1.1 Introduction

Definition: Combination overhead cost allocation method is an approach of overhead cost allocation which involves use of various direct cost basis when allocating different overhead costs over the projects. The approach is such that one type of overhead may be allocated using for example direct material cost basis which is a direct expense, another type of overhead is allocated using another category of direct cost basis such as direct labor and even another type of overhead cost may be allocated using another direct cost such as direct expenses.

Example

Amazing co. ltd. manufactures all types of construction raw materials. Currently, the firm is manufacturing four types of construction products as per the following departments

i). As per the General Ledger (GL), there are two types of overheads, namely;

W-Overhead cost which was totaling to \$3,000

Y-Overhead cost which was totaling to \$5,000

ii). The management of Amazing co. ltd feels that W-overhead category is driven by direct material cost. So, direct material cost is used as the base for allocating W-overhead cost to the various departments.

iii). The management of Amazing co. ltd also feels that Y-overhead category is driven by direct labor cost. So, direct labor cost is used as the base for allocating Y-overhead cost to the various departments.

Required

i). Show how the two types of overheads (W and Y) were allocated to the departments

ii). Determine the total production cost (i.e., prime cost-plus overhead cost) thereof.

Solution

Workings

W-1 computation of proportions (percentage) of allocating W-overheads.

NB-1: That W-overhead cost is driven by direct material cost. Hence, it is the base of allocation.

W-2 computation of proportions (percentage) of allocating Y-overheads

NB-2: That W-overhead cost is driven by direct labor cost. Hence, it is the base of allocation.

ii). Determination of the total production cost from all the departments.

Concluding remark

The aforementioned methods of overhead allocations are sure way of allocating the overhead cost. This is the approach/methodology used when it is crystal clear about the drivers or causes of changes of overhead costs. But sometimes it is not clear what causes the overhead costs to change. In other words, there is no specific overhead drivers/causes of overhead cost. In such a scenario, the management uses overhead apportionment methods. See the following discussion.

About the Author - Dr Geoffrey Mbuva(PhD-Finance) is a lecturer of Finance and Accountancy at Kenyatta University, Kenya. He is an enthusiast of teaching and making accounting & research tutorials for his readers.