what are the two factors of importance to differential absorption

In this article we will talk over about the Absorption of Overhead:- 1. Definition Absorption of Overhead 2. Bases of Absorption three. Method of Assimilation of Overheads—Option of Method.

Definition Absorption of Overhead:

Overhead absorption is a procedure by which overheads are included in the total toll of a production. According to Terminology of Cost Accountancy overhead absorption is defined every bit "the charging overheads to cost units by ways of rates separately calculated for each price heart. In most cases the rates are pre-determined".

When dissimilar products are made which crave unlike production processes or for jobs using identical facilities, overhead assimilation becomes very much essential.

The overhead to be captivated by a cost unit is computed with reference to 2 factors:

(i) The overheads owing to a given toll centre; and

(2) The number of units of the absorption base i.e. labour hours, auto hours etc.

And then, Overhead Absorption Charge per unit:

Bases of Absorption:

The objective of overhead absorption procedure is to include in the total cost of a production an appropriate share of a firm's total overheads. Diverse bases to blot overheads have been developed.

These bases are:

(i) Direct labour hour overheads absorption rate (OAR) .

Total overheads ÷ Direct labour hours.

(two) Direct wages OAR = Full overheads ÷ Direct wages ten 100.

(iii) Direct Materials OAR = Full overheads ÷ Straight Materials used.

(iv) Prime Cost OAR = Total overheads ÷ Prime Cost x 100.

(v) Automobile hr OAR = Total overheads ÷ Total Machine Hours.

Selection of Base :

Sure factors are considered for choosing a particular and appropriate base for absorption of overheads, merely final choice is a matter of sentence arid mutual sense. Permit united states of america talk over them 1 past one.

1. Direct labour hour basis:

This method of absorbing overhead is most appropriate in a labour intensive cost heart. Moreover, it is easy to use. Nowadays, nigh production methods involve substantial utilize of mechanism and and then the labour 60 minutes method may go increasingly inappropriate.

2. Machine hour rate:

This method is most appropriate, in a mechanised cost heart, i.e. where production is mainly carried on mechanically. In such a cost centre, many of the overheads are related to the machinery, this method of assimilation of overheads reflects more than accurately the incidence of overheads in the total cost.

And so, where a large function of the overhead is incurred by the utilize of mechanism, the use of machine hour rates can be suggested.

three. Direct Material:

This method of overhead assimilation is non commendable since its use leads to some absurd anomalies.

Though this method is simple and piece of cake to sympathize and apply, information technology suffers from the post-obit disadvantages:

(i) There is no logical relationship betwixt direct materials cost of a product and factory overhead.

(ii) Nowadays, in every economy, material prices fluctuate substantially. This change in price leads to loftier or low overhead costs, even though overhead costs remain unchanged.

(iii) Almost of the overhead expenses vary with fourth dimension, they accrue on fourth dimension footing and not on materials consumed. The use of straight materials price as the basis of absorption totally ignores the time factor which is considered equally an important cistron in resource allotment of overhead.

(iv) This method is not rational when part of the materials passes through all processes and office through only some processes.

iv. Direct Wages:

This method is oft used in practice. This is computed in the post-obit way:

This method is simple to operate and understand. It considers the fourth dimension factor and so it is a rational method for the assimilation of factory overheads. Under this method, labour toll is computed by multiplying number of hours spent on work by an hourly labour charge per unit. This signifies that the more hours worked, the college the labour cost and greater the charge for mill overheads.

This method is beneficial where product is compatible. The post-obit are the demerits of this method:

(i) Information technology does non consider the share of other factors of production other than direct labour. In many concerns, machinery is considered the major factor of produc­tion but not the labour. In such example, motorcar 60 minutes is recommended as the base of operations of absorption.

(2) Information technology does not take into account the variations in the rates of wages for different personnel. Where wage rates vary and different incentive schemes are in existence, correlation between wages paid and time elapsed does not exist.

If there is but one rate of wage per hour paid throughout a cost centre and no course of incentive scheme exists and then the Direct Wages system would be more appropriate to utilise. Merely such a state of affairs is a distant possibility.

5. Prime Cost:

This method combines the full of direct materials toll and direct labour cost.

The formula is:

Advantages:

This method is unproblematic to operate as the prime toll data is easily available.

Disadvantages :

(i) Information technology ignores fourth dimension factor in absorbing factory overhead.

(ii) Since the method is a combination of direct materials and directly wages, it suffers from the shortcomings of both the methods.

(iii) Where the toll of materials forms a larger part of prime price, the fourth dimension factor will exist ignored.

(iv) Additional costs which arise due to the employ of costlier machines are ignored and thus, this method is likely to effect in an inequitable allocation of overheads.

Method of Absorption of Overheads—Pick of Method :

It is really a hard chore to choose the proper method of absorption of overhead. Out of the methods discussed previously the directly labour hour method is commonly the best method because most of the manufactory overheads are menstruation costs as they relate to time and not to the production.

If all the workers in a section or in a Cost Eye are paid wages at the aforementioned rate, direct labour hour method is to be followed. If the workers are paid at different rates, direct wages percentage rate is to be adopted.

Circumstances:

i. If the cost middle is labour intensive and the workers are paid at the same rate of wages

2. If the cost heart is labour intensive and the workers are paid at different rates of wages

3. If the cost centre is machine intensive

4. If the cost of materials is predominant

5. If the prime cost is predominant

Method to be followed:

1. Directly labour method

2. Direct wages per centum rate

3. Car hour charge per unit

4. Directly materials price percent

five. Prime price percentage rate.

Source Documents :

The post-obit are some of the primary documents from which overhead expenses can exist collected:

1. Store requisitions – Indirect, materials

ii. Job cards or tickets – Indirect labour

3. Purchase vouchers – Indirect materials

4. Salary or Pay Bills – Indirect labour

5. Subsidiary records – Indirect expenses Cash vouchers, Cash Book

6. Plant Annals – Depreciation

7. Charter Human action – Hire

viii. Local government assessment – Rates.

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Source: https://www.accountingnotes.net/cost-accounting/overheads/absorption-of-overheads-definition-bases-and-methods/4617