Calculation of Predetermined Overhead rate and Allocation of Factory Overhead

This article explains the calculation of predetermined overhead rate and allocation of factory overheads. It also discusses the concept of under and over application of overheads. Additionally, it provides a solution to a revenue and cost analysis problem and suggests the alternative that leads to incremental revenue.

Solution-1
(a) Calculation of Predetermined Overhead rate
Aloe Ltd.
Predetermined overhead rate = Budgeted factory overheads/Budgeted units of production
= 499,200/104,000
= $ 4.80
Basil Ltd.
Predetermined overhead rate = Budgeted factory overheads/Budgeted direct labor hours
= 888,160/164,000
= $ 5.42
(b) Allocation of factory overhead
Aloe Ltd.
Actual Units of production = 109,600
Predetermined overhead rate = $ 4.80
Overheads applied = $ 526,080
Actual overheads incurred = $ 528,000
Under application of overheads = 528,000-526,080
= $ 1,920
Basil Ltd.
Actual direct labor hours = 174,000
Predetermined overhead rate = $ 5.42
Overheads applied = $ 942,316
Actual overheads incurred = $ 860,000
Over application of overheads = 942,316-860,000
= $ (82,316)
Conclusion
Allocation of overheads is an important factor in cost accounting. This allocation of overhead is done
with the help of predetermined overhead allocation rate. This predetermined overhead allocation rate is
calculated by dividing the budgeted overheads with budgeted activities, which differs from companies to

companies. After this, allocation of overheads is done according to this predetermined overhead
allocation rate and the allocated overheads are compared with the actual overheads incurred. If the actual
overheads incurred are in excess of applied overheads then this situation is known as under application of
overheads and similarly, if the applied overheads are in excess of actual overheads then this situation is
known as over application of overheads.
In the given case, the company Aloe Ltd. allocates the overheads on the basis of units of production. The
resultant predetermined overhead rate for this company is $4.80 and the allocated overheads are $526,080
whereas the actual overheads are $528,000. Since, the actual overheads are in excess of applied
overheads, so the company has an under application of overheads by $1,920.
Similarly, in the company Basil Ltd., the company allocates the overheads on the basis of direct labor
hours. The resultant predetermined overhead rate of the company is $5.42 and the allocated overheads
comes to $942,316 whereas the actual overheads are $860,000. Since, the applied overheads are in excess
of actual overheads, the company faces a situation of over application of overheads by $82,316.

Solution-2
Given Information
Revenue for the first six months 2020
(Amount in $)
Particulars Jan Feb Mar Apr May June Total
Revenue 10,000 50,000 80,000 25,000 80,000 60,000 305,000
Schedule of estimated cash collections from revenue for the first six months of 2020
(Amount in $)
Particulars Jan Feb Mar Apr May June Total
Cash collection
- 70% in the month
following billing - 7,000 35,000 56,000 17,500 56,000 171,500
- 30% in the 2nd month
following billing' - - 3,000 15,000 24,000 7,500 49,500
Total cash collection - 7,000 38,000 71,000 41,500 63,500 221,000

Solution-3
Calculation of costs under both the alternatives
(Amount in $)
Particulars Adventure 1 Adventure 2 Differential
Nature of service Rock climbing
adventure
White water
rafting adventure
David's time 1,100 1,100 -
Specially fitted-out SUV 2,800 2,800 -
Cost of food & equipment 1,800 1,360 440
Fixed setup costs 2,500 2,500 -
Total costs 8,200 7,760 440
Calculation of revenue under both the alternatives
(Amount in $)
Particulars Adventure 1 Adventure 2 Differential
Nature of service Rock climbing
adventure
White water rafting
adventure
Revenue 8,600 7,200 1,400
Total revenue 8,600 7,200 1,400
Analysis of Profit under both the alternatives
(Amount in $)
Particulars Adventure 1 Adventure 2 Differential
Nature of service Rock climbing
adventure
White water rafting
adventure
Revenue 8,600 7,200 1,400
Costs 8,200 7,760 440
Profit 400 (560) 960
Conclusion
Using the differential income and expenses, the David should provide the adventure with rock climbing
of 10 persons as it leads to an incremental revenue of $960.