Absorption of factory overheads Introduction Once departmentalization both primary amp secondary is completed the total overhead cost pertaining to a production department or cost centre is to be charged to the cost of products cost units ID: 1029776
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1. OVERHEAD ACCOUNTING PART 3
2. Absorption of factory overheadsIntroduction: Once departmentalization (both primary & secondary) is completed , the total overhead cost pertaining to a production department or cost centre is to be charged to the cost of products cost units. The toal cost of the production deptt after departmentalisation consists of : its own indirect cost (I.mat., I.Wages or I.Exp)Cost allocated & apportioned to production depttCosts of service deptt. reapportioned to production deptt
3. ABSORBTIONThe process of charging of overhead from cost centres( production deptt) to products or services by means of an absorption rate is called absorption of overheads.Steps involved:Computation of overhead rate for each production deptt Application of overhead absorption rate to cost unit/ product
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5. Computation of overhead Absorption rateAbsorption rate is the rate at which overheads are charged to different cost units/ products. There are 6 methods for this discussed further in the slides.Oh. absorption rate = Total overheads of the cost centre Total amount/ units in the base
6. Application of rates to cost unit To calculate the overhead cost of each unit the overhead rate is multiplied by the number of units Overhead absorbed = Overhead rate x No. of units
7. Methods of Absorption of factory overheads Production unit methodDirect material cost percentage rateDirect wages cost percent ratePrime cost percentage rateDirect labour hour rateMachine hour rate
8. Production unit methodUnder this method the base is the number of units produced. Oh. Absorption rate = Amount of production ohs. No. of units produced in the deptt
9. Direct material cost percentage rateUnder this method the base is the direct material cost. Oh. Absorption rate = Production ohs. Direct material cost
10. Direct wages cost percent rateUnder this method the absorption rate is computed by taking direct wages as the base & expressing it as a percentage. Oh. Absorption rate = Production ohs. x 100 Direct labour cost
11. Prime cost percentage rateThis method takes the prime cost (DM + DL + DE) as the base to compute the overhead absorption rate.Oh. Absorption rate = Production overheads x 100 Prime Cost
12. Direct labour hour rateUnder this method the absorption rate is computed by taking number of labour hours worked by the labourOh. Absorption rate = Production overhead Direct labour hours
13. Machine hour rateUnder this method the base is taken as the number of hours the machine has worked. Also known as the machine hour rate. ( it is simply the cost of running the machine for one hour)Machine hour rate = Production overhead No. of machine hours
14. Computation of machine hour rate(mhr) MHR refers to the overhead cost of running a machine for one hour Steps for computation:1. The overheads concerning the machine are divided into fixed & variable overheads. Fixed are those that remain constant irrespective of the use of the machine eg. rent, lighting, supervisor salary etc. variable are those that vary with the use of the machine eg. Depreciation, repairs, power etc.
15. Computation of machine hour rate(mhr) 2. The fixed or standing overheads are totalled and then divided by the machine hours to obtain fixed overhead hourly rate .For each variable overhead, per hour rate is individually computed. The total of fixed & variable hourly rate are summed up to give the final MHR
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