Question

State why hourly rates are generally accepted to be the most appropriate method of overhead absorption, and comment upon other methods that may be used.

Answer 1

Answer:

There various methods and techniques of absorbing manufacturing overhead: 1. Direct Material Cost Method 2. Direct Labour Cost (or Direct Wages) Method 3. Prime Cost Percentage Method 4. Direct Labour Hour Method 5. Machine Hour Rate Method 6. Rate per Unit of Production Method 7. Sale Price Method.

Hourly rates; Machine hour rate method of absorption is used in those industries where machines are extensively used for production and manual labour is negligible or plays very minor role.

hour rate as “an actual or predetermined rate of cost apportionment or overhead absorption, which is calculated by dividing the cost apportioned or absorbed by the number of hours for which a machine is operated or expected to be operated”. It is not desirable to calculate a blanket rate or one single rate for the entire factory, since the cost, horse power, capacity of machines differ. It is appropriate to calculate multiple rates.

hour rates= factory overhead / machine hours

Machine hour rate method is suitable when machines are extensively used in production.

Merits:   

(1) It is a scientific method of absorption, since time factor is taken into account.

(2) Cost of operating different machines is computed and efficiency of different machines is compared.

(3) The difference between machine work and manual work, cost wise and quality wise can be ascertained.

(4) Machine hour rate reveals idle time.

Demerits:   

(1) It involves additional cost in ascertaining working hours of machines.

(2) Expenses not connected to machine operation are ignored.

(3) It is inaccurate when manual labour plays equally important role in production.