Allocation and Apportionment of overhead including machine hour rate

In cost accounting, the allocation and apportionment of overheads are crucial for accurately determining the cost of products. Overheads are indirect costs that cannot be directly attributed to specific cost objects, like products or services.

Allocation of Overhead

Allocation refers to the process of assigning entire overhead costs directly to a specific cost center or department that exclusively incurs the overhead. This process is straightforward when there is a direct relationship between the overhead and the cost center. For example, the salary of a department manager can be entirely allocated to their respective department.

Apportionment of Overhead

Apportionment is used when overhead costs relate to more than one cost center and need to be divided in a rational and equitable manner. This distribution is based on estimates and may use various bases for apportionment, such as floor area (for rent and utilities), machine hours (for machine-related expenses), labor hours, or units produced, among others.

Steps in Apportionment of Overhead

• Identify Overheads:

First, gather all overhead costs that need apportionment.

• Select Bases for Apportionment:

Choose appropriate bases that reflect the way in which the services (represented by the overheads) are consumed by different cost centers.

• Calculate Apportionment Ratios:

Establish the proportion or ratio for each cost center based on the chosen base.

• Distribute Overheads:

Apply the ratios to distribute the overhead costs among the cost centers.

Incorporating Machine Hour Rate

The machine hour rate is particularly relevant for allocating and apportioning overheads related to machinery and equipment. This rate is used as a base for apportioning the costs directly associated with machine usage.

Steps to Calculate Machine Hour Rate:

• Total Machine-Related Overheads:

Sum all costs related to the operation and maintenance of a machine, including depreciation, repairs, electricity, and other running costs.

• Total Machine Hours:

Calculate the total hours the machine is operated during the period.

• Machine Hour Rate Calculation:

Divide the total machine-related overheads by the total machine hours to find the rate per machine hour.

This rate can then be used to allocate costs to products based on the number of machine hours each product requires during its production. This method ensures that products requiring more machine time absorb a correspondingly higher share of overheads, reflecting their actual consumption of resources.