Overheads: Absorption Costing Method

Question 1.
Distinguish between Fixed overheads and Variable overheads. (May 2010, 2 marks)
Answer:
Fixed Overheads Vs. Variable Overheads
Fixed overheads are not affected by any variation in the volume of activity, e.g., managerial remuneration, rent etc. These remain the same from one period to another except when they are deliberately changed. Fixed overheads are generally variable per unit of output or activity e.g Rent,  Insurance, Depreciation, Audit fees etc.

Whereas, the variable overheads that change in proportion to the change in the volume of activity or output, e.g., power consumed, consumable stores etc. The variable overheads are generally constant per unit of output or activity, e.g. direct material, direct labour, commission on sale.

Question 2.
Following information is available for the first and second quarter of the year 2008-09 of ABC Limited:

You are required to segregate the semi-variable cost and calculate:
(a) Variable cost per unit; and
(b) Total fixed cost. (May 2009, 2 marks)
Answer:

Variable Cost per Unit =  Change in Semi Variable Cost  Change in Production 
= ₹30,0006,000 units 
= ₹ 5 per units

Total Fixed Cost = Semi Variable Cost – (Production × Variable Cost per Unit)
Total fixed cost in Quarter I:
= 2,80,000 – (36,000 × 5)
= 2,80,000 – 1,80,000
= 1,00,000
Total fixed cost in Quarter II:
= 3,10,000 – (42,000 × 5)
= 3,10,000 – 2,10,000
= 1,00,000

Question 3.
Distinguish Between between cost allocation and cost absorption. (May 13, 4 marks)
Answer:
Cost allocation: It is defined as the process of allotment or identification or assignment of whole items to cost centers or costs units. Thus the charging of direct cost to a cost centre or a cost unit is the process of allocation of costs.

Cost absorption : It is the process of absorbing all indirect costs (or Overheads) allocated or apportioned over particular cost centre or production deptt. by the units produced.

Question 4.
POR Ltd. has its own power plant, which has two users, Cutting Department and Welding Department. When the plans were prepared for the power plant, top management decided that its practical capacity should be 1.50,000 machine-hours. Annual budgeted practical capacity fixed costs are 9,00,000 and budgeted variable costs are ₹ 4 per machine-hour.
The following data are available :

Required:
(i) Allocate the power plant’s cost to the cutting and the Welding department using a single rate method n which the budgeted rate is calculated using practical capacity and costs are allocated based on actual usage.
(ii) Allocate the power plant’s cost to the cutting and welding departments, using the dual-rate method in which fixed costs are allocated based on practical capacity and variable costs are allocated based on actual usage.
(iii) Allocate the power plant’s cost to the cutting and welding1 departments using the dual-rate method in which the fixed-cost rate is calculated using practical capacity, but fixed costs are allocated to the cutting and welding department based on actual usage. Variable costs are allocated based on actual usage.
(iv) Comment on your results in requirements (i), (ii) and (iii). (May 2003, 2 + 2 + 2 + 2 = 8 marks)
Answer:
Working Notes :
1. Fixed Practical capacity cost per Machine Hour:
Practical Capacity (machine hours) – 1,50,000
Practical Capacity fixed cost (₹) – 9,00,000
Fixed Practical Capacity cost per machine hour
[₹9,00,0001,50,000Hr] – ₹ 6

2. Budgeted rate per machine hour (Using practical capacity):
= Fixed Practical capacity cost per machine hour + Budgeted Variable cost per machine hour.
= ₹ 6 + ₹ 4 = ₹ 1o.
(i) Statement showing Power Plants cost allocation to the cutting and Welding deptts. by using single rate method on actual usage of machine Hours:

(ii) Statement showing power plants cost allocation to the cutting and welding deptts. by using actual rate method:

(iii) Statement showing Power Plant’s cost allocation to the cutting and welding deptts. using dual rate method :

(iv) Comments: Under dual rate method, under (iii) and under single rate method under (i), the allocation of fixed cost of practical capacity of plant over each deptt. are based on single rate. The major advantage of this approach is that the uses deptts. are allocated fixed capacity . cost only for the capacity used. The unused capacity cost of ₹ 3,00,000 (₹ 9,00,000 – ₹ 6,00,000) will not be allocated to the uses deptts. This highlights the cost of unused capacity.

Under (ii) fixed cost of capacity are allocated to operating deptts. on the basis of practical capacity, so all fixed costs are allocated and there is no unused capacity identified with the power plant.

Question 5.
Write a note on ‘classification’, ‘allocation’ and ‘absorption’ of overheads. How does it help in controlling overheads? (May 1998, 5 marks)
Answer:
On the basis of a common base or characteristic features overheads are grouped into two or more classes: This is known as classification of OHE’s. There are no. of bases for classification. But the selection of a particular base for classification depends upon a no. of factors such as nature and size of the business, nature of product etc. However the following 3 bases are generally used for classification:
Answer:
On the basis of a common base or characteristic features overheads are grouped into two or more classes: This is known as classification of OHEs. There are no. of bases for classification. But the selection of a particular base for classification depends upon a no. of factors such as nature and size of the business, nature of product etc. However the following 3 bases are generally used for classification:

Function wise classification:

1. Factory or Production O/H: It includes :
   1. Stores overhead (expenses connected with purchasing and handling of materials).
   2. Labour overhead (costs related to labour).
   3. Factory and administration overheads (expenses connected with administration of the factory.
2. Office and Administration overhead: It includes :
   1. Office expenses (expenses on routine office work).
   2. Administration expenses (expenses on managerial personnel whether form in of salary or facilities).
3. Selling and distribution overhead: It includes :
   1. Selling expenses (expenses incurred to persuade customers and maintenance and expansion of market).
   2. Distribution expenses (expenses incurred to execute the orders.)

Behavioural wise classification:
If costs are classified on the basis of tendency to change with change in production volume or sales volume or activity level, costs are classified as:
1. Fixed costs: Fixed cost is one whose total amount remains fixed irrespective of change in level of activity. It is also known as “Period cost” or policy cost”.
e.g.: Rent, depreciation, audit fees, salaries and allowances, direct labour (if paid on time rate basis).

2. Variable Cost: Variable costs are the costs whose total amount changes in proportion to the output activity level.
e.g. : Direct material, direct labour (if paid on piece rate basis), sales representatives, commission.

3. Semi Variable Costs: Semi variable costs containing both fixed and variable elements which is thus partly affected by fluctuations in the activity level.
Fixed cost element remains constant for the activity level while variable cost element varies proportionately with the activity level.
e.g.: Costs of electric power, telephone expenses etc.
Graphically these 3 types of expenses are shown as below:

Note:
The amount of fixed cost times remains constant for a particular range of level of activity upto a specific period. This is known as “Relevant Range” and “ Relevant period’ respectively concept of relevant range is applicable to fixed cost as well as variable costs.

For Fixed Cost: It is related to the plant capacity or range of production level means after a certain range of production it can be hiked.

For Variable Cost: Per unit variable cost will behave differently outside the relevant range of production. It means it is constant upto that Relevant Range.
e.g.: Quantity discount available on the basis of certain limit.

Allocation of Costs:
Allocation is the process of identification of O/H with cost centre. If an expenses which is directly identifiable with a specific cost centre is known it is allocated to the same e.g.:

1. Power if separate meter for each cost centre is there.
2. Wage to indirect workers
3. Depreciation of plant and machinery
4.  Insurance of plant and machinery
5. Fuel oil for boiler, generation, ovens etc.

Absorption of OH :
Absorption is an excercise by which OH is properly spread over to production for the period. After OH is collected, a basis for absorption of OH is found out for each departments so that each product gets due share of OH. Thus OH absorption involves apportionment of OH relating to a department among units produced in that department.

Role of classification, allocation and absorption of overheads in controlling overheads:
The classification, allocation and absorption of overhead costs over different cost centres helps in two ways. Firstly, the overhead costs assigned to cost centres are used for cost control and performance evaluation purpose. These assigned costs are periodically totaled and listed on performance repeat which also has the figures of budgeted costs differences between budgeted and actual cost for each item of expenditure are highlighted in the performance reports and provide feedback information for performance evaluation and cost control purposes. Secondly, the accumulated production cost centre O/H costs are assigned in the second stage of the procedure to products to satisfy financial accounting requirements for inventory valuation.

Question 6.
Discuss the difference between allocation and apportionment of overhead. (May 2008, 2 marks)
OR
Distinguish between allocation and apportionment of cost. (May 2014, 4 marks)
Answer:
Cost allocation:
The term ‘allocation’ implies relating overheads directly to the various departments. The estimated amount of various items of manufacturing overheads should be allocated to various cost centers or departments.

Cost apportionment:
Those items of estimated overheads (like the salary of the works manager) which cannot be directly allocated to the various departments and cost centers are apportioned. Apportionment implies “the allotment of proportions of items of cost to cost centres or departments.” It implies that the unallocable expenses are to be spread over the various departments or cost centres on an equitable basis.

The differences between Allocation and Apportionment are as follows:

Basis of Difference	Allocation	Apportionment
Meaning	Identifying a cost centre and charging its expenses in full.	Allotment of pro-porjions of common cost to various cost centre.
Nature of expenses	Specific and identifiable	General and common
Number of centre (Deptt.)	One	Many
Basis	Allocate directly	Allocate Indirectly
Amount of overhead	Charge in full	Charge in proportion­able
Assumption	Not required	Required

Question 7.
State the bases of apportionment of following overhead costs:
(i) Air-conditioning
(ii) Time keeping
(iii) Depreciation of plant and machinery
(iv) Power! steam consumption
(v) Electric power (Machine operation) (Nov 2018, 5 marks)
Answer:
Basis for apportionment of overhead costs:

	Overhead costs	Basis for Apportionment
(i)	Air – Conditioning	Floor area, or volume of department
(ii)	Time – Keeping	Number of workers
(iii)	Depreciation of plant and machinery	Capital values
(iv)	Power/steam consumption	Technical estimates
(v)	Electric Power (Machine Operation)	Horse power of machines, or number of machine hour, or value of machines or units consumed.

Question 8.
What are the methods of re-apportionment of service department expenses over the production departments? Discuss. (Nov 2010, 4 marks)
Answer:
The following methods are generally used for re-apportionment according to the specified circumstances:

These are explained in detail as follows :
1. Direct Re-apportionment method:

• This method is used when cost of service departments are apportioned only to the production department directly.
• Therefore, number of re-apportionment will be equivalent to the number of service departments.
• It means each service department provides service to different ,
  production department but not to other service departments.

2. Step method: When it is recognised that the service rendered by one service departments, to other service department has been done on partial basis, the re-apportionment procedure involves the following steps:
Step 1 : Find out such service departments, which give services to large no. of other departments Distribute the cost of this service departments to other departments (including other service departments) on an equitable basis.
Step 2 :Then identify other service departments which give services to next largest number of departments After that, distribute the cost of such service departments, to other departments (excluding the service department whose cost has already been apportioned) on some equitable basis.
Step 3 : Continue the distribution process till the cost of service departments, is apportioned fully.

Note: If all the service departments, provide service to equal no. of other departments, then it will be difficult to re-apportion the cost of service departments In such case, it is apportioned on the basis of largest amount to lowest one. It means first apportion largest amount, then the next largest and so on.

3. Reciprocal service method: This method is used when one Service department renders services to other department and vice-versa in addition to the services provided to the production departments That is on reciprocal basis, it means, before determining the cost of each service department, they should recognise the cost of inter service departmental services.

This method Is generally used for the dealing of such problems:

1. Trial and Error Method,
2. Repeated Distribution Method
3. Simultaneous Equation Method

Question 9.
M/s. NOP Limited has its own power plant and generates its own power. Information regarding power requirements and power used are as follows:

	Production Dept.		Service Dept.
	A	B	X	Y
	(Horse power hours)
Needed capacity production	20000	25000	15000	10000
Used during the quarter ended September 2018	16000	20000	12000	8000

During the quarter ended September 2018, costs for generating power amounted to ₹ 12.60 Iakhs out of which ₹ 4.20 Iakhs was considered as. fixed cost.

Service department X renders services to departments. A, B, and Y in the ratio of 6:4:2 whereas department Y renders services to department A and B in the ratio of 4:1. The direct labour hours of department A and B are 67500 hours and 48750 hours respectively.

Required:
(i) Prepare overheads distribution sheet.
(ii) Calculate factory overhead per labour hour for the dept. A and dept. B. (Nov 2018, 5 marks)
Answer:
(1) Overhead Distribution Sheet

(2) Calculation of the Factory Overhead per labour hour:

Question 10.
CAS Ltd. has three production departments and tour service departments. The expenses for departments as per Primary Distribution Summary are as follows:

The following information is also available in respect of the production departments:

Required: Apportion the costs of service departments over the production departments.
Answer:
Statement showing the Secondary Distribution of Overheads

Question 11.
RST Ltd. has two production departments : Machining and Finishing. There are. three service departments : Human Resource (HR), Maintenance and Design. The budgeted costs in these service departments are as follows :

Required:
(i) Use the direct method to re-apportion RST Ltd’s service department cost to its production departments.
(ii) Determine the proper sequence to use In re-apportioning the firm’s service department cost by step-down method.
(iii) Use the step-down method to reapportion the firm’s service department cost. (Nov 2006, 3 + 1 + 3 = 7 marks)
Answer:
(i) Re-apportion of service departments cost to its production department by using direct method

(ii) Sequence of re-apportionment :- As H.R. department serves large number of departments so its cost should be first re-apportioned then overhead of maintenance department should be re-apportioned and lastly overhead of design department should be re-apportioned.

(iii) Use of step down method for re-apportioning overhead of service department:

Question 12.
Discuss the step method and reciprocal service method of secondary distribution of overheads. , (Nov 2004, 4 marks)
Answer:
Step Method: When it is recognised that the service rendered by one service department to other service department has been done on partial basis, the re-apportionment procedure involves the following steps:

Step 1: Find Out such service deptts., which gives services to large no. of other deptts. Distribute the cost of this service deptt. to other deptts. (including other service deptts.) on an equitable basis.

Step 2: Then identity other service deptts. which gives services to next largest number of deptts. After that, distribute the cost of such service deptt, to other deptts. (excluding the service deptt. Whose cost has already been apportioned) on some equitable basis.

Step 3: Continue the distribution process till the cost of service deptts., cost is apportioned fully.

Note: If all the service deptts. provide service to equa no. of other deptts.. then it will be dit ticult to re-apportion the cost of service deptts. In such case, it is apportioned on the basis of largest amount to lowest one, It means first apportion largest amount, then the next highest and so on.

Reciprocal Service Method:
This method Is used when one service deptt. renders services to other deptt. and vice-versa in addition to the services provided to the production deptts. That is reciprocal basis it means before determining the cost of each service deptt, they should recognise the cost of inter service departmental services.
This method is generally used for the dealing of such problems:

1. Trial and Error Method,
2. Repeated Distribution Method
3. Simultaneous Equation Method

(i) Trial and Error Method:
Under this method, the total cost of each service deptt. will be determined as per primary distribution and the percentage of services rendered to each other:
After such process, total cost of each service cieptt. is determined by adding the above amounts (i.e. as per step 1 + step 2 + step 3).

(ii) Repeatec1 Distribution Method:
Under this method, the total overhead cost of all the deptts. (i.e. production and service) as per primary distribution summary are put on a line.

(iii) Simultaneous Equation Method:
This method is recommended where these are only two service deptts. If no. of service deptt is more than two then for finding out the unknown figures may possess problems in computation.

Question 13.
S Ltd. has two production departments P₁ and P₂ and two service departments S1 and S,. Expenses of these departments are as follows:
P₁ – ₹ 51,837, P₂ – ₹ 12,163, S₁ – ₹ 40,000, S₂ – ₹ 16,000
The expenses of service departments are to be apportioned are as follows:

	P1	P2	S1	S2
S1 S2	50% 30%	40% 50%	– 20%	10% –

Determine
Apportion the cost of service departments by using Trial and Error Method.
Answer:
Calculation of Total Costs of Each Service Department

Question 14.
A company has two production departments and two service departments. The data relating to a period are as under:

The power requirement of these departments are met by a power generation plant. The said plant incurred an expenditure, which is not included above, of ₹ 1,21,875 out of which a sum of ₹ 84,375 was variable and the rest fixed.

After apportionment of power generation plant costs to the four departments, the service department overheads are to be redistributed on
the following bases:

You are required to:
(I). Apportion the power generation plant costs to the four departments.
(ii) Re-apportion service department cost to production departments.
(iii) Calculate the overhead rates per direct labour hour of production departments, given that the direct wage rates of PD₁ and PD₂ are 5 and 4 per hour respectively. (Nov 1996, 8 marks)
Answer:
(i) Statement of Power Generation Plant Cost of 4 deptts.:

(ii) Re-apportionment of Service deptt. Cost to production deptt.-Under Repeated Distribution Method:

Alternatively,
By Equational approach –
Let total O/Hs of SD₁ be ‘X’ and of SD₂ be ‘Y’.
Thus,
x = 80,890 + 20% of y
y = 72,720 + 10% of x
Or x = 80890 + 0.2y
Or x – 0.2y = 80,890 ……………. (1)
Or y = 72,720 + 0.1 x
Or – 0.1 x + y = 72,720
Or – 0.02x + 0.2y = 14,544 (multiplying both the sides by 0.2) ……………. (ii)
Solving the above equation (i) and (ii),
We get,

Now, putting the value of ‘X’ in equation (i)
x – 0.2y = 80,890
– 97,381 – 0.2y = 80,890
– 0.2y = 16,491
y = ₹ 82,455
Total OMs SD₁ and SD₂:

Note: in such type of problems, if the problem is silent about the application of the method of redistribution of service deptt. O/H, then ‘Repeated Distribution Method’ for distributing service deptt. O/H to other deptts. should be adopted.

(iii) Computation of O/H Rates per direct labour hour of Production deptts.:

Question 15.
A company. has three production departments and two service departments. Distribution summary of overheads is as follows:
Production Departments
A – ₹ 13,600
B – ₹ 14,700
C – ₹ 12,800
Service Departments
X – ₹ 9,000
Y – ₹ 3,000
The expenses of service departments are charged on a percentage basis which is as follows:

Apportion the cost of Service Departments by using the Repeated Distribution method. (Nov 1998, 8 marks)
Answer:
Statement of apportionment of Service Deptts. O/H to Production Depts. under Repeated Distribution Method:

Question 16.
TEE Ltd. is a manufacturing company having three production departments ‘P’, ‘Q’ and ‘R’ and two service departments ‘X’ and ‘Y’ details pertaining to which are as under:

The expenses of Service Departments are allocated as under:

	(₹)
Rent and Rates General Lighting Indirect Wages Power Depreciation on Machines Sundries (apportionment on the basis of direct wages)	10,000 600 3,450 3,500 70,000 13,800

Product ‘A’ is processed for manufacture in Departments P, Q and R for 6, 5 and 2 hours respectively.
Direct Costs of Product A are:
Direct material cost is 65 per unit and Direct labour cost is 40 per unit.

You are Required to:
(i) Prepare a statement showing distribution 01 overheads among the production and service departments.
(ii) Calculate recovery rate per hour of each production department after redistributing the service departments costs
(iii) Find out the Total Cost of a ‘Product A’. (Nov 2020, 10 marks)

Question 17.
In a factory of ABC Ltd. the following particulars have been extracted for the period ended 31 .3.2001.
           

You are required to prepare the statements showing:
(i) The allocation of overheads;
(ii) The apportionment of overheads;
(iii) The distribution of service departments overheads by method of
(a) Repeated Distribution and (b) Algebraic Equations;
(iv) Overhead distribution summary and rates of overhead absorption.
Answer:
(i) Statement showing the Allocation of Overheads

(ii) Statement showing the Apportionment of Overheads

(iii) Statement showing the Distribution of Overheads of Service Deptt. [According to Repeated Distribution Method]

Distribution of Service Departments’ Overheads through Algebraic
Equations
Letx be the total overheads of Deptt. x
Let y be the total overheads of Deptt. y
Thus, x = 1,000 + 1/4y ………………. (i)
y = 3,500 + 1/4x ………….. (ii)
= 3,500 + 1/4 (1,000 + 1/4y) (Putting the value of x in equation II)
= 3500 + 250 + 1/16 y
16y = 60,000 + y
15y = 60,000
y = ₹ 4,000
x = 1,000 + 1/4 × 4,000 (Putting the value of y in equation I)
= ₹ 2,000

(iv) Statement showing Overheads Distribution Summary and Rates of Overhead Absorption

Question 18.
E-books is an online book retailer. The Company has tour departments. The two sales departments are Corporate Sales and Consumer Sales. The two support-departments are Administrative (Human resources, Accounting), and Information systems. Each of the sales departments conducts merchandising and marketing operations independently.

The following data are available for October, 2003:

The company uses number of employees as a basis to allocate Administrative costs and processing time as a basis to allocate Information systems costs.

Required:
(i) Allocate the support department costs to the sales departments using the direct method.
(ii) Rank the support departments based on percentage of their services rendered to other support departments. Use this ranking to allocate support costs based on the step-down allocation method.
(iii) How could you have ranked the support department differently?
(iv) Allocate the support department costs to two sales departments using the reciprocal allocation method. (Nov 2003, 2 + 2 + 1 + 5 = 10 marks)
Answer:
(i) Statement showing the allocation of support deptt. cost to the sales deptt: .
(Using the Direct Deptt.)

(ii) Ranking of support deptts. based on % of their services rendered to other support deptts.:

• Administration support deptt. provides 23.077% (21×10042+28+21) of its services to information systems.
  Support thus deptt. 23.077% of ₹ 94,510 = ₹ 21,810/-
• Information system support deptt. provides 8.33% (4002,400+2,000+400×100) of its services to Admin. support deptt. thus 8.33% of ₹ 3,04,720 = ₹ 25,383/- .

Statement showing allocation of support costs
(By using step down allocation method)

(iii) An alternative ranking is based on the rupee amount of services rendered to other service deptt., using the rupee figures obtained under requirement (II). This approach would use the following sequence of ranking:

• Allocation of information systems 0/1-l as (i) (₹ 25,383 provided to administrative.)
• Allocated administrative OIHs as (ii) (₹ 21,810 provided to information systems.)

(iv) Working Notes:
1. Percentage of services provided by each service deptt. to other service deptt. and Sales deptts.:

2. Total cost of the support deptt.: (by using simultaneous equation method):
Let A and I be the total costs of support deptts. Administrative and Information Systems respectively. These cost can be determined by using the following Simultaneous equations:
A = 94,510 + 0.0833 I
I = 3,04,720 + 0.2307 A
or A = 94,510 + 0.0833 {3,04,720 + 0.2307 A)
or A = 94,510 + 25,383 + 0.01922 A
or 0.98078 A = 1,19,893
or A = ₹ 1,22,243/-
and I = ₹ 3,32,922/-
Statement showing the allocation of support deptts. cost to the sales deptt. (using Reciprocal allocation method):

Question 19.
The following account balances and distribution of indirect charges are taken from the accounts of a manufacturing concern for the year ending 31^st March, 2012:

Prepare an overhead distribution statement to show the total overheads of production departments after re-apportioning service departments’ overhead by using simultaneous equation method. Show all the calculations to the nearest rupee. (Nov 2012, 8 marks)
Answer:
Primary Distribution of Overheads

Re-distribution of Overheads of Service Department A and B
Total overheads of Service Departments may be distributed using simultaneous equation method
Let, the total overheads of A = a and the total overheads of B = b
a = 1,57,250 + 0.10 b ……………. (i)
or, 10a – b = 15,72,500 [(i) × 10]
b = 90,250 + 0.20 a (ii)

Putting the value of a in equation (ii), we get
b = 90,250 + 0.20 × 1,69,668
b = 1,24,184

Secondary Distribution of Overheads

Question 20.
The Union Ltd. has the following account balances and distribution of direct charges on 31^st March, 2019.

Overheads to be appórtioned:
Power – 78,000
Rent – 72,000
Fuel and Heat – 60,000
 Insurance -12,000
Taxes – 8,400
Depreciation – 1,20,000
The following data were compiled by means of the factory survey made in the previous year:

Expenses charged to the stores departments are to be distributed to the other departments by the following percentages:
Machine shop 50%; Packing 20%; General Plant 30%:
General Plant overheads Is distributed on the basis of number of employees.
(a) PREPARE an overhead distribution statement with supporting schedules to show computations and basis of distribution.
(b) DETERMINE the service department distribution by simultaneous equation method.
Answer:
(a) Overheads Distribution Statement

Schedule of Apportionment of Overheads

(b) Re-distribution of Overheads of Service Departments to Production Departments:
Let, the total overheads of General Plant = ‘a’ and the total overheads of Stores = ‘b’
a = 1.25,775 + 0.3b ………………… (i)
b = 87.550 + 0.2a …………… (ii)
Puting the value of ‘b’ in equation no. (i)
a = 1.25,775 + 0.3 (87,550 + 0.2a)
Or a = 1,25,775 + 26,265 + 0.06a
Or 0.94a = 1.52,040 Or a = 1,61,745 (appx.)
Putting the value of a = 1 61 ,745 in equation no. (ii) to get the value of ‘b’
b = 87,550 + 0.2 × 1,61,745 = 1,19,899
Secondary Distribution Summary

Question 21.
Explain, how under-absorption and over-absorption of overheads are treated in Cost Accounts. (May 2010, Nov 2010, Nov 2014, Nov 2015, 3, 4, 4, 4 marks)
Answer:
There are varieties of methods used for over or under absorption of OHEs in the accounts. However in the corporate sector 3 important methods are widely used for accounting of over and under absorption of POHEs:

1. Use of supplementary OH absorption rates.
2. Write oft to costing P&L A/c.
3. Carry over to the next period accounts.

1. Use of supplementary OH absorption rates. :
This method is used when it is caused due to normal or avoidable reasons. When the amount of over & under absorbed POHEs is significant (i.e. more than 10% of total OH incurred), supplementary absorption rates are computed by way of addition or deduction. This rate may be called Negative Supplementary Rate if over absorbed amount is to be deducted, on the other hand, the supplementary rate may be called positive supplementary rate if under absorbed amount is to be added.
∴ Negative Supplementary Rate =  Over Absorbed POHEs  Actual value of the Base output 
And Positive Supplementary Rate =  Under absorbed POHEs  Actual value of Base output 
This method is preferred when:

1. There are serious estimational errors.
2. When there is a substantial change in the level of activities.
3. When there is a major change in the production method.
4. In case of contract on cost plus basis.

2. Write oft to costing P&L A/c. :
When the amount of over and under absorbed POHEs is not so significant, it may be written off to costing P&L A/c. But if it is significant (sizeable) and it arises due to:

1. Some uncontrollable and abnormal factors.
2. Estimation of output is contingent.

Then such over or under absorbed POHEs may be written off to costing P & L A/c. But it suffers from some limitation like it cannot he adjusted in the value of WIP, unsold stock or sold unit (it means pricing policy cannot be adjusted).

3. Carry over to the next period accounts.
This method is used when:

1. Balance amount is comparatively small.
2. In case of new product whose output is low in initial years due to lack of demand.
3. Normal business cycle is of more than one accounting period.

Over under absorbed 0/H is carried over to next period in the hope that the same will automatically be adjusted or absOrbed. But under this method comparability of the performance is not properly feasible.

Question 22.
ABS Enterprises produces a product arid adopts the policy to recover factory overheads applying blanket rate based on machine hours. The cost records of the concern reveal following information:
Budgeted production overheads – ₹ 10,35,000
Budgeted machine hours – 90,000
Actual machine hours worked – 45,000
Actual production overheads – ₹ 8.80,000

Production overheads (actual) include —
Paid to worker as per court’s award – ₹ 50,000
Wages paid for strike period – ₹ 38,000
Stores written off – ₹ 22,000
Expenses of previous year booked in current year – ₹ 18,500

Production —
Finished goods – 30000 units
Sale of finished goods – 27000 units
The analysis of cost information reveals that 1/3 of the under absorption of overheads was due to defective production planning and the balance was attributable to increase in Costs.
You are required:
(i) To find out the amount of under absorbed production overheads.
(ii) To give the ways of treating it in Cost Accounts.
(iii) To apportion the under absorbed overheads over the items. (Nov 2019, 10 marks)
Answer:
(i) Amount of Under Absorption of Production Overheads during the period:

Budgeted Machine hour rate (Blanket rate) = ₹10,35,00090,000 = ₹ 11.50 per hour.

(ii) Accounting treatment of Under Absorbed Production Overheads:
(a) As. 1/3 of the under absorbed overheads were due to defective production polices, this being abnormal, hence should be debited to Costing Profit and Loss Account.
Amount to be debited to Costing (2,34,000 × 1/3)
Profit and Loss Account = ₹ 78,000

(b) Balance of under absorbed production overheads should be distributed over works in progress, Finished goods and cost of sales by applying supplementary rate:
Amount to be distributed = (₹ 2,34,000 × 2/3) = ₹ 1,56,000
Supplementary rate = ₹1,56,00030,000 units  = ₹ 5.20 per unit

(iii) Apportionment of Under Absorbed Production Overheads over finished goods and Cost of Sales:

Question 23.
Why is the use of an overhead absorption rate based on direct labour hours generally preferable to a direct wages percentage rate for a labour incentive operation? (Nov 1995, 3 marks)
Answer:
A method of overhead absorption is considered appropriate if the total amount of overhead absorbed in a period does not fluctuate materially from the actual expenses incurred in the period direct wage % rate method do not posses the aforesaid feature. In other words, the O/H charged varies from period to period due to changes in direct wages.

In fact, O/H expenses are generally a function of time. Therefore, a time based O/H absorption rate method is always preferred over any other method. In the case of labour incentive operations. It is advisable to use labour hour method for O/H absorption.

Question 24.
In a factory, a machine is considered to work for 208 hours In a month. It includes maintenance time of 8 hours and set up time of 20 hours.
The expense data relating to the machine are as under:

• Cost of the machine is ₹ 5,00,000. Life 10 years. Estimated scrap value at the end of life is ₹ 20,000.
• Repairs and maintenance per annum – ₹ 60,480
• Consumable stores per annum – ₹ 47,520
• Rent of building per annum (The machine under reference occupies 1/6 of the area) – ₹ 72,000
• Supervisor’s salary per month (Common to three machines) – ₹ 6,000
• Wages of operator per month per machine – ₹ 2,500
• General lighting charges per month allocated to the machine – ₹ 1,000
• Power 25 units per hour at ₹ 2 per unit.

Power is required for productive purposes only. Set up time, though productive, does not require power. The Supervisor and Operator are permanent. Repairs and maintenance and consumable stores vary with the running of the Machine.
Required:
Calculate a two-tier machine hour rate for (a) set up time and (b) running time. (May 2002, 8 marks)
Answer:
Calculation of Two tier Machine Hour Rate:

B. Effective Hour per month of the machine for recovery of fixed expenses
= 208 Hrs. – 8 Hrs.200 Hrs.
C. Effective Hrs per month of the machine for recovery of expenses = 208 Hrs. – 8 Hrs. – 20 Hrs. 180 Hrs.
D. Variable Expense per Hours:

Question 25.
A manufacturing unit has purchased and installed a new machine of ₹ 12,70000 to its fleet of 7 existing machines. The new machine has an estimated life of 12 years and i expected to realise ₹ 70.000 as scrap at the end of its working life. Other relevant data are as follows:

1. Budgeted working hours are 2,592 based on 8 hours per day for 324 days. This includes 300 hours for plant maintenance and 92 hours for setting up of plant.
2. Estimated cost of maintenance of the machine is ₹ 25,00C’ (p.a.).
3. The machine require a special chemical solution, which is replaced at the end of each week (6 days in a week) at a cost of 400 each time.
4. Four operators control operation of 8 machines and the average wages per person amounts to ₹ 420 per week plus 15% fringe benefits.
5. Electricity used by th machine during the production is 16 units per hour at a cost of ₹ 3 per unit. No current is taken during maintenance and setting up.
6. Departmental, and general works overhead allocated to the operation during last year was 50,000. During the current year it is estimated to increase 10% of this amount.

Calculate machine hour rate, it (a) setting up time is unproductive; (b) setting up time is productive. (May 2005, 2 + 3 = 5 marks)
Answer:
Computation of Machine hour Rate

Working Notes:
Computation of Machine hours:
(ì) Setting time (unproductive) = 2,592 – 300 – 92 = 2,200 hrs.
(ii) Setting time (productive) = 2,592 – 300 = 2,292 hrs.

Question 26.
From the details furnished below you are required to compute a comprehensive machine-hour rate:
Original purchase price of the machine (subject to depreciation at 10% per annum on original cost) – ₹ 3,24,000
Normal working hours for the month (The machine works to only 75% of capacity) – 200 hours
Wages of Machine man – ₹ 125 per day (of 8 hours)
Wages for a Helper (Machine attendant) – ₹ 75 per day (of 8 hours)
Power cost f o the month for the time worked – ₹ 15,000
Supervision charges apportioned for the machine centre for the month – ₹ 3,000
Electricity and Lighting for the month – ₹ 7,500
Repairs and maintenance (machine) induding consumable stores per month – ₹ 17,500
 Insurance of Plant and Building (apportioned) for the year – ₹ 16,250
Other general expenses per annum – ₹ 27,500

The workers are paid a fixed dearness allowance of ₹ 1,575 per month. Production bonus payable to workers in terms of an award is equal to 33.33% of basic wages and dearness allowance. Add 10% of the basic wage and dearness allowance against leave wages and holidays with pay to arrive at a comprehensive labour-wage for debit to production. (Nov 2005, 14 marks)
Answer:
Statement Showing Comprehensive MachIne Hour Rate

Question 27.
A machine shop cost centre contains three machines of equal capacities. Three operators are employed on each machine, payable 20 per hour each. The factory works for forty- eight hours in a week which includes 4 hours setup time. The work is jointly done by operators. The operators are paid fully for the forty-eight hours. In additions they are paid a bonus of 10 per cent of productive time. Costs are reported for this company on the basis of thirteen four-weekly period.

The company for the purpose of computing machine hour rate includes the direct wages of the operator and also recoups the factory overheads allocated to the machines. The following details of factory overheads applicable to the cost centre are available:

• Depreciation 10% per annum on original cost of the machine. Original cost of the each machine is 52000
• Maintenance and repairs per week per machine is ₹ 60.
• Consumable stores per week per machine are ₹ 75.
• Power: 20 units per hour per machine at the rate of 80 paise per unit.
• Apportionment to the cost centre: Rent per annum ₹ 5,400, Heat and Light per annum ₹ 9,720. and foreman’s salary per annum ₹ 12,960.

Required:
(i) Calculate the cost of running one machine for a four week period.
(ii) Calculate machine hour rate. (Nov 2007, 7+1 = 8 marks)
Answer:
(i) Computation of cost of running one machine for a four week period

Question 28.
You are given the following information of the three machines of a manufacturing department of X Ltd.:

There are 12 holidays besides Sundays in the year, of which two were on Saturdays. The manufacturing department works 8 hours in a day but Saturdays are half days. All machines work at 90% capacity throughout the year and 2% is reasonable for breakdown.

You are required to:
Calculate predetermined machine hour rates for the above machines after taking into consideration the following factors:

• An increase of 15% in the price of spare parts:
• An increase of 25% in the consumption of spare parts for machine ‘B’ & ‘C’ only.
• 20% general increase in wages rates. (May 2011, 8 marks)

Answer:
Computation of Machine Hour Rate

Working Notes:
1. Calculation of effective working hours:
No. of holidays 52 (Sundays) + 12 (other holidays) = 64
Saturday (52 – 2) = 50
No. of days (Work full time) = 365 – 64 – 50 = 251