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# Methods of Absorbing Production Overheads (Part - 2) - Cost Accounting B Com Notes | EduRev

## B Com : Methods of Absorbing Production Overheads (Part - 2) - Cost Accounting B Com Notes | EduRev

The document Methods of Absorbing Production Overheads (Part - 2) - Cost Accounting B Com Notes | EduRev is a part of the B Com Course Cost Accounting.
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STEPS FOR CALCULATION OF MACHINE HOUR RATE

The following steps are required to be taken for the calculation of machine hour rate:

(i) Each machine or group of machine should be treated as a cost centre.

(ii) The estimated overhead expenses for the period should be determined for each machine or group of machines.

(iii) Overheads relating to a machine are divided into two parts i.e. fixed or standing charges and variable or machine expenses.

(iv) Standing charges are estimated for a period for every machine and the amount so estimated is divided by the total number of normal working hours of the machine during that period in order to calculate an hourly rate for fixed charges. For machine expenses, an hourly rate is calculated for each item of expenses separately by dividing the expenses by the normal working hours.

(v) Total of standing charges and machine expenses rates will give the ordinary machine hour rate.

There are two ways of computing the machine hour rate. According to the first method, only indirect expenses directly or immediately connected with the operation of the machine are taken into account, e.g., power, depreciation, repairs and maintenance, insurance, etc. The rate is calculated by dividing the estimated total of these expenses for a period by the estimated number of operating hours of the machines during the period.

It will be obvious, however, that in addition to the expenses stated above there may still be other manufacturing expenses such as supervision charges, shop cleaning and lighting, consumable stores and shop supplies, shop general labour, rent and rates, etc., incurred for the department as a whole and, hence, not charged to any particular machine or group of machines. In order to see that such expenses are not left out of production costs, one should include a proportionate amount of such expenses, in the expenses of machines, before proceeding to compute the machine hour rate. Some people even prefer to add the wages paid to the machine operator in order to get a comprehensive rate for working a machine for one hour. But it is preferable to include the machine operator’s wages in direct wages.

Generally, all expenses are not allocated to machines; it will be, therefore, necessary to calculate another rate for charging the general departmental expenses to production. This second rate will be calculated on the basis of direct labour hours or wages. In effect, therefore, both the machine hour and the labour hour rates will be applied, though separately.

As regards the superiority of one method over the other, it may be considered that the recovery of the direct machine expenses without the proportion of the departmental expenses is likely to be more accurate than when these are made part thereof, because the general departmental expenses are not connected with the actual operation of the machines except remotely. Therefore, when merged with the direct machine expenses for the purpose of computing the machine hour rate, the resultant rate may not be as accurate or as it would be otherwise. But the second method has the advantage of simplifying the routine and procedure of applying manufacturing overheads in as much as only the machine hour rate has to be applied for charging the general departmental overhead.

Advantages of Machine Hour Rate

(1) Where machinery is the main factor in production, it is usually the best method of charging machine operating expenses to production.

(2) The under-absorption of machine overheads would indicate the extent the machines have been idle.

(3) It is particularly advantageous where one operator uses several machines (e.g., automatic screw manufacturing machines) or where several operators are engaged in one machine (e.g., the belt press used in making conveyor belts).

(4) It is a logical method and takes into consideration the time factor completely.

Disadvantages of Machine Hour Rate

(1) Additional data concerning the operating time of machines, not otherwise necessary, must be recorded and maintained.

(2) As general data concerning rates for all the machines in a department may be suitable, the computation of a separate machine hour rate for each machine or group of machines would mean additional work.

(3) It gives inaccurate result if hand labour is equally important. If production is carried on in different departments having different degrees of mechanisation, the best method would be the machine hour rate. The machine may be treated as a small department or cost centre and the total cost for, say, a month may be divided by the effective hours for which the machine is usually used. Suppose the total cost of running a machine, including, expenses on rent, lighting, insurance, supervision, depreciation, power, etc. for a month is Rs.12,600 and the total number of hours is 200 including 20 for maintenance, the machine hour rate is Rs.70 i.e. 12,600/180. If the machine is used on job for 5 hours, the job should be charged with Rs.350 i.e. Rs.70 x 5 as production overheads.

[In small firms however, quite good results are obtained by working out the percentage of factory overheads to direct wages or by dividing the total factory overheads by the total number of direct labour hours (productive labour hour rate); production overheads may then be charged to jobs or products using one of these methods. Office expenses are usually charged as a percentage of works cost].

Illustration 4

Following information is made available from the costing records of a factory:

(i)

(i) The original cost of the machine           : Rs.1,00,000

Estimated life                                             : 10 years

Residual Value                                          : Rs.5,000

Factory operates for 48 hours per week  : 52 weeks in a year

Allow 15% towards machine maintenance down time.

5% (of productive time assuming unproductive) may be allowed as setting up time.

(ii) Electricity used by the machine is 10 units per hour at a cost of 50 paise per unit.

(iii) Repair and maintenance cost is ` 500 per month.

(iv) Two operators attend the machine during operations alongwith two other machines.  Their total wages including fringe benefits, amounting to Rs.5,000 per month is paid.

(v) Othe overheads attributable to the machine are Rs.10,431 per year.

Using above data, calculate machine hour rate.

Solution

Computation of Machine Hour Rate:

 Particulars Per Year Rs. Per Year Rs. Standing Charges Wages for Operator (Rs.5,000 × 12)/3 20,000 Other Overheads 10,431 Standing charges per hour (30,431/2,015) 15.10 Machine Exoences [(1,00,000 – 5,000)/10]/2015 4.71 Repair and maintenance (5.00 × 12/2,015) 2.98 Electricity (10 units @ 50 paise) 5.00 Machine Hour Rate 27.79

Working Note:

Calculation of effective machine hours:

 Total working hours per year (4 × 52) 2,496 Less: 15% maintenance time 375 2,121 Less: 5% for setting up time 108 Effective time 2,015

Illustration 5

The following information has been collected from the cost records of a small company for the year ended 31st March, 2014:

 Direct Materials 2,50,000 Direct Labour 2,00,000 Direct Expenses 20,000 Works Overheads 1,60,000 Office Expenses 94,500

The total number of direct labour hours were 1,00,000 involving 40,000 machine hours. What should be the price quoted for a job involving 2,000 labour hours @ Rs.3 per hour, 1,000 machine hours and Rs.10,000 in direct materials if the profit desired is 20% on the selling price?

Solution:

It should be realised that three methods for apportioning production overheads are possible in the problem. These are:

(i) Percentage on Direct Wages: 80%, i.e.,

(ii) Productive Labour Hour Rate: Rs.1.60, i.e. Rs.1,60,000 ÷ 1,00,000

(iii) Machine Hours Rate: Rs.4.00, i.e. Rs.1,60,000 ÷ 40,000.

The total work cost comes to Rs.6,30,000; office expenses are Rs.94,500. The percentage of office expenses to works cost is 15%, i.e.,

Statement of Cost of Job No.............

 Percentage on  Direct wages Rs. Productive Labour Hour rate Rs. Machine Hour rate  Rs. Direct Materials 10,000 10,000 10,000 Direct Labour 6,000 6,000 6,000 16,000 16,000 16,000 Works Overhead* 4,800 3,200 4,000 Works Cost 20,800 19,200 20,000 Office Expenses (15% of Works Cost) 3,120 2,880 3,000 23,920 22,080 23,000 Profit (25% on cost, or at 20% on selling price) 5,980 5,520 5,750 Price 29,900 27,600 28,750

One should note that by using a different method a different figure is obtained.

Illustration 6

Calculate the machine hour rate from the following:

 Rs. Cost of machine 18,000 Cost of installation 2,000 Scrap value after 10 years 2,000 Rates and rent for a quarter for the shop 600 General lighting 200 p.m. Shop supervisor’s salary Rs.6,000 per quarter Insurance premium for a machine 120 p.a. Estimated repair 200 p.a. Power 2 units per hour @ Rs.150 per 100 units Estimated working hours p.a. 2,000

The machine occupies 1/4th of the total area of the shop. The supervisor is expected to devote 1/6th of his time for supervising the machine. General lighting expenses are to be apportioned on the basis of floor area.

Solution:

Computation of Machine Hour Rate

Machine No.:

 Per yearRs. Per hourRs. Standing Charges: Rent and Rates - 1/4th 600 General lighting as per floor area - (200x12)/4 600 Supervisor’s Salary (6,000x4)/6 4,000 Insurance premium 120 Total yearly standing charges 5,320 Hourly rate (5,320 ÷ 2,000) 2.66 Machine Expenses: Depreciation Cost 18,000 Installation 2,000 Total 20,000 Less: Scrap value 2,000 Amount to be written off 18,000 0.90 Repairs etc. — Rs.200/2,000 hours 0.10 Power 2 units @ Rs.1.5 per unit 3.00 Machine Hour Rate 6.66

Combined machine hour and direct labour hour rate

Where the work is done partly by machines and partly by manual labour, a combination of Machine Hour and Direct Labour Hour Method is used for the purpose of absorbing works expenses. Such expenses as are inseparable from the running of the machine, are allocated on the basis of the Machine Hour Rate and the other expenses which are not directly attached to the machines are allocated on the basis of the direct labour hour basis. In fact, because of inconvenience, it may not be possible to cover all the items included in factory overheads while computing machine hour and direct labour hour rates. For example, it is likely that such overhead items as salary of the works manager or the factory clerical staff, stationery, etc. are left out. To cover such items also there will be need to apply the method of the percentage of wages to overhead (remaining items only). Suppose the various rates worked out are the following:

The total wages (direct) for a month come to  Rs.1,50,000 and the items of overheads   not  covered  while  computing  the  rates  mentioned  above  totalled Rs.22,500 per  month.  For a  job undertaken during  the month,  the  following information is available:

Total of direct wages Rs.600

The overheads to be applied to the job will be Rs.790 i.e.

 Rs. Machine A   10 hours @ Rs.35 350 Machine B     5 hours @ Rs.45 225 Workers Category 1   25 hours @ Rs.3.00 75 Category 2   20 hours @ Rs.2.50 50 "Remaining" overheads (15% on Rs.600) 90 790

Rate per unit of production

This is also known as unit cost method. Under this method, actual or pre-determined overhead rate is calculated by dividing the overheads to be absorbed by number of units produced or expected to be produced. The rate is calculated as under:

This method is very simple. The main limitation of this method is that it is restricted to those concerns which produce only one item of product or a few sizes, quantities or grades of the same product.

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## Cost Accounting

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