^ 31,350^ 20,900 104,

Light and heat

Floor space

Indirect labour Allocated 101,150 (^) 36,050 240,100 377,

charged for Maintenance change, because the 10% of the Maintenance department’s time spent in the General Admin centre is ignored. (50/90; 30/90 and 10/90 are charged to the remaining three centres).

The revised secondary apportionments become:

Basis of apportionment

Plastic moulding £

Plastic extrusion £

Maintenance £

Stores £

General Admin £

Totals £

Totals after primary apportionment

Reapportion General Admin

Reapportion Maintenance

Reapportion Stores

Total overheads to production centres

We can see that the choice of secondary apportionment method has changed the total overheads in each of the production centres, which will in turn affect their budgeted overhead absorption rates.

Step 3

The final step is to calculate the budgeted overhead absorption rates themselves. Suppose that in the step down example, above, the overheads were to be recovered on the machine hour basis, and the budgeted machine hours were 25,734 for the Plastic moulding department and 18,434 for the Plastic extrusion department.

The budgeted overhead absorption rates would be:

Plastic moulding: £1,286,706/25,734 = £50 per machine hour

Plastic extrusion: £737,344/18,434 = £40 per machine hour

Les Nightingale is Chief Assessor for Unit 6