OVERHEAD ACCOUNTING PART 4 - PowerPoint Presentation

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OVERHEAD ACCOUNTING PART 4

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.

Computation of machine hour rate(

mhr)

2. The

fixed or standing overheads are

totaled

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

Types of overhead rates

Overhead absorption rates can be :

Actual & predetermined rates

Blanket & multiple rates

Actual Overhead rates

Actual rate

: is the overhead rate arrived at after computation.

actual Oh. absorption rate = actual overheads

actual base

The major limitation of actual rate is it cannot be computed till the end of the accounting period as a result it leads to delay in computing the cost of the product. Thereby resulting in fixing the selling price of the product.

Predetermined overhead rate

Predetermined rate

: is an estimated rate determined in advance and is used for computing the cost of the product and fixing the selling price.

Predetermined oh. Ab. rate =

Estimated amount of overheads

Estimated base

Facilitates cost control as the actual ohs. can be compared with the predetermined ohs.

Helps to derive benefits of standard and budgetary costing

Blanket & multiple rates

Blanket rate: is a single overhead rate for the entire factory. Can be used:

For small firms producing single products

Output is of uniform nature

Blanket rate = Total ohs. For the factory

Total no. of units for the factory

Multiple rates

: means a number of separate rates used for each

deptt

. or cost centre

Blanket & multiple rates can be either actual or predetermined

Over & under absorption of factory overheads

When the actual overheads Rates are used

,

the absorbed overheads will be equal to the actual overheads . Thus

there are no under or over absorption of overheads.

When predetermined rates are applied

overheads

absorbed may not be equal to the amount of the actual overheads incurred. Thus this

may result in under or over absorption of overheads.

Over & under absorption of factory overheads

Overabsorbtion or

O

ver recovery of overheads:

Results in over stating the cost of jobs/ processes

Results in over stating the cost of production

Underabsorbtion or Under recovery of overheads:

Results in assigning lower cost to the jobs/processes

Results in understating the cost of production

When the amount of ohs. Absorbed > amount of actual ohs

When the amount of ohs. Absorbed

<

amount of actual ohs

Causes of over & under absorption of overheads

Faulty estimation of overhead cost

Faulty estimation of quantity or output

Faulty estimation of the base

Unforeseen changes in the production capacity

Unexpected changes in the methods of production

Seasonal fluctuations in the amount of overheads in certain industries

Accounting treatment of under & over absorption of

overheads

Under or over absorption of ohs affects the COP. Under absorption understates it and over absorption inflates the COP. The methods for treating this can be :

Application of supplementary rate

Writing off to costing profit & loss account

Carry over to the next year

Application of supplementary rate

If the amount of under or over absorption is significant then supplementary oh. Absorption rate is used

Supplementary oh. Rate = actual ohs. – Absorbed ohs

Actual base

(this can be positive or negative)

In case of under absorption, adjustment is done by adding this rate to the predetermined rate

In case of over absorption the supplementary rate is subtracted from the pre determined rate

Writing off to costing profit & loss account

This method is used:

when the under or over absorbed amount is quite negligible/insignificant

When it arises because of abnormal factors such as idle capacity, defective planning

the under or over absorbed amount is transferred to the costing P & L A/c

Major drawback is COP will either be under or over stated and will affect valuation of stocks (WIP and FG) and will get transferred to the next year

Carry over to the next year

Under this method the under or over absorbed amount of overheads is transferred to overhead reserve account or suspense account and carried forward to the next year.

This method is considered suitable:

where normal business cycle extends to more than one year

Business is of seasonal nature products

The business is absolutely new

Treatment of certain items in cost accounts

interest on capital

Packaging expenses

Bad debts

Research and development

depreciation

Past year questions

What do you mean by absorption of ohs? Discuss different methods of absorption of factory ohs.

What is the importance of machine hour as a basis for absorption of factory ohs?

What are the causes of under/over absorption of factory ohs.?

Explain the treatment of over & under absorption of ohs. In cost accounting?

Distinguish Between allocation, apportionment & absorption of ohs.

Past year questions

Discuss the treatment of the following items in the cost accounts

Interest on capital

Packaging expenses/ packaging material cost

Distinguish between:

Cost allocation & cost absorption

Fixed ohs and variable ohs.