Learning Outcomes
After reading this article, you will be able to explain what overheads are and why they need to be assigned to products. You will distinguish between allocation, apportionment, and reapportionment of overheads to cost centres. You will learn the basis for sharing overheads among departments, apply secondary apportionment (including the reciprocal method), and understand the impact on product costing and absorption rates. You will be equipped to perform common exam calculations and avoid typical errors.
ACCA Management Accounting (MA) Syllabus
For ACCA Management Accounting (MA), you are required to understand the treatment of overheads for allocation to cost units, and how production and service overheads are split among departments. This includes the techniques for initial distribution, secondary sharing, and the use of absorption rates.
- Explain the different treatment of direct and indirect expenses
- Describe procedures involved in determining production overhead absorption rates
- Allocate and apportion production overheads to cost centres using appropriate bases
- Reapportion service cost centre costs to production cost centres (including reciprocal method)
- Select, apply, and discuss appropriate bases for absorption rates
- Calculate and interpret under- and over-absorption of overheads
Test Your Knowledge
Attempt these questions before reading this article. If you find some difficult or cannot remember the answers, remember to look more closely at that area during your revision.
- What is the main difference between allocation and apportionment of overheads?
- Which basis would be most appropriate to apportion factory rent among cost centres?
a) Number of employees
b) Floor area
c) Machine hours
d) Direct labour hours - A maintenance department serves two production departments. How would you ensure its overheads are fairly assigned?
- True or false? All service department overheads must be assigned to production departments before calculating absorption rates.
Introduction
Indirect costs ("overheads") cannot be directly traced to a particular product or service, but must still be included in cost calculations for accurate pricing, budgeting, and reporting. To ensure product costs are complete, overheads are assigned using systematic methods: allocation, apportionment, and reapportionment. These processes distribute costs from shared resources across the areas that benefit.
You will need to distinguish between cost centres (where costs are accumulated) and cost units (products), and apply overheads efficiently and fairly using standard approaches—a key skill tested in the ACCA Management Accounting exam.
Key Term: Overheads
Indirect costs incurred in the manufacture or provision of products or services, which cannot be traced directly to a specific cost unit.Key Term: Allocation
The process of charging an entire overhead cost directly to a single cost centre when it is incurred solely by that centre.Key Term: Apportionment
The sharing out of a common overhead cost among two or more cost centres on a fair and reasonable basis.Key Term: Reapportionment
The redistribution of service cost centre overheads to production cost centres so that all overheads are ultimately absorbed by products.
DIRECT AND INDIRECT COSTS
Costs are classified as either direct (refer directly to one product, job, or department) or indirect (shared and cannot be specifically identified with a single cost object). Direct material and labour are traced directly to cost units; overheads require allocation or apportionment.
COST CENTRES AND OVERHEAD DISTRIBUTION
Overheads are first collected and grouped by:
- Production cost centres (directly involved in manufacturing, e.g., machining, assembly)
- Service cost centres (provide support to production, e.g., maintenance, stores, canteen)
Accurate assignment ensures each department bears its fair share of costs.
Key Term: Cost centre
A location, department, or function for which costs are collected and controlled, enabling accountability for cost management.
Initial Distribution: Allocation and Apportionment
Allocation is possible if an overhead is wholly attributable to a single cost centre (e.g., supervisor’s salary in one department).
Apportionment is needed when an overhead relates to more than one cost centre (e.g., factory rent), so the cost is split using a systematic basis such as floor area, machine hours, or headcount.
Common apportionment bases include:
- Floor area (rent, heat, lighting)
- Machine value (depreciation, insurance)
- Number of employees (canteen costs)
- Power usage (electricity)
REAPPORTIONMENT (SECONDARY APPORTIONMENT)
After initial overhead distribution, service cost centre overheads must be transferred to production cost centres. There are three main methods:
1. Direct method: Reapportion all service centre costs directly to production centres only, ignoring reciprocal services between service centres.
2. Step down (sequential) method: Reapportion service centres one at a time, starting with the centre providing the most service to others, and moving their assigned costs along the sequence.
3. Reciprocal (repeated distribution) method: Recognise that service cost centres may mutually serve each other, and allocate costs repeatedly between them until all service overheads are absorbed by production centres.
Worked Example 1.1
A factory has two production centres (Machining and Assembly) and two service centres (Maintenance and Stores). The allocated and apportioned overheads (before reapportionment) are:
- Machining: $20,000
- Assembly: $22,000
- Maintenance: $9,000
- Stores: $5,000
Maintenance is used 60% by Machining, 40% by Assembly. Stores is used 70% by Machining, 30% by Assembly.
Question: Complete secondary apportionment (direct method) and state the revised total for each production centre.
Answer:
Reapportion Stores:
Machining receives 70% × $5,000 = $3,500
Assembly receives 30% × $5,000 = $1,500
Reapportion Maintenance:
Machining receives 60% × $9,000 = $5,400
Assembly receives 40% × $9,000 = $3,600Final totals:
Machining = $20,000 + $3,500 + $5,400 = $28,900
Assembly = $22,000 + $1,500 + $3,600 = $27,100
Worked Example 1.2
Two service centres (S1 and S2) mutually support each other with the following proportions: S1 gives 10% of its service to S2; S2 gives 20% of its service to S1. Initial overheads: S1 = $6,000; S2 = $4,000.
Question: Using the reciprocal method (equations), calculate the final overhead for S1 and S2 before distributing fully to production centres.
Answer:
Set up:
S1 total = $6,000 + 0.2 × S2
S2 total = $4,000 + 0.1 × S1Substitute:
S1 = $6,000 + 0.2($4,000 + 0.1×S1)
S1 = $6,000 + $800 + 0.02×S1
0.98×S1 = $6,800
S1 = $6,938
S2 = $4,000 + 0.1 × $6,938 = $4,694
BASES FOR ABSORPTION OF OVERHEADS
After all overheads are assigned to production cost centres, products must absorb them. Common absorption bases are:
- Direct labour hours (labour-intensive processes)
- Machine hours (machine-intensive processes)
- Units produced
- Percentage of direct wages, or prime cost
Select the base that best matches how overheads are truly incurred.
Key Term: Overhead Absorption Rate (OAR)
The rate at which overheads are charged to products, calculated by dividing budgeted overheads by the chosen absorption base.
THE IMPACT OF ALLOCATION METHODS ON PRODUCT COSTS
Correct allocation, apportionment, and reapportionment ensures product costs are not under- or overstated. This directly affects pricing, profitability analysis, and inventory valuation. Choosing an appropriate basis is necessary for fair cost assignment.
Worked Example 1.3
A department's budgeted overheads are $60,000. The absorption base is direct labour hours, and 12,000 hours are budgeted.
Question: What is the OAR, and how much overhead is absorbed by a job requiring 100 direct labour hours?
Answer:
OAR = $60,000 / 12,000 hours = $5 per labour hour
Overhead absorbed = 100 hours × $5 = $500
COMMON ISSUES AND ERRORS
Exam Warning
A frequent error is to use incorrect apportionment bases (e.g., splitting rent by number of employees instead of floor area). Always match the overhead to the base that best "drives" it.
UNDER- AND OVER-ABSORPTION OF OVERHEADS
If actual activity differs from budgeted activity, overheads absorbed may be less or more than overheads incurred. This leads to under- or over-absorption, which must be accounted for in profit calculations.
Summary
Overheads consist of indirect costs that must be shared across products. Accurate costing involves careful allocation (when wholly attributable), apportionment (when shared), and reapportionment (to assign service centre overheads to production). Only once all overheads are in production centres can they be absorbed by products using appropriate bases such as labour hours or machine hours. Failure to assign overheads fairly results in distorted product costs.
Key Point Checklist
This article has covered the following key knowledge points:
- Define and distinguish allocation, apportionment, and reapportionment of overheads
- Identify and explain the role of production and service cost centres
- Select suitable bases for sharing different overheads
- Allocate all service cost centre overheads fully to production cost centres
- Distinguish the direct, step down, and reciprocal methods of reapportionment
- Apply absorption rates to assign overheads to products
- Understand the impact on product costing and absorption
- Recognise the implications of under- and over-absorption
Key Terms and Concepts
- Overheads
- Allocation
- Apportionment
- Reapportionment
- Cost centre
- Overhead Absorption Rate (OAR)