Absorption of Overheads: More than one department and more than one product example

• We have already looks at the theory of overhead absorption here
• We have also looked at allocation and apportionment here
• We have also looked at the theory of how to calculate overhead absorption rates (OARs) and why
• Now we will look at a scenario where a business has more than one department in the factory and makes two or more products in this factory (department)
• In such cases we nee to allocate and apportion the overheads between the departments first
• We can then absorb the overheads in each department separately

The Question

Lux Furniture produces desks and chairs in the same factory. The factory has two departments, assembly
and finishing.

Each desk uses 3 kg of wood at a cost of $4 per kg., and takes 4 hours to produce – 3 hours in
assembly and 1 hour in finishing. Each chair uses 2 kg of wood at a cost of $4 per kg, and takes 1 hour to produce – half an hour in assembly and half an hour in finishing.

All labour is paid at the rate of $2 per hour.Fixed costs of production are estimated to be $700,000 p.a.. Of this total, $100,000 is the salary of the supervisors – $60,000 to Assembly supervisor, and $40,000 to Finishing supervisor. The remaining overheads are to be split 40% to Assembly and 60% to Finishing. The company expects to produce 30,000 desks and 20,000 chairs.

(Overheads to be absorbed on a labour hour basis)

Required:

1. Calculate the cost per unit for desks and for chairs

Solution

• Here we need an overhead analysis sheet

• Here the supervisor’s salary is allocated as we can attribute it to the relevant department
• On the other hand the other overheads are simply being apportioned according to the instruction given in the question. In some instances we are given a rationale e.g. floor area
• Now we will calculate the OAR to use when absorbing overheads into products. According to the question we need to use labour hours
• The formula for finding OAR is:
• \dfrac{\text{Budgeted Overheads Per Department}}{\text{Total of Absorption Basis Per Department}}
• Here we are using labour hours in both departments so for each department:
• \text{OAR for each department=}\dfrac{\text{Overhead total in department}}{\text{Total labour hours in department}}
• Since we already know the total overheads in each department as shown in the overhead analysis sheet above we now only have to find to total labour hours in each department

• Now that we have the total labour hours it is time to calculate the OARs for both departments
• For the assembly department:
• \dfrac{\text{\$300 000}}{\text{10 000 hours}}
• This gives an OAR of $3/hour i.e. for each hour a product spends in the Assembly department must absorb(be charged with) $3
• For the finishing department:
• \dfrac{\text{\$400 000}}{\text{40 000 hours}}
• This gives an OAR of $10/hour i.e. for each hour an item spends in the Finishing department it should absorb (be charged with) $10
• Now that we know these things we can create the cost cards for both desks and chairs

• The cards clearly show the total cost of both desks and chair that include fixed cost
• A more detailed example of overhead analysis can be found here

To access more topics go the ZIMSEC Advanced Level Accounting page

To access more topics go to the Cambridge AS/A level page