Methods of Absorption - I - Factory Overheads Distribution

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Methods of Absorption - I -Factory Overheads Distribution:


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The methods of absorption are to be applied in order to absorbfactory overhead to individual articles or jobs. The rate which

is used to charge overhead cost to the articles or jobs iscalled as absorption rate. We are going to discuss two of themethods in this chapter and they are Percentage on Direct

Materials and Percentage on Direct Wages.


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(i) Percentage on Direct Materials :An absorption rate base on materials cost is acquired bydividing aggregate approximate factory overhead by aggregatedirect materials cost likely to be used in manufacturing course.

For instance, if factory overhead is $150,000 and materialscost is $125,000, the absorption rate will be as below:

150,000125,000


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Every job or manufactured goods would be charged on thebase of 120% absorption rate. For instance, if materials costof article is $25,000, the factory overhead to be charged fortheir article would be $30,000 i.e. (25,000 * 120%).


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Merits:The percentage on direct material cost method isuncomplicated and effortless to learn and apply. This method

will give correct overhead cost figure where the prices ofraw materials do not differ importantly, where quantity andcost materials in every article are similar and where

processing for the varied articles are also similar. It isconstructive in very simple forms of small businessconcerns.


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Demerits:

1. There is no rational association amidst material cost of

an article and factory overhead utilized in manufacture.

2. Material prices are matter to changes somewhatfrequently and this phenomenon tends to high or low

overhead costs even though overhead figures stayunaffected.


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Demerits:

3. Most of the overhead expenses diverge with time phase.

For instance, an article or job using inexpensive materialshowever a longer period of processing must bear more foroverhead as contrasted to a job or an article which utilizescostly materials but a shorter period of processing.

However the use of direct material cost completely pays noattention to the time phase which is a significant part indistribution of overhead costs.


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Demerits:

4. This method is improper where part of the materialssurpass through all stages and part through only somestages.

5. The mere aspect that a job takes materials of a verycostly nature does not mean that the overhead occurred on

that job or article will also be weighty. If the materials costbasis is used to charge overhead, the product using costlymaterials will in this crate be charged with more than itspart of overhead.


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(ii) Percentage on Direct Wages:

This method is computed as below:Factory Overhead

Direct Labor Cost

5. The mere aspect that a job takes materials of a verycostly nature does not mean that the overhead occurred on

that job or article will also be weighty. If the materials costbasis is used to charge overhead, the product using costlymaterials will in this crate be charged with more than itspart of overhead.

100x


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If for instance, factory overhead is $100,000 and thedirect labor cost is also $100,000 then absorption ratebased on direct wages will be 100%.

A job or an article with a direct labor cost of $15,000would be charged with $15,000 for factory overhead.


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Merits:

1. It is effortless to operate and comprehend.

2. It judges the time aspect as labor cost is calculated bymultiplying number of hours expended on work by anhourly labor rate.

3. Labor rate changes however less often than that ofprices of materials.


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Demerits:1. It is based on cost of direct labor which may not

reflect precisely the contribution of factory overheadin the cost of product. Many costs such as taxes,

property insurance, and depreciation are task oftime

2. It does not considers disparities if any, in the rates

of compensation for various types of labor andhence, the wages incurred on various jobs are notrequired in the like proportion as the hoursexpended.


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Methods of Absorption - I - Factory Overheads Distribution