# Methods of absorption ii - factory overheads distribution prime cost percentage

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Published on February 7, 2014

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Methods of Absorption - II - Factory Overheads Distribution Prime Cost Percentage:

The prime cost basis unites the aggregate of direct materials cost and direct labor cost and uses this aggregate a basis for charging overhead. The formula used in ascertaining the rate is: Factory Overhead x 100 Prime cost

Illustration: If in a case the factory overhead is \$150,000 and prime cost is \$300,000. Calculate the prime cost percentage rate. Solution: 150,000 300,000 x 100 = 50 % of Prime Cost

Merits: This method is simple to function. It integrates both materials and labor in charging overhead to every job or article. The prime cost data is easily accessible devoid any extra difficulty of accretion. Demerits: 1. Two factors that is, materials and labor both of which has many demerits influence the charging of factory overhead to jobs and articles.

Demerits: 2. Where the cost of materials is a larger part of the prime cost, the time factor (direct labor costs) will be uncared for which is more connected to the factory overhead. 3. It pays no attention to time factor in absorbing factory overhead. 4. It can be helpful to only a few sections where the type of labor and value of materials used are invariable.

Unit of Production Basis The unit of production method is the simplest and most direct method of charging factory overhead. The unit may be a kilogram, a foot, an article or whatever unit of measure is used for the article. As a formula, the calculation is as follows: Factory Overhead Units of Production

Illustration: If for instance, let us presume the factory overhead as \$500,000 and the company plans to make 300,000 units during the subsequent period; compute the unit charge as a share of factory overhead. Also calculate the total unit charge for an order of 5,000 completed units. Solution : Unit Charge = \$500,000 / 300,000 units = \$1.67 Total unit charge for 5,000 units = 5,000 x 1.67 = \$8,333

Labour Hour or Production Hour Rate : One of the most extensively used methods for overhead application is the labour hour basis. Since many companies require direct labour employees to record their time spent on every job or in every department of a process cost factory, the data for absorption of overhead on this basis is readily available. The equation for ascertaining the overhead rate under this method is: Factory Overhead Direct Labour Hours

Illustration: Let us assume the factory overhead as \$200,000 and the direct labour hours as 100,000. Compute the overhead rate based on direct labour hours. Also compute total overhead rate for 2,000 labour hours. Overhead rate based on direct labour hours = \$200,000 / 100,000 hours = \$2 per hour Total Overhead Rate for 2,000 labour hours = 2,000 x \$2 = \$4,000

Machine Hour Rate The machine hour rate is used where the labour is carried out primarily on machines. The formula used in calculating the rate is: Factory Overhead Machine hours

Illustration: If factory overhead is \$150,000 and aggregate machine hours are 75,000. Compute the machine hour. Solution: (\$150,000 / 75,000 hours) = \$2

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