Page 86 - DMGT202_COST_AND_MANAGEMENT_ACCOUNTING

Unit 5: Overheads

Overhead costs may be classified according to: (1) Functions, (2) Elements, and Notes
(3) Behaviour-wise classifi cation.

The fixed overhead rate serves as a measure of utilisation of the facilities while the extent
of idle capacity is indicated by under absorption.
The following are the main methods of absorbing factory overheads:
Percentage on direct material cost

Percentage on direct wages
Percentage on prime cost
Direct labour hour rate
Machine hour rate
Rate per unit of output

The overheads are under absorbed if the actual overheads incurred are more than the
overheads absorbed.
The overheads are over absorbed if the actual overheads incurred are less than the
overheads absorbed.

5.5 Keywords

Fixed Expenses: Expenses that are not affected by changes in output or sales such as rent, salaries,
etc.
Over Absorption of Overheads: The overheads are over absorbed if the actual overheads incurred
are less than the overheads absorbed.

Overheads: Overheads are those indirect costs which cannot be directly related to any product,
job or process, because they cannot be directly attached to production activities.
Semi-variable Expenses: Expenses that change in the same proportion to which output (or sales)
changes but not in the same ratio. Depreciation is not doubled if output is doubled it may be 50%
more. Semi-variable expenses are partly fixed and partly variable.

Under Absorption of Overheads: The overheads are under absorbed if the actual overheads
incurred are more than the overheads absorbed.
Variable Expenses: Expenses that change in the same proportion in which output (or sales) changes
for example, power consumed, indirect materials, insurance in transit, carriage outwards etc.

5.6 Review Questions

1. What are overheads? How are they classified? Discuss in detail with a chart.

2. Defi ne fixed, variable and semi-variable expenses giving examples of each.
3. Name the different methods of ‘absorption of factory overheads’ and explain any two of
them giving the merits and demerits of each.
4. What is Machine Hour Rate method? Explain and describe its areas of application.

5. Calculate Machine-hour Rate for Machine No. 5 which is one of five machines in operation
in a department of a factory.

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