Chapter 5: Overheads

Elements of Cost

Direct Factory OHs

MATERIAL
Indirect Office OHs

S & Dist. OHs

ELEMENTS OF COST

Direct Factory OHs

LABOR
Indirect Office OHs

S & Dist. OHs

Direct Factory OHs

EXPENSES
Indirect Office OHs

S & Dist. OHs

Types of Overheads

Indirect Material

Nature Indirect Labor

Indirect Expenses

Normal
Normality
Abnormal
Overheads according to:

Controllable
Controllability
Uncontrollable

Fixed

Variability Variable

Semi-Varibale

Factory/ Works/ Shop/

Manufacturing/ Production

Function Office/ Establishment/ Administrative

Selling and Distribution

Factory overheads
1. Depreciation on plant and machinery
1. Fixed installment method
2. Diminishing balance method
3. Machine hour rate method:
𝐷𝑒𝑝𝑟𝑒𝑐𝑖𝑎𝑡𝑖𝑜𝑛 𝑅𝑎𝑡𝑒 𝑃𝑒𝑟 𝐻𝑜𝑢𝑟
𝐶𝑜𝑠𝑡 𝑜𝑓 𝑡ℎ𝑒 𝑀𝑎𝑐ℎ𝑖𝑛𝑒𝑟𝑦 + 𝐼𝑛𝑠𝑡𝑎𝑙𝑙𝑎𝑡𝑖𝑜𝑛 𝐸𝑥𝑝𝑒𝑛𝑠𝑒𝑠 − 𝑅𝑒𝑠𝑖𝑑𝑢𝑎𝑙 𝑉𝑎𝑙𝑢𝑒
=
𝐸𝑠𝑡𝑖𝑚𝑎𝑡𝑒𝑑 𝑈𝑠𝑒𝑓𝑢𝑙 𝐿𝑖𝑓𝑒 𝑜𝑓 𝑀𝑎𝑐ℎ𝑖𝑛𝑒 (𝑖𝑛 𝑡𝑒𝑟𝑚𝑠 𝑜𝑓 𝐻𝑜𝑢𝑟𝑠)
70,000 + 20,000 − 10,000
⇒ ⇒ ₹5.33 𝑝𝑒𝑟 ℎ𝑜𝑢𝑟
15,000 𝐻𝑜𝑢𝑟𝑠
In order to calculate the depreciation, multiply the rate per hour with the number of hours
worked in the given period. E.g. Machine worked for 600 hours. Depreciation would be ₹3,200
i.e. 600 ℎ𝑜𝑢𝑟𝑠 × ₹5.33 𝑝𝑒𝑟 ℎ𝑜𝑢𝑟.
4. Revaluation method
5. Replacement cost method
2. Provision for obsolescence
Added to the works overheads. But if created as a precautionary measure only then it is an
appropriation of profits and shall be excluded from cost accounts.
3. Cost of defective work
Already discussed in the chapter-Material Control
4. Idle facilities
If unavoidable then included in the works overheads otherwise to be charged to the costing profit and
loss account.
5. Expenses on removal of machinery
Charged to the costing profit and loss account.
6. Experimental expenses
If incurred as a whole then shall be added to the works overheads. But if incurred for a particular job
or work order then shall be charged to the that particular job or work order.
7. Rent of factory building
It is included in factory overheads.
In case the factory is owned by the business then a reasonable amount shall be added to the factory
overheads so that the cost can be compared though no outflows are there.
8. Interest on capital
Generally, not included in the works overheads, however, may be included for taking managerial
decisions.
9. Research cost and Development Cost
May be included in the works overheads. If expenses are quite heavy then may be debited to the
costing profit and loss account as deferred revenue expenditure.
10. Royalties and patent fees
If paid on the basis of output then it is a direct expense.
If paid on the basis of sales then shall be included in the selling and distribution overheads.
11. Fuel and power
Added to the works overheads.
12. Tool costs
Depreciation is charged on LARGE TOOLS and included in the works overheads.
Cost incurred on SMALL TOOLS either may be CAPITALIZED AND DEPRECIATED or REVALUATION
METHOD CAN BE USED TO APPLY DEPRECIATION or the cost MAY DIRECTLY BE ADDED TO THE
WORKS OVERHEADS.
13. Computer
Depreciation is applied on the computer and printer and included in the works overheads. Expenses
on consumables is also included in works overheads.
14. Insurance
Insurance of incoming material-included in cost of material.
Insurance of finished goods-included in selling and distribution overheads.
Insurance of plant and machinery-included in works overheads.
Insurance of stores-included in works overheads.
Insurance of godown/warehouse-included in distribution overheads.
Insurance of building-included in the overheads to which building is related.
15. Incentives to indirect workers
Included in the factory overheads.
16. Leave travel assistance
If paid to direct workers then it’s included in the direct wages.
If paid to workers not engaged in the production process then included in the overheads to which the
workers are related.
17. Carriage and cartage
Paid for incoming material-included in cost of material.
Paid for finished goods-included in selling and distribution overheads.
If can’t be identified then included in works overheads.
If incurred due to abnormal reasons then charged to the costing profit and loss account.
19. Bonus
If paid on account of legal provisions then included in the direct wages or factory overheads as the
case may be.
If paid voluntarily then charged to the costing profit and loss account.
Technical Journals Trade Journals Marketing Journals
Works OHs Office OHs S & Distribution OHs
Allocation
When an item of the overhead is directly charged to a particular department.

Apportionment
Primary distribution
Those items which cannot be allocated, are divided among various departments (Production and
Service Departments) on some logical bases.
Secondary distribution
Some items are distributed among various service departments also. Now the total cost of these
service departments is transferred to the production departments (divided among the production
department) on some logical bases. This is called secondary distribution.

Absorption
A rate is calculated to estimate the overheads to prepare the estimates or quotation.
Apportionment of overheads among various departments
Primary apportionment
Overheads Basis of apportionment
Factory rent Floor area occupied OR capital value of the asset
Depreciation of factory building Floor area occupied OR capital value of the asset
Insurance of factory building Floor area occupied OR capital value of the asset
Heating and lighting Number of light points OR floor area occupied
Depreciation of plant and machinery Value of machinery
Insurance of plant and machinery Value of machinery
Electric power Horse power of machinery OR machine hours
Supervision Number of workmen OR amount of wages paid OR floor area
OR time devoted by the supervisor
Electric light Number of light points OR floor area occupied OR hours used
OR units (if specific meters are attached)
Stores overheads Value of direct material
Material handling charges Weight of material of each department OR value of material
of each department

Apportionment of overheads of various service departments

among various production departments
Secondary distribution
Service Department Basis of apportionment
Maintenance department Actual service utilized (if records are maintained) OR hours worked
for each department
Pay roll or time keeping Direct labour hours OR machine hours OR number of employees
Personnel (HR) department Rate of labour turnover OR number of employees
Store-keeping department Number of requisitions OR quantity OR value of material purchased
Purchase department Number of purchase orders OR value of materials purchased
Welfare department Number of employees
Internal transport service, Weight OR value of the material/product OR weight and distance
overhead crane service, fork- covered
lift truck service
Secondary distribution of the overheads
Service departments do The most serviceable
not provide services to department method
each other

A X A X

B Y B Y

C Z C Z

Reciprocal service
method

A X

B Y

C Z

When it is assumed that service departments do not provide services to each

other
The overheads of the service departments are directly transferred to the production departments on
some logical basis.
Example
Production Overheads Service Overheads Percentage of OHs to be charged to
Departments (₹) Departments (₹) production departments
A B C
A 1,000 X 500 50 25 25
B 2,000 Y 700 30 30 40
C 3,000 Z 900 40 20 40
Now, the overheads of service departments will be apportioned as follows—
Particulars Prod. Prod. Prod. Service Service Service
Dept. A Dept. B Dept. C Dept. X Dept. Y Dept. Z
Overheads as per primary distribution 1,000 2,000 3,000 500 700 900
X (50% to A, 25% to B and 25% to C) 250 125 125 (500) -- --
Y (30% to A, 30% to B and 40% to C) 210 210 280 -- (700) --
Z (40% to A, 20% to B and 40% to C) 360 180 360 -- -- (900)
Total 1,820 2,515 3,765 0 0 0
When it is assumed that service departments are providing services to each
other
The most serviceable department method
First of all, it is decided that which department is the most serviceable. It can be decided either on the
basis of services rendered (if records are maintained) OR on the basis of amount of overheads of the
service departments. Now first of all the overheads of the most serviceable departments are
apportioned among production and service departments (excluding the one the overheads of which
are being apportioned) on some logical basis. After this, the overheads of the next most serviceable
department are apportioned among the production and service departments on some logical basis.
This process is continued till overheads of all the service departments are exhausted. For example, A,
B and C are three production departments and X, Y and Z are three service departments. We also
assume that the most serviceable department is X, then Y and then Z. First of all, the overheads of the
X will be apportioned among A, B, C, Y and Z. Then the overheads of Y will be apportioned among A, B,
C and Z and after this the overheads of Z will be apportioned among A, B and C.
Example
Production Departments Overheads Service Departments Overheads
Jam ₹1,00,000 Maintenance ₹1,00,000
Bhujia ₹2,00,000 Electricity ₹85,000
Chips ₹3,00,000 HRM ₹60,000
Rasgulla ₹2,50,000 Accounting ₹50,000
The following ratios may be used to divide the overheads of service departments—
Service Jam Bhujia Chips Rasgulla Maint- Elect- HRM Accou-
Department enance ricity nting
Maintenance 30% 20% 10% 10% -- 5% 10% 15%
Electricity 25% 25% 15% 15% -- -- 15% 5%
HRM 20% 20% 30% 10% -- -- -- 20%
Accounting 25% 40% 15% 20% -- -- -- --
Now, the overheads of service departments will be apportioned as follows—
Department Jam (₹) Bhujia (₹) Chips (₹) Rasgulla Mainte- Elect- HRM (₹) Accou-
(₹) nance (₹) ricity (₹) nting (₹)
OHs as per 1,00,000 2,00,000 3,00,000 2,50,000 1,00,000 85,000 60,000 50,000
P. Dist.
Maintenance 30,000 20,000 10,000 10,000 (1,00,000) 5,000 10,000 15,000
Electricity 22,500 22,500 13,500 13,500 0 (90,000) 13,500 4,500
HRM 16,700 16,700 25,050 8,350 0 0 (83,500) 16,700
Accounting 21,550 34,480 12,930 17,240 0 0 0 (86,200)
TOTAL 1,90,750 2,93,680 3,61,480 2,99,090 0 0 0 0
Interdepartmental service method/Reciprocal service method
Under this method it is assumed that service departments are providing services to each other then
three methods are available viz. simultaneous equation method, repeated distribution method and
trial and error method.
a. Simultaneous equation method
b. Repeated distribution method
c. Trial and error method
Simultaneous equation method
𝑋 = 𝑎 + 𝑏𝑌 ⇒ 𝑋 = 630 + 0.2𝑌
𝑌 = 𝑎 + 𝑏𝑋 ⇒ 𝑌 = 510 + 0.1𝑋
Where,
X=Total overheads (after the secondary distribution) of the service department X
Y=Total overheads (after the secondary distribution) of the service department Y
a=Overheads of the particular department
b=% of overheads of another department

Department A B C X Y
X 30% 40% 20% -- 10%
Y 10% 20% 50% 20% --
Total OHs 1,380 2,190 1,290 630 510

𝑋 = 630 + 0.20𝑌 𝑌 = 510 + 0.10𝑋

⇒ 𝑋 = 630 + 0.20(510 + 0.10𝑋) ⇒ 𝑌 = 510 + 0.10(747)
 ⇒ 𝑋 = 630 + 102 + 0.02𝑋 ⇒ 𝑌 = 510 + 74.70
⇒ 𝑋 − 0.02𝑋 = 732 ⇒ 𝑌 ≅ 585
⇒ 0.98𝑋 = 732
⇒ 𝑋 ≅ 747
Overheads of A: Overheads of B:
𝐴 = 1,380 + 0.30𝑋 + 0.10𝑌 𝐵 = 2,190 + 0.40𝑋 + 0.20𝑌
⇒ 𝐴 = 1,380 + 0.30(747) + 0.10(585) ⇒ 𝐵 = 2,190 + 0.40(747) + 0.20(585)
⇒ 𝐴 = 1,380 + 224 + 59 ⇒ 𝐵 = 2,190 + 299 + 117
⇒ 𝐴 = 1,663 ⇒ 𝐵 = 2,606
Overheads of C:
𝐶 = 1,290 + 0.20𝑋 + 0.50𝑌
⇒ 𝐶 = 1,290 + 0.20(747) + 0.50(585)
⇒ 𝐶 = 1,290 + 149 + 293
⇒ 𝐶 = 1,732

A B C X Y
Overheads before secondary distribution 1,380 2,190 1,290 747 585
X (30% to A, 40% to B and 20% to C) 224 299 149 -747 --
Y (10% to A, 20% to B and 50% to C) 59 117 293 -- -585
Total overheads after secondary distribution 1,663 2,606 1,732 0 0
Repeated distribution method
Items A B C X Y
Overheads before secondary distribution 1,380 2,190 1,290 630 510
X (30% to A, 40% to B, 20% to C & 10% to Y) 189 252 126 -630 63
Y (10% to A, 20% to B, 50% to C & 20% to X) 57 115 286 115 -573
X (30% to A, 40% to B, 20% to C & 10% to Y) 35 46 23 -115 11
Y (10% to A, 20% to B, 50% to C & 20% to X) 1 2 6 2 -11
X (30% to A, 40% to B, 20% to C & 10% to Y) 1 1 -- -2 --
Total overheads after secondary distribution 1,663 2,606 1,731 0 0
Trial and error method
Items A B C X Y
Overheads before secondary distribution 1,380 2,190 1,290 630 510
X (10% to Y) -- -- -- -- 63
Y (20% to X) -- -- - 115 --
X (10% to Y) -- -- -- -- 12
Y (20% to X) -- -- -- 2 --
Overheads before secondary distribution 1,380 2,190 1,290 747 585
X (30% to A, 40% to B and 20% to C) 224 299 149 -747 --
Y (10% to A, 20% to B and 50% to C) 59 117 292 -- -585
Total overheads after secondary distribution 1,663 2,606 1,731 0 0
5.1, 5.2 (to be appended), 5.3, 5.4 and 5.5
Basis for apportionment of different expenses for the purpose
of calculating Machine Hour Rate
Expenses Basis of apportionment
STANDING (FIXED) CHARGES
Rent and rates According to the floor area occupied by each machine including
surrounding space.
Heating and lighting The number of light points used plus cost of special lighting OR
heating for any individual machine. Alternatively, according to the
floor area occupied by each machine.
Supervision Estimated time devoted by the supervisory staff to each machine.
Lubricating oil and Capital values OR machine hours OR past experience.
consumable stores
Insurance Insured value of each machine (if aggregate amount of the insurance
premium is given) OR the specific amount of insurance premium.
Miscellaneous Equitable basis depending upon facts.
expenses
MACHINE OR RUNNING (VARIABLE) CHARGES
Depreciation Machine hours OR capital values of the machines OR both.
Depreciation for each machine can be calculated separately if details
regarding cost, scrap (residual) value and estimated working life have
been given.
𝐷𝑒𝑝𝑟𝑒𝑐𝑖𝑎𝑡𝑖𝑜𝑛 𝑝𝑒𝑟 ℎ𝑜𝑢𝑟
𝐶𝑜𝑠𝑡 𝑜𝑓 𝑡ℎ𝑒 𝑚𝑎𝑐ℎ𝑖𝑛𝑒𝑟𝑦 + 𝐼𝑛𝑠𝑡𝑎𝑙𝑙𝑎𝑡𝑖𝑜𝑛 𝑒𝑥𝑝𝑒𝑛𝑠𝑒𝑠 − 𝑆𝑐𝑟𝑎𝑝 𝑜𝑟 𝑟𝑒𝑠𝑖𝑑𝑢𝑎𝑙 𝑣𝑎𝑙𝑢𝑒
=
𝐸𝑓𝑓𝑒𝑐𝑡𝑖𝑣𝑒 𝑤𝑜𝑟𝑘𝑖𝑛𝑔 𝑙𝑖𝑓𝑒 (𝑖𝑛 ℎ𝑜𝑢𝑟𝑠)
The aggregate amount of depreciation can also be divided in the ratio
of 𝑉𝑎𝑙𝑢𝑒 𝑜𝑓 𝑀𝑎𝑐ℎ𝑖𝑛𝑒 × 𝑀𝑎𝑐ℎ𝑖𝑛𝑒 𝐻𝑜𝑢𝑟𝑠*
*If value of the machines and machine hours vary considerably.
Power Horse power of machines OR number of units (if separate meters are
attached) OR machine hours.
Can also be divided in the ratio of 𝐻𝑜𝑟𝑠𝑒 𝑃𝑜𝑤𝑒𝑟 × 𝑀𝑎𝑐ℎ𝑖𝑛𝑒 𝐻𝑜𝑢𝑟𝑠*
*If value of the horse power of machines and machine hours vary
considerably.
Repairs Machine hours OR capital values.

Calculation of machine hour rate

CALCULATION OF MACHINE HOUR RATE
PARTICULARS Rate Per
Hour (₹)
STANDING (FIXED) CHARGES/EXPENSES Per annum (₹) *
Rent and rates xxxx
Heating and lighting xxxx
Supervision xxxx
Lubricating oil and consumable stores xxxx
Insurance xxxx
Operator’s/attendant’s salary/wages xxxx
Miscellaneous expenses xxxx
TOTAL xxxx
RATE PER HOUR (TOTAL FIXED CHARGES / NUMBER OF EFFECTIVE HOURS) xxxx
MACHINE OR RUNNING (VARIABLE) CHARGES/EXPENSES **
Depreciation per hour xxxx
Power/electricity per hour *** xxxx
 Repairs per hour xxxx
MACHINE HOUR RATE XXX
* Written per annum and then total is divided by the effective number of hours in a year.
** Calculated per hour.
*** The calculation of power/electricity bill has nothing to do with the CALCULATION OF EFFECTIVE
HOURS. In order to calculate the power/electricity bill per hour, the total bill is divided by the
effective hours.

Repair and maintenance time & setting-up time and calculation

of effective hours
Annual working hours xxxx
Less: Repair and maintenance time (always) * xxxx
Less: Setting up time (if unproductive) ** xxxx
EFFECTIVE MACHINE HOURS xxxx
* Repair & maintenance time is always unproductive, so it is always subtracted while calculating
effective machine hours.
** Setting-up time is subtracted only when it is unproductive. But how to decide whether it is
productive or unproductive? Read the statement carefully. It must be given in the statement. But what
if the statement is silent? In such a case, take an assumption regarding whether setting-up time is
productive or unproductive and append a note at the end of the solution. I ASSUME THAT SETTING-
UP TIME IS UNPRODUCTIVE IF NOTHING IS MENTIONED.
*** The calculation of power/electricity bill has nothing to do with the CALCULATION OF EFFECTIVE
HOURS. In order to calculate the power/electricity bill per hour, the total bill is divided by the
effective hours.
Example: Total number of hours—3,000
Repair and maintenance time—100 hours
Setting-up time—200 hours
Calculate effective machine hours if setting-up time is productive and unproductive [Repair and
maintenance time is unproductive in any case].
Calculation:
CALCULATION OF EFFECTIVE HOURS
Particulars Setting-up time is Setting-up time is
productive unproductive
Number of working hours 3,000 3,000
Less: Repair and maintenance time (Always subtracted) -100 -100
Less: Setting-up time 0 -200
EFFECTIVE HOURS 2,900 2,700

Calculation of power/electricity bill

Number of power/electricity units shall be calculated for the time (hours) during which the current
was used.
Example: Repair and maintenance time—100 hours
Setting-up time—200 hours
Units consumption per hour—10
Rate per unit—₹5
Number of working hours in a year—2,000
Calculate the total and per hour electricity bill if setting up time is productive and unproductive.
During setting-up time current was used and during repair and maintenance time current was not
used.
What will be your solution if current was used during repair and maintenance time also?
Solution:
Particulars Repair—No Repair—Yes
Setting—Yes Setting—Yes

Number of hours (including repair & maintenance and setting-up time) 2,000 2,000
Less: Repair and maintenance time -100 0
Less: Setting-up time 0 0
HOURS DURING WHICH CURRENT WAS USED 1,900 2,000
1,900 × 10 2,000 × 10
Power/electricity bill
×5 ×5
(𝐻𝑜𝑢𝑟𝑠 𝑑𝑢𝑟𝑖𝑛𝑔 𝑤ℎ𝑖𝑐ℎ 𝑐𝑢𝑟𝑟𝑒𝑛𝑡 𝑤𝑎𝑠 𝑢𝑠𝑒𝑑 × 𝑈𝑛𝑖𝑡𝑠 𝑝𝑒𝑟 ℎ𝑜𝑢𝑟 × 𝑅𝑎𝑡𝑒 𝑝𝑒𝑟 𝑢𝑛𝑖𝑡)
= ₹95,000 = ₹1,00,000
₹95,000 ₹1,00,000
𝐵𝑖𝑙𝑙 𝑎𝑚𝑜𝑢𝑛𝑡
Rate per hour (𝐸𝑓𝑓𝑒𝑐𝑡𝑖𝑣𝑒 ℎ𝑜𝑢𝑟𝑠) when setting-up time is PRODUCTIVE 1,900 1,900
= ₹50 = ₹52.63
₹95,000 ₹1,00,000
𝐵𝑖𝑙𝑙 𝑎𝑚𝑜𝑢𝑛𝑡
Rate per hour (𝐸𝑓𝑓𝑒𝑐𝑡𝑖𝑣𝑒 ℎ𝑜𝑢𝑟𝑠) when setting-up time is UNPRODUCTIVE 1,700 1,700
= ₹55.88 = ₹58.82

CALCULATION OF EFFECTIVE HOURS

Particulars Setting-up time is Setting-up time is
productive unproductive
Number of working hours 2,000 2,000
Less: Repair and maintenance time (Always subtracted) -100 -100
Less: Setting-up time 0 -200
EFFECTIVE HOURS 1,900 1,700
Note 1: What if in the question nothing is mentioned whether during repair and maintenance time
and setting up time the current was used or not? Then make assumptions as follows—
Assumption regarding SETTING-UP time—
Is it productive? — Yes — Current is used.
Is it productive? — No — Current is not used.
Assumption regarding REPAIR AND MAINTENANCE time—NO CURRENT

Note 2: If you already have assumed that setting-up time is productive then you have to assume that
current is used during this time because without current production is not possible.

Note 3: Always read the statement carefully and look for any information regarding productive-
unproductive time and use of current. Its only after reading the statement that you make certain
assumptions.

Illustration 1 (10 (Surender Singh))

Calculate the machine hour rate from the following details provided by a production department of
ABC Ltd.:
(i) Purchase of machinery ₹4,50,000
(ii) Installation charges ₹50,000
(iii) Life of machine 5 years
(iv) Working hours per year 2,500
(v) Repair charges are 75% of depreciation
(vi) Electric power consumed 10 units per hour @ ₹3 per unit
(vii) Lubricating oil ₹40 per day of 8 hours
(viii) Wages of machine operator ₹200 per day of 8 hours
(B. Com., University of Delhi, 2012 (R), 2015 (Sem.))
Solution
COMPUTATION OF MACHINE HOUR RATE
PARTICULARS Rate Per
Hour (₹)
STANDING (FIXED) CHARGES/EXPENSES Per day (₹)
Lubricating oil 40
Consumables store 80
Wages of machine operator 200
TOTAL 320
RATE PER HOUR (TOTAL / NUMBER OF EFFECTIVE HOURS)
(320 / 8 hours) 40.00
MACHINE OR RUNNING (VARIABLE) CHARGES/EXPENSES
Depreciation per hour (see Note) 40.00
Repair charges (75% of deprecation) 30.00
Power (10 units per hour @ ₹3 per unit) 30.00
MACHINE HOUR RATE 140.00
NOTES:
4,50,000 + 55,000
𝐷𝑒𝑝𝑟𝑒𝑐𝑖𝑎𝑡𝑖𝑜𝑛 𝑃𝑒𝑟 𝐻𝑜𝑢𝑟 = = ₹40 𝑝𝑒𝑟 ℎ𝑜𝑢𝑟
5 × 2,500
(4,50,000 + 55,000)
𝑌𝑒𝑎𝑟𝑙𝑦 𝐷𝑒𝑝𝑟𝑒𝑐𝑖𝑎𝑡𝑖𝑜𝑛 5 𝑌𝑒𝑎𝑟𝑠
𝑜𝑟 𝐷𝑒𝑝𝑟𝑒𝑐𝑖𝑎𝑡𝑖𝑜𝑛 𝑃𝑒𝑟 𝐻𝑜𝑢𝑟 = ⇒ ⇒ ₹40 𝑝𝑒𝑟 ℎ𝑜𝑢𝑟
𝐴𝑛𝑛𝑢𝑎𝑙 𝐸𝑓𝑓𝑒𝑐𝑡𝑖𝑣𝑒 𝐻𝑜𝑢𝑟𝑠 2,500 𝐻𝑜𝑢𝑟𝑠

Illustration 2 (11 (Surender Singh))

From the following particulars compute Machine Hour Rate—
₹
Cost of machine 1,14,800
Installation charges 5,400
Anticipated life of machine 10 years
Residual value at the end of 10 years 5,000
Rent and rates per annum 12,000
Insurance of the machine per annum 3,000
Repairs and maintenance per annum 8,640
Consumable stores per annum 1,200
Total production services per annum 1,080
Power cost is 5 units per working hour @ 40 paise per unit
Setting up time (non-productive) 400 hours per annum
There are 300 working days of eight hours in a year.
[B. Com. (Pass), Delhi. 1994, 2011]
Solution
COMPUTATION OF MACHINE HOUR RATE
PARTICULARS Rate Per
Hour (₹)
STANDING (FIXED) CHARGES/EXPENSES Per annum (₹)
Rent and rates 12,000
Insurance 3,000
Consumable stores 1,200
Production services 1,080
TOTAL 17,280
RATE PER HOUR (TOTAL / NUMBER OF EFFECTIVE HOURS)
(17,280/2,000 hours (see Note 1)) 08.64
MACHINE OR RUNNING (VARIABLE) CHARGES/EXPENSES
Depreciation per hour (see Note 3) 5.76
Power/electricity per hour (see Note 5) 2.00
Repairs and maintenance per hour (see Note 4) 4.32
MACHINE HOUR RATE 20.72
NOTES:
1. 𝐸𝑓𝑓𝑒𝑐𝑡𝑖𝑣𝑒 𝐻𝑜𝑢𝑟𝑠 𝑝𝑒𝑟 𝑎𝑛𝑛𝑢𝑚 = (300 𝐷𝑎𝑦𝑠 × 8 𝐻𝑜𝑢𝑟𝑠) − 400 𝐻𝑜𝑢𝑟𝑠 ⇒ 2,400 𝐻𝑜𝑢𝑟𝑠 −
400 𝐻𝑜𝑢𝑟𝑠 = 2,000 𝐻𝑜𝑢𝑟𝑠

2. Life of the Machine: 10 𝑌𝑒𝑎𝑟𝑠 × 2000 𝐻𝑜𝑢𝑟𝑠 = 20,000 𝐻𝑜𝑢𝑟𝑠

1,14,800 + 5,400 − 5,000

3. 𝐷𝑒𝑝𝑟𝑒𝑐𝑖𝑎𝑡𝑖𝑜𝑛 𝑃𝑒𝑟 𝐻𝑜𝑢𝑟 = = ₹ 5.76 𝑝𝑒𝑟 ℎ𝑜𝑢𝑟
20,000 𝐻𝑜𝑢𝑟𝑠 (𝑁𝑜𝑡𝑒 2)
(1,14,800 + 5,400 − 5,000)
𝑌𝑒𝑎𝑟𝑙𝑦 𝐷𝑒𝑝𝑟𝑒𝑐𝑖𝑎𝑡𝑖𝑜𝑛 10 𝑌𝑒𝑎𝑟𝑠
𝑜𝑟 𝐷𝑒𝑝𝑟𝑒𝑐𝑖𝑎𝑡𝑖𝑜𝑛 𝑃𝑒𝑟 𝐻𝑜𝑢𝑟 = ⇒
𝐴𝑛𝑛𝑢𝑎𝑙 𝐸𝑓𝑓𝑒𝑐𝑡𝑖𝑣𝑒 𝐻𝑜𝑢𝑟𝑠 2,000 𝐻𝑜𝑢𝑟𝑠 (𝑠𝑒𝑒 𝑁𝑜𝑡𝑒 1)
⇒ ₹5.76 𝑝𝑒𝑟 ℎ𝑜𝑢𝑟

4. 𝑅𝑒𝑝𝑎𝑖𝑟 𝑎𝑛𝑑 𝑀𝑎𝑖𝑛𝑡𝑒𝑛𝑎𝑛𝑐𝑒 = 8,640/2,000 ℎ𝑜𝑢𝑟𝑠 = ₹4.32 𝑝𝑒𝑟 ℎ𝑜𝑢𝑟

((2,400 ℎ𝑜𝑢𝑟𝑠 − 400 ℎ𝑜𝑢𝑟𝑠) × 5 𝑢𝑛𝑖𝑡𝑠) × ₹0.40 𝑝𝑒𝑟 𝑢𝑛𝑖𝑡

5. 𝐸𝑙𝑒𝑐𝑡𝑟𝑖𝑐𝑖𝑡𝑦 𝑜𝑟 𝑃𝑜𝑤𝑒𝑟 𝐵𝑖𝑙𝑙 𝑃𝑒𝑟 𝐻𝑜𝑢𝑟 =
2,000 𝐻𝑜𝑢𝑟𝑠
₹4,000
⇒ ⇒ ₹2 𝑝𝑒𝑟 ℎ𝑜𝑢𝑟
2,000 𝐻𝑜𝑢𝑟𝑠

Illustration 3 (12 (Surender Singh))

The machine shop has 6 identical machines. The total cost of the machines is ₹18,00,000. From the
following information, calculate machine hour rate on a 6 monthly (26 weeks) basis:
Effective productive hours per machine per month 160
Productive wages ₹7,86,600 per annum
Power and fuel consumption for the shop ₹9,000 per quarter
Supervision ₹52,800 per annum
Electricity ₹4,000 per month
Repairs and maintenance per annum 3% of the value of the machine
Insurance per annum per machine ₹7,000
Depreciation per annum 10% of the original cost of the machine
Other factory overheads of the shop per annum ₹75,670
Consumable stores per week per machine ₹500
(B. Com., University of Delhi, 2018)
Solution
CALCULATION OF MACHINE HOUR RATE
PARTICULARS Rate Per
Hour (₹)
STANDING (FIXED) CHARGES/EXPENSES Per 6 months (₹)
₹7,86,600
Productive wages ( 12 × 6) 3,93,300
Electricity (₹4,000 × 6) 24,000
₹52,800
Supervision ( 12 × 6) 26,400
Insurance (₹7,000 × 6 𝑀𝑎𝑐ℎ𝑖𝑛𝑒𝑠 × 6 /12) 21,000
₹75,670
Other factory overheads of the shop ( 12 × 6) 37,835
87.246
TOTAL 5,02,535
RATE PER HOUR (TOTAL / NUMBER OF EFFECTIVE HOURS)
(5,02,535/5,760 Hours)
MACHINE OR RUNNING (VARIABLE) CHARGES/EXPENSES
Depreciation per hour (see Note 2) 15.625
Power and fuel consumption for the shop (see note 3) 3.125
Consumables stores (see Note 4) 13.542
 MACHINE HOUR RATE 119.538
NOTES:
1. 𝐸𝑓𝑓𝑒𝑐𝑡𝑖𝑣𝑒 ℎ𝑜𝑢𝑟𝑠 = 160 𝑃𝑒𝑟 𝑀𝑜𝑛𝑡ℎ × 6 𝑀𝑎𝑐ℎ𝑖𝑛𝑒𝑠 × 6 𝑀𝑜𝑛𝑡ℎ𝑠 = 5,760 𝐻𝑜𝑢𝑟𝑠
₹18,00,000 × 10 6 𝑀𝑜𝑛𝑡ℎ𝑠
×
2. 𝐷𝑒𝑝𝑟𝑒𝑐𝑖𝑎𝑡𝑖𝑜𝑛 = 100 12 𝑀𝑜𝑛𝑡ℎ𝑠
5,760 𝐻𝑜𝑢𝑟𝑠
₹9000
( × 6 𝑀𝑜𝑛𝑡ℎ𝑠)
3. 𝑃𝑜𝑤𝑒𝑟 𝑎𝑛𝑑 𝑓𝑢𝑒𝑙 𝑐𝑜𝑛𝑠𝑢𝑚𝑝𝑡𝑖𝑜𝑛 𝑓𝑜𝑟 𝑡ℎ𝑒 𝑠ℎ𝑜𝑝 = 3 𝑀𝑜𝑛𝑡ℎ𝑠 = 3.125 𝑃𝑒𝑟 𝐻𝑜𝑢𝑟
5,760 𝐻𝑜𝑢𝑟𝑠
₹500 × 6 𝑀𝑎𝑐ℎ𝑖𝑛𝑒𝑠 × 26 𝑊𝑒𝑒𝑘𝑠
4. 𝐶𝑜𝑛𝑠𝑢𝑚𝑎𝑏𝑙𝑒𝑠 𝑠𝑡𝑜𝑟𝑒𝑠 = = 13.5416̅ 𝑃𝑒𝑟 𝐻𝑜𝑢𝑟
5,760 𝐻𝑜𝑢𝑟𝑠

Illustration 4 (13 (Surender Singh))

A machines costs ₹3,00,000 and is deemed to have a scrap value of 10% at the end of its effective life
(10 years). Ordinarily, the machine is expected to run for 2,500 hours per year but it is estimated that
350 hours will be lost for normal repairs and maintenance and further 150 hours will be lost due to
staggering. Other details in respect of machine shop are as under:
₹
Annual wages of each of two operators 50,000
Rent of the shop (per year) 30,000
General lighting of the shop (per month) 5,000
Insurance premium for one machine per annum 24,000
Cost of repairs and maintenance per machine per quarter 6,000
Shop supervisor’s monthly remuneration 5,000
Power consumption of machine per hour 15 units @ ₹3 per unit
Allocated factory overheads attributable to the shop per annum 80,000
There are five identical machines in the shop. The supervisor is expected to devote one-fifth of time
for supervising the machine. Compute a comprehensive machine-hour rate from the above details.
(B. Com., university of Delhi, 2013 (Regular))
Solution
CALCULATION OF MACHINE HOUR RATE
PARTICULARS Rate Per
Hour (₹)
STANDING (FIXED) CHARGES/EXPENSES Per annum (₹)
Operator wages (₹50,000×2 Operators/5 Machines) 20,000
Rent (₹30,000/5 Machines) 6,000
General lighting (₹5,000×12 Months/5 Machines) 12,000
Insurance premium 24,000
Shop supervisor’s remun… (₹5,000×12 Months/5 Machines) 12,000
Allocated factory overheads (₹80,000/5 Machines) 16,000
TOTAL 90,000
RATE PER HOUR (TOTAL / NUMBER OF EFFECTIVE HOURS)
(90,000/2,000 Hours) 45.00
MACHINE OR RUNNING (VARIABLE) CHARGES/EXPENSES
Depreciation per hour (see Note 2) 13.50
Repairs and maintenance per hour (𝑠𝑒𝑒 Note 3) 12.00
Power (15 Units Per Hour×₹3 Per Unit) 45.00
MACHINE HOUR RATE 115.50
NOTES:
1. 𝐸𝑓𝑓𝑒𝑐𝑡𝑖𝑣𝑒 𝐻𝑜𝑢𝑟𝑠 = 2,500 − 350 − 150
⇒ 2,000 𝐻𝑜𝑢𝑟𝑠 (𝐻𝑜𝑢𝑟𝑠 𝑙𝑜𝑠𝑡 𝑑𝑢𝑒 𝑡𝑜 𝑠𝑡𝑎𝑔𝑔𝑒𝑟𝑖𝑛𝑔 𝑎𝑟𝑒 𝑎𝑠𝑠𝑢𝑚𝑒𝑑 𝑡𝑜 𝑏𝑒 𝑛𝑜𝑟𝑚𝑎𝑙)
₹2,70,000 × 10
2. 𝐷𝑒𝑝𝑟𝑒𝑐𝑖𝑎𝑡𝑖𝑜𝑛 = 100 = ₹13.50 𝑃𝑒𝑟 𝐻𝑜𝑢𝑟
2,000 𝐻𝑜𝑢𝑟𝑠
 ₹6,000
× 12 𝑀𝑜𝑛𝑡ℎ𝑠
3. 𝑅𝑒𝑝𝑎𝑖𝑟 𝑎𝑛𝑑 𝑚𝑎𝑖𝑛𝑡𝑒𝑛𝑎𝑛𝑐𝑒 = 𝑀𝑜𝑛𝑡ℎ𝑠
3 = 12.00 𝑃𝑒𝑟 𝐻𝑜𝑢𝑟
2,000 𝐻𝑜𝑢𝑟𝑠

Illustration 5 (5.8)
From the following information, compute machine hour rate—
Cost of the machine ₹44,000
Scrap value ₹4,000
Rent for the workshop ₹25,000 per annum
General lighting for the workshop ₹160 per month
Power consumption 20 units per hour @ ₹20 for every 100 unis
Administrative expenses allocated to the machine 4,000 per annum
Repairs and maintenance 75% of depreciation
Workshop supervisor’s salary ₹3,000 per month
Estimated working time per year 50 weeks of 40 hours each
Setting up time which is regarded as productive time 200 hours per year
Effective life of the machine 10 years
The machine occupies 1/4th area of the workshop
The supervisor is expected to devote one third of his time in supervising the machine.
[B. Com. (Pass), University of Delhi, 1998]
Solution
As the setting-up time is productive so current will be used during this time.
CALCULATION OF MACHINE HOUR RATE
PARTICULARS Rate Per
Hour (₹)
STANDING (FIXED) CHARGES/EXPENSES Per annum (₹)
Rent and rates [₹25,000/4] 6,250
General lighting [₹160 × 12 Months]/4 480
Administrative expenses 4,000
Workshop supervisor’s salary [₹3,000 × 12 Months]/3 12,000
TOTAL 22,730
RATE PER HOUR (TOTAL / NUMBER OF EFFECTIVE HOURS)
(22,730/2,000 Hours) 11.37
MACHINE OR RUNNING (VARIABLE) CHARGES/EXPENSES
Depreciation per hour [(₹44,000 − ₹4,000)/10 Years]/2,000 Hours 2.00
Power/electricity per hour [₹8,000/2,000 Hours] 4.00
Repairs and maintenance per hour [₹2.00 × 75%] 1.50
MACHINE HOUR RATE 18.87
1. 𝐸𝑓𝑓𝑒𝑐𝑡𝑖𝑣𝑒 𝐻𝑜𝑢𝑟𝑠 = 50 𝑊𝑒𝑒𝑘𝑠 × 40 𝐻𝑜𝑢𝑟𝑠 𝑃𝑒𝑟 𝑊𝑒𝑒𝑘 ⇒ 2,000 𝐻𝑜𝑢𝑟𝑠

2. As setting-up time is productive, so no need to subtract while calculating effective hours.

3. 𝑃𝑜𝑤𝑒𝑟 𝑏𝑖𝑙𝑙 = 2,000 𝐻𝑜𝑢𝑟𝑠 × 20 𝑈𝑛𝑖𝑡𝑠 × ₹0.20 𝑃𝑒𝑟 𝑈𝑛𝑖𝑡 ⇒ ₹8,000

4. 𝑅𝑎𝑡𝑒 𝑝𝑒𝑟 𝑢𝑛𝑖𝑡 = ₹20/100 𝑢𝑛𝑖𝑡𝑠 = ₹0.20 𝑝𝑒𝑟 𝑢𝑛𝑖𝑡

In case students assume that current is not used during setting-up time then the solution will be as
follows—
CALCULATION OF MACHINE HOUR RATE
PARTICULARS Rate Per
Hour (₹)
STANDING (FIXED) CHARGES/EXPENSES Per annum (₹)
Rent and rates [₹25,000/4] 6,250
 General lighting [₹160 × 12 Months]/4 480
Administrative expenses 4,000
Workshop supervisor’s salary ₹[3,000 × 12 Months]/3 12,000
TOTAL 22,730
RATE PER HOUR (TOTAL / NUMBER OF EFFECTIVE HOURS)
(22,730/2,000 hours) 11.37
MACHINE OR RUNNING (VARIABLE) CHARGES/EXPENSES
Depreciation per hour [(₹44,000 − ₹4,000)/10 Years]/2,000 Hours 2.00
Power/electricity per hour [₹7,200/2,000 Hours] 3.60
Repairs and maintenance per hour [₹2.00 × 75%] 1.50
MACHINE HOUR RATE 18.47
1. 𝐸𝑓𝑓𝑒𝑐𝑡𝑖𝑣𝑒 𝐻𝑜𝑢𝑟𝑠 = 50 𝑤𝑒𝑒𝑘𝑠 × 40 ℎ𝑜𝑢𝑟𝑠 𝑝𝑒𝑟 𝑤𝑒𝑒𝑘 ⇒ 2,000 𝐻𝑜𝑢𝑟𝑠

2. Setting-up time is productive, so no need to subtract while calculating effective hours.

3. 𝑃𝑜𝑤𝑒𝑟 𝑏𝑖𝑙𝑙 = [2,000 𝐻𝑜𝑢𝑟𝑠 − 200 𝐻𝑜𝑢𝑟𝑠] × 20 𝑈𝑛𝑖𝑡𝑠 × ₹0.20 𝑃𝑒𝑟 𝑈𝑛𝑖𝑡 ⇒ ₹7,200

4. 𝑅𝑎𝑡𝑒 𝑝𝑒𝑟 𝑢𝑛𝑖𝑡 = ₹20/100 𝑈𝑛𝑖𝑡𝑠 = ₹0.20 𝑃𝑒𝑟 𝑈𝑛𝑖𝑡

Illustration 6 (5.11)
The following annual charges are incurred in respect of a machine in a shop where manual labour is
almost nil and where work is done by means of five machines exactly of similar type and specification.
₹
1. Rent and Rates (proportional to the floor space occupied) for the Shop 4,800
2. Depreciation on each machine 500
3. Repairs and maintenance for the five machines 1,000
4. Power consumed (as per meter) @ 5 paise per unit for the shop 3,000
5. Electric/lighting charges for light in the shop 540
6. Attendants:
There are two attendants for the five machines and they are each paid ₹60 per month
7. Supervision:
For the five machines in the Shop there is one supervisor whose emoluments are 250 p. m.
8. Sundry supplies such a Lubricants, Jute and Cotton Waste, etc. for the Shop 450
9. Hire Purchase Instalments payable for the machine (including ₹300 as interest) 1,200
10. The Machine uses 10 units of power per hour. Calculate the machine hour rate for the machine for
the year.
[B. Com. (Pass), University of Delhi, 2003 & 2004]
Solution
CALCULATION OF MACHINE HOUR RATE
PARTICULARS Rate Per
Hour (₹)
STANDING (FIXED) CHARGES/EXPENSES Per annum (₹)
Rent and rates [₹4,800/5] 960
Lighting [₹540/5] 108
Attendant’s salary [(2 × ₹60 × 12 Months)/5] 288
Supervision [(₹250 × 12 Months)/5] 600
Sundry supplies [₹450/5] 90
TOTAL 2,046
RATE PER HOUR (TOTAL / NUMBER OF EFFECTIVE HOURS)
(₹2,046/1,200 hours) 1.70
MACHINE OR RUNNING (VARIABLE) CHARGES/EXPENSES
Depreciation per hour [₹500/1,200 𝐻𝑜𝑢𝑟𝑠] 0.42
Power/electricity per hour [(₹3,000/5)/1,200 𝐻𝑜𝑢𝑟𝑠] 0.50
Repairs and maintenance per hour [(₹1,000/5)/1,200 𝐻𝑜𝑢𝑟𝑠] 0.17
MACHINE HOUR RATE 2.79
1. 𝑇𝑜𝑡𝑎𝑙 𝑒𝑓𝑓𝑒𝑐𝑡𝑖𝑣𝑒 ℎ𝑜𝑢𝑟𝑠 (5 𝑚𝑎𝑐ℎ𝑖𝑛𝑒𝑠) = 𝑇𝑜𝑡𝑎𝑙 𝑈𝑛𝑖𝑡𝑠 𝐶𝑜𝑛𝑠𝑢𝑚𝑒𝑑/10 𝑈𝑛𝑖𝑡𝑠 𝑃𝑒𝑟 𝐻𝑜𝑢𝑟 ⇒
60,000 𝑢𝑛𝑖𝑡𝑠/10 𝑢𝑛𝑖𝑡𝑠 𝑝𝑒𝑟 ℎ𝑜𝑢𝑟 ⇒ 6,000 ℎ𝑜𝑢𝑟𝑠
2. 𝐸𝑓𝑓𝑒𝑐𝑡𝑖𝑣𝑒 ℎ𝑜𝑢𝑟𝑠 𝑝𝑒𝑟 𝑚𝑎𝑐ℎ𝑖𝑛𝑒 = 6000 𝐻𝑜𝑢𝑟𝑠/5 𝑀𝑎𝑐ℎ𝑖𝑛𝑒𝑠 ⇒ 1,200 ℎ𝑜𝑢𝑟𝑠
3. 𝑇𝑜𝑡𝑎𝑙 𝑈𝑛𝑖𝑡𝑠 = 𝑃𝑜𝑤𝑒𝑟 𝐵𝑖𝑙𝑙/₹0.05 𝑃𝑒𝑟 𝑈𝑛𝑖𝑡 ⇒ ₹3,000/0.05 ⇒ 60,000 𝑈𝑛𝑖𝑡𝑠

Illustration 7 (5.12)
The following particulars refer to process used in the treatment of a material subsequently
incorporated in a component forming part of an electrical appliance—
(a) The original cost of the machine used (purchased in June 2006) was ₹10,000. Its estimated life
is 10 years, the estimated scrap value at the end of its life is ₹1,000, and the estimated working
time per year (50 weeks of 44 hours) is 2,200 hours of which machine maintenance, etc. is
estimated to take up 200 hours. No other loss of working time is expected. Setting up time
estimated at 100 hours, is regarded as productive time. (Bank holidays are to be ignored).
(b) Electricity used by the machine during production is 16 units per hour at a cost of 9 paise per
unit. No current is taken during maintenance or setting up.
(c) The machine requires a chemical solution which is replaced at the end of each week at a cost of
₹20 each time.
(d) The estimated cost of maintenance per year is ₹1,200.
(e) Two attendants control the operation of the machine together with five others identical
machines. Their combined weekly wages, insurance and the employer’s contributions to holiday
pay amount to ₹120.
(f) Department and general works overheads allocated to this machine for the year 2006-2007
amount to ₹2,000.
You are required to calculate the machine-hour rate necessary to provide for recoupment of the costs
of operating the machine.
Solution
CALCULATION OF MACHINE HOUR RATE
Effective machine hours=2,200 Hours-200 Hours (Maintenance)=2,000 Hours
PARTICULARS Rate Per
Hour (₹)
STANDING (FIXED) CHARGES/EXPENSES Per annum (₹)
Department and general works overheads 2,000
Wages of attendants (₹120*50 Weeks/6 Machines) 1,000
TOTAL 3,000
RATE PER HOUR (TOTAL / NUMBER OF EFFECTIVE HOURS)
(₹3,000/2,000 Hours) 1.50
MACHINE OR RUNNING (VARIABLE) CHARGES/EXPENSES
₹10,000 − ₹1,000
𝐷𝑒𝑝𝑟𝑒𝑐𝑖𝑎𝑡𝑖𝑜𝑛 = 0.45
2,000 𝐻𝑜𝑢𝑟𝑠 × 10 𝑌𝑒𝑎𝑟𝑠
₹1,200
𝑅𝑒𝑝𝑎𝑖𝑟𝑠 𝑎𝑛𝑑 𝑚𝑎𝑖𝑛𝑡𝑒𝑛𝑎𝑛𝑐𝑒 = 0.60
2,000 𝐻𝑜𝑢𝑟𝑠
₹20 × 50 𝑊𝑒𝑒𝑘𝑠
𝐶ℎ𝑒𝑚𝑖𝑐𝑎𝑙𝑠 = 0.50
2,000 𝐻𝑜𝑢𝑟𝑠
𝑃𝑜𝑤𝑒𝑟
(2,200 𝐻𝑜𝑢𝑟𝑠 − 200 𝐻𝑜𝑢𝑟𝑠 − 100 𝐻𝑜𝑢𝑟𝑠) × 16 𝑈𝑛𝑖𝑡𝑠 𝑃𝑒𝑟 𝐻𝑜𝑢𝑟 × ₹0.09 1.37
=
2,000 𝐻𝑜𝑢𝑟𝑠
MACHINE HOUR RATE 4.42
Illustration 8 (5.13)
Continuing the information given in the Illustration 5.12, compute the machine hour rate in each of
the following cases—
(a) If setting up time is taken as productive time and the current is taken during setting-up.
(b) If setting up time is taken as unproductive time and the current is taken during setting-up.
(c) If setting up time is taken as productive time and no current is taken during setting-up.
Solution
Effective hours when setting-up time is PRODUCTIVE
= 2,200 𝐻𝑜𝑢𝑟𝑠 − 200 𝐻𝑜𝑢𝑟𝑠 − 0 𝐻𝑜𝑢𝑟𝑠 = 2,000 𝐻𝑜𝑢𝑟𝑠
Effective hours when setting-up time is UNPRODUCTIVE
= 2,200 𝐻𝑜𝑢𝑟𝑠 − 200 𝐻𝑜𝑢𝑟𝑠 − 100 𝐻𝑜𝑢𝑟𝑠 = 1,900 𝐻𝑜𝑢𝑟𝑠
Power bill when current is used during setting-up time
= (2,200 𝐻𝑜𝑢𝑟𝑠 − 200 𝐻𝑜𝑢𝑟𝑠 − 0 𝐻𝑜𝑢𝑟𝑠) × 16 𝑈𝑛𝑖𝑡𝑠 × ₹0.09 ⇒ ₹2,880
Power bill when current is not used during setting-up time
= (2,200 𝐻𝑜𝑢𝑟𝑠 − 200 𝐻𝑜𝑢𝑟𝑠 − 100 𝐻𝑜𝑢𝑟𝑠) × 16 𝑈𝑛𝑖𝑡𝑠 × ₹0.09 ⇒ ₹2,730
Case-A: Setting-up time is PRODUCTIVE and current IS USED during setting-up
time
𝑃𝑜𝑤𝑒𝑟 𝐵𝑖𝑙𝑙 ₹2,880
𝐻𝑜𝑢𝑟𝑙𝑦 𝑟𝑎𝑡𝑒 𝑜𝑓 𝑝𝑜𝑤𝑒𝑟 = ⇒ ⇒ ₹1.440 𝑝𝑒𝑟 ℎ𝑜𝑢𝑟
𝐸𝑓𝑓𝑒𝑐𝑡𝑖𝑣𝑒 𝐻𝑜𝑢𝑟𝑠 2,000 𝐻𝑜𝑢𝑟𝑠
Case-B: Setting-up time is UNPRODUCTIVE and current IS USED during
setting-up time
𝑃𝑜𝑤𝑒𝑟 𝐵𝑖𝑙𝑙 ₹2,880
𝐻𝑜𝑢𝑟𝑙𝑦 𝑟𝑎𝑡𝑒 𝑜𝑓 𝑝𝑜𝑤𝑒𝑟 = ⇒ ⇒ ₹1.516 𝑝𝑒𝑟 ℎ𝑜𝑢𝑟
𝐸𝑓𝑓𝑒𝑐𝑡𝑖𝑣𝑒 𝐻𝑜𝑢𝑟𝑠 1,900 𝐻𝑜𝑢𝑟𝑠
Case-C: Setting-up time is PRODUCTIVE and current IS NOT USED during
setting-up time
𝑃𝑜𝑤𝑒𝑟 𝐵𝑖𝑙𝑙 ₹2,730
𝐻𝑜𝑢𝑟𝑙𝑦 𝑟𝑎𝑡𝑒 𝑜𝑓 𝑝𝑜𝑤𝑒𝑟 = ⇒ ⇒ ₹1.365 𝑝𝑒𝑟 ℎ𝑜𝑢𝑟
𝐸𝑓𝑓𝑒𝑐𝑡𝑖𝑣𝑒 𝐻𝑜𝑢𝑟𝑠 2,000 𝐻𝑜𝑢𝑟𝑠
Case-D: Setting-up time is UNPRODUCTIVE and current IS NOT USED during
setting-up time
𝑃𝑜𝑤𝑒𝑟 𝐵𝑖𝑙𝑙 ₹2,730
𝐻𝑜𝑢𝑟𝑙𝑦 𝑟𝑎𝑡𝑒 𝑜𝑓 𝑝𝑜𝑤𝑒𝑟 = ⇒ ⇒ ₹1.437 𝑝𝑒𝑟 ℎ𝑜𝑢𝑟
𝐸𝑓𝑓𝑒𝑐𝑡𝑖𝑣𝑒 𝐻𝑜𝑢𝑟𝑠 1,900 𝐻𝑜𝑢𝑟𝑠

Absorption
Absorption of factory overheads
𝐹𝑎𝑐𝑡𝑜𝑟𝑦 𝑜𝑣𝑒𝑟ℎ𝑒𝑎𝑑𝑠
𝐷𝑖𝑟𝑒𝑐𝑡 𝑚𝑎𝑡𝑒𝑟𝑖𝑎𝑙 𝑐𝑜𝑠𝑡 𝑝𝑒𝑟𝑐𝑒𝑛𝑡𝑎𝑔𝑒 𝑚𝑒𝑡ℎ𝑜𝑑 = × 100
𝐷𝑖𝑟𝑒𝑐𝑡 𝑚𝑎𝑡𝑒𝑟𝑖𝑎𝑙 𝑐𝑜𝑠𝑡

𝐹𝑎𝑐𝑡𝑜𝑟𝑦 𝑜𝑣𝑒𝑟ℎ𝑒𝑎𝑑𝑠
𝐷𝑖𝑟𝑒𝑐𝑡 𝑙𝑎𝑏𝑜𝑟 𝑐𝑜𝑠𝑡 𝑝𝑒𝑟𝑐𝑒𝑛𝑡𝑎𝑔𝑒 𝑚𝑒𝑡ℎ𝑜𝑑 = × 100
𝐷𝑖𝑟𝑒𝑐𝑡 𝑙𝑎𝑏𝑜𝑟 𝑐𝑜𝑠𝑡

𝐹𝑎𝑐𝑡𝑜𝑟𝑦 𝑜𝑣𝑒𝑟ℎ𝑒𝑎𝑑𝑠
𝑃𝑟𝑖𝑚𝑒 𝑐𝑜𝑠𝑡 𝑝𝑒𝑟𝑐𝑒𝑛𝑡𝑎𝑔𝑒 𝑚𝑒𝑡ℎ𝑜𝑑 = × 100
𝑃𝑟𝑖𝑚𝑒 𝑐𝑜𝑠𝑡

𝐹𝑎𝑐𝑡𝑜𝑟𝑦 𝑜𝑣𝑒𝑟ℎ𝑒𝑎𝑑𝑠
𝑀𝑎𝑐ℎ𝑖𝑛𝑒 ℎ𝑜𝑢𝑟 𝑟𝑎𝑡𝑒 𝑚𝑒𝑡ℎ𝑜𝑑 =
𝐸𝑓𝑓𝑒𝑐𝑡𝑖𝑣𝑒 𝑚𝑎𝑐ℎ𝑖𝑛𝑒 ℎ𝑜𝑢𝑟𝑠

𝐹𝑎𝑐𝑡𝑜𝑟𝑦 𝑜𝑣𝑒𝑟ℎ𝑒𝑎𝑑𝑠
𝐷𝑖𝑟𝑒𝑐𝑡 𝑙𝑎𝑏𝑜𝑟 ℎ𝑜𝑢𝑟 𝑟𝑎𝑡𝑒 𝑚𝑒𝑡ℎ𝑜𝑑 =
𝐷𝑖𝑟𝑒𝑐𝑡 𝑙𝑎𝑏𝑜𝑟 ℎ𝑜𝑢𝑟𝑠
Absorption of administrative overheads
𝐴𝑑𝑚𝑖𝑛𝑖𝑠𝑡𝑟𝑎𝑡𝑖𝑣𝑒 𝑜𝑣𝑒𝑟ℎ𝑒𝑎𝑑𝑠
𝑃𝑒𝑟𝑐𝑒𝑛𝑡𝑎𝑔𝑒 𝑜𝑓 𝑤𝑜𝑟𝑘𝑠 (𝑓𝑎𝑐𝑡𝑜𝑟𝑦)𝑐𝑜𝑠𝑡 𝑚𝑒𝑡ℎ𝑜𝑑 = × 100
𝐹𝑎𝑐𝑡𝑜𝑟𝑦 𝑐𝑜𝑠𝑡

𝐴𝑑𝑚𝑖𝑛𝑖𝑠𝑡𝑟𝑎𝑡𝑖𝑣𝑒 𝑜𝑣𝑒𝑟ℎ𝑒𝑎𝑑𝑠
𝑃𝑒𝑟𝑐𝑒𝑛𝑡𝑎𝑔𝑒 𝑜𝑓 𝑓𝑎𝑐𝑡𝑜𝑟𝑦 𝑜𝑣𝑒𝑟ℎ𝑒𝑎𝑑𝑠 𝑚𝑒𝑡ℎ𝑜𝑑 = × 100
𝐹𝑎𝑐𝑡𝑜𝑟𝑦 𝑜𝑣𝑒𝑟ℎ𝑒𝑎𝑑𝑠

𝐴𝑑𝑚𝑖𝑛𝑖𝑠𝑡𝑟𝑎𝑡𝑖𝑣𝑒 𝑜𝑣𝑒𝑟ℎ𝑒𝑎𝑑𝑠
𝑃𝑒𝑟𝑐𝑒𝑛𝑡𝑎𝑔𝑒 𝑜𝑓 𝑠𝑎𝑙𝑒𝑠 𝑚𝑒𝑡ℎ𝑜𝑑 = × 100
𝑆𝑎𝑙𝑒𝑠

𝐴𝑑𝑚𝑖𝑛𝑖𝑠𝑡𝑟𝑎𝑡𝑖𝑣𝑒 𝑜𝑣𝑒𝑟ℎ𝑒𝑎𝑑𝑠
𝑃𝑒𝑟𝑐𝑒𝑛𝑡𝑎𝑔𝑒 𝑜𝑓 𝑐𝑜𝑛𝑣𝑒𝑟𝑠𝑖𝑜𝑛 𝑐𝑜𝑠𝑡 𝑚𝑒𝑡ℎ𝑜𝑑 = × 100
𝐶𝑜𝑛𝑣𝑒𝑟𝑠𝑖𝑜𝑛 𝑐𝑜𝑠𝑡
𝐴𝑑𝑚𝑖𝑛𝑖𝑠𝑡𝑟𝑎𝑡𝑖𝑣𝑒 𝑜𝑣𝑒𝑟ℎ𝑒𝑎𝑑𝑠
𝑃𝑒𝑟𝑐𝑒𝑛𝑡𝑎𝑔𝑒 𝑜𝑓 𝑔𝑟𝑜𝑠𝑠 𝑝𝑟𝑜𝑓𝑖𝑡 𝑚𝑒𝑡ℎ𝑜𝑑 = × 100
𝐺𝑟𝑜𝑠𝑠 𝑐𝑜𝑠𝑡
Absorption of selling and distribution overheads
𝑆𝑒𝑙𝑙𝑖𝑛𝑔 𝑎𝑛𝑑 𝑑𝑖𝑠𝑡𝑟𝑖𝑏𝑢𝑡𝑖𝑜𝑛 𝑜𝑣𝑒𝑟ℎ𝑒𝑎𝑑𝑠
𝑅𝑎𝑡𝑒 𝑝𝑒𝑟 𝑎𝑟𝑡𝑖𝑐𝑙𝑒 𝑠𝑜𝑙𝑑 𝑚𝑒𝑡ℎ𝑜𝑑 =
𝑁𝑢𝑚𝑏𝑒𝑟 𝑜𝑓 𝑢𝑛𝑖𝑡𝑠 𝑠𝑜𝑙𝑑

𝑆𝑒𝑙𝑙𝑖𝑛𝑔 𝑎𝑛𝑑 𝑑𝑖𝑠𝑡𝑟𝑖𝑏𝑢𝑡𝑖𝑜𝑛 𝑜𝑣𝑒𝑟ℎ𝑒𝑎𝑑𝑠

𝑃𝑒𝑟𝑐𝑒𝑛𝑡𝑎𝑔𝑒 𝑜𝑓 𝑠𝑎𝑙𝑒𝑠 𝑚𝑒𝑡ℎ𝑜𝑑 = × 100
𝑆𝑎𝑙𝑒𝑠
𝑆𝑒𝑙𝑙𝑖𝑛𝑔 𝑎𝑛𝑑 𝑑𝑖𝑠𝑡𝑟𝑖𝑏𝑢𝑡𝑖𝑜𝑛 𝑜𝑣𝑒𝑟ℎ𝑒𝑎𝑑𝑠
𝑃𝑒𝑟𝑐𝑒𝑛𝑡𝑎𝑔𝑒 𝑜𝑓 𝑤𝑜𝑟𝑘𝑠 (𝑓𝑎𝑐𝑡𝑜𝑟𝑦) 𝑐𝑜𝑠𝑡 𝑚𝑒𝑡ℎ𝑜𝑑 = × 100
𝐹𝑎𝑐𝑡𝑜𝑟𝑦 𝑐𝑜𝑠𝑡
Actual vs. predetermined overhead rate
𝐴𝑐𝑡𝑢𝑎𝑙 𝑜𝑣𝑒𝑟ℎ𝑒𝑎𝑑𝑠 𝑓𝑜𝑟 𝑡ℎ𝑒 𝑝𝑒𝑟𝑖𝑜𝑑
𝐴𝑐𝑡𝑢𝑎𝑙 𝑜𝑣𝑒𝑟ℎ𝑒𝑎𝑑 𝑟𝑎𝑡𝑒 = × 100∗
𝐴𝑐𝑡𝑢𝑎𝑙 𝑏𝑎𝑠𝑒 𝑓𝑜𝑟 𝑡ℎ𝑒 𝑝𝑒𝑟𝑖𝑜𝑑
*Multiply with 100 if it is to be expressed in percentage

𝐵𝑢𝑑𝑔𝑒𝑡𝑒𝑑 𝑜𝑣𝑒𝑟ℎ𝑒𝑎𝑑𝑠 𝑓𝑜𝑟 𝑡ℎ𝑒 𝑝𝑒𝑟𝑖𝑜𝑑

𝑃𝑟𝑒𝑑𝑡𝑒𝑟𝑚𝑖𝑛𝑒𝑑 𝑜𝑣𝑒𝑟ℎ𝑒𝑎𝑑 𝑟𝑎𝑡𝑒 =
𝐵𝑢𝑑𝑔𝑒𝑡𝑒𝑑 𝑏𝑎𝑠𝑒 𝑓𝑜𝑟 𝑡ℎ𝑒 𝑝𝑒𝑟𝑖𝑜𝑑
Blanket overhead rate
𝑇𝑜𝑡𝑎𝑙 𝑜𝑣𝑒𝑟ℎ𝑒𝑎𝑑𝑠 𝑓𝑜𝑟 𝑡ℎ𝑒 𝑝𝑒𝑟𝑖𝑜𝑑
𝐵𝑙𝑎𝑛𝑘𝑒𝑡 𝑜𝑣𝑒𝑟ℎ𝑒𝑎𝑑 𝑟𝑎𝑡𝑒 = × 100∗
𝐵𝑎𝑠𝑒 𝑓𝑜𝑟 𝑡ℎ𝑒 𝑝𝑒𝑟𝑖𝑜𝑑
* Multiply with 100 if it is to be expressed in percentage

Illustration 9 (5.15)
Compute Machine Hour Rate from the following information—
(i) The machine room will work on 90% capacity throughout the year and that a breakdown of
10% is reasonable.
(ii) There are three days holiday at Deepawali; Two days at Holi and two days at Christmas,
exclusive of Sundays. The factory works 8 hours a day and 4 hours on Saturdays.
(iii) Number of machines (each or same type) are 40.
(iv) Expenses per annum—
Power ₹3,120 for 40 machines
Lubricating oil ₹66 per machine
Light ₹640 per machine
Repairs to machines ₹1,446 for 40 machines
Salaries to Foreman ₹1,200 per machines
Depreciation ₹785.60 for 40 machines
[B. Com. (Pass), University of Delhi, 2006]
Solution
Particulars Days
Number of days in a year 365
Less: Deepawali (3 Days) -3
Less: Holi (2 Days) -2
Less: Christmas (2 Days) -2
Less: Sundays (52 Days) -52
Less: Saturdays (52 Days/2=26 Days) [On Saturday factory operates for 4 hours only] -26
Number of Working Days 280
Effective Machine Hours: 𝑁𝑢𝑚𝑏𝑒𝑟 𝑜𝑓 𝑊𝑜𝑟𝑘𝑖𝑛𝑔 𝐷𝑎𝑦𝑠 × 8 𝐻𝑜𝑢𝑟𝑠 𝑃𝑒𝑟 𝐷𝑎𝑦 × 90% 𝐶𝑎𝑝𝑎𝑐𝑖𝑡𝑦 ×
90% (10% 𝑀𝑎𝑐ℎ𝑖𝑛𝑒 𝐵𝑟𝑒𝑎𝑘𝑑𝑜𝑤𝑛 𝑖𝑠 𝑡ℎ𝑒𝑟𝑒)
OR
Effective Machine Hours: (𝑁𝑢𝑚𝑏𝑒𝑟 𝑜𝑓 𝑊𝑜𝑟𝑘𝑖𝑛𝑔 𝐷𝑎𝑦𝑠 × 8 𝐻𝑜𝑢𝑟𝑠 𝑃𝑒𝑟 𝐷𝑎𝑦 × 90% 𝐶𝑎𝑝𝑎𝑐𝑖𝑡𝑦) −
10% 𝑀𝑎𝑐ℎ𝑖𝑛𝑒 𝐵𝑟𝑒𝑎𝑘𝑑𝑜𝑤𝑛

Effective Machine Hours (for 1 machine): 280 𝐷𝑎𝑦𝑠 × 8 𝐻𝑜𝑢𝑟𝑠 𝑃𝑒𝑟 𝐷𝑎𝑦 × 90% 𝐶𝑎𝑝𝑎𝑐𝑖𝑡𝑦 × 90% ⇒
18,144 𝐻𝑜𝑢𝑟𝑠

Effective Machine Hours (for 40 machines): 280 𝐷𝑎𝑦𝑠 × 8 𝐻𝑜𝑢𝑟𝑠 𝑃𝑒𝑟 𝐷𝑎𝑦 × 40 𝑀𝑎𝑐ℎ𝑖𝑛𝑒𝑠 ×
90% 𝐶𝑎𝑝𝑎𝑐𝑖𝑡𝑦 × 90% ⇒ 18,144 𝐻𝑜𝑢𝑟𝑠 ⇒ 7,25,760 𝐻𝑜𝑢𝑟𝑠
Answer: ₹0.112 Per Machine Hour

Illustration 10 (5.16)
Cost Centre in a factory furnishes the following information—
(i) Working hours per week: 30 hours
(ii) Number of identical machines installed in the centre: 5
(iii) Budgeted Factory Overheads for a 4-weekly period for the Cost Centre: ₹6,000
(iv) Direct Labour Cost for a 4-weekly period for the Cost Centre: 15,000
You are required to calculate Factory Overhead Absorption Rate based on—
(1) Machine Hours;
(2) Labour Cost.
[B. Com. (Pass), University of Delhi, 2002]
Solution
(i) Factory Overhead Absorption Rate based on machine hour
𝐹𝑎𝑐𝑡𝑜𝑟𝑦 𝑂𝑣𝑒𝑟ℎ𝑒𝑎𝑑𝑠 ₹6,000
= ⇒ = ₹10 𝑃𝑒𝑟 𝐻𝑜𝑢𝑟
𝑀𝑎𝑐ℎ𝑖𝑛𝑒 𝐻𝑜𝑢𝑟𝑠 30 𝐻𝑜𝑢𝑟𝑠 × 5 𝑀𝑎𝑐ℎ𝑖𝑛𝑒𝑠 × 4 𝑊𝑒𝑒𝑘𝑠

(ii) Factory Overhead Absorption Rate based on labor cost

𝐹𝑎𝑐𝑡𝑜𝑟𝑦 𝑂𝑣𝑒𝑟ℎ𝑒𝑎𝑑𝑠 ₹6,000
= × 100 ⇒ × 100 = 40%
𝐷𝑖𝑟𝑒𝑐𝑡 𝐿𝑎𝑏𝑜𝑟 ₹15,000

Illustration 11 (5.17)
Nadira Enterprises has two departments A and B. Work is done manually in department A and
through machines in department B. You are required to compute—
(i) Direct labour cost percentage; and
(ii) Machine hour rate,
for the absorption of overheads from the annual data given below—
Direct Wages ₹1,00,000
Factory Overheads allocated to Department A ₹60,000
Factory Overheads allocated to Department B ₹90,000
Factory Overheads not traceable directly to both departments amount to 20,000 and are to be shared
equally between the two departments.
There are 5 machines of similar size and specifications. Each machine works 40 hours in a week. Each
machine remains idle on account of repairs and holidays, etc. for 80 hours annually.
[B. Com. (Pass), University of Delhi, 1987]
Solution
(i) Computation of Direct Labor Cost Percentage (Department A)
𝑇𝑜𝑡𝑎𝑙 𝐹𝑎𝑐𝑡𝑜𝑟𝑦 𝑂𝑣𝑒𝑟ℎ𝑒𝑎𝑑𝑠 = ₹60,000 + ₹10,000 = ₹70,000

𝐹𝑎𝑐𝑡𝑜𝑟𝑦 𝑂𝑣𝑒𝑟ℎ𝑒𝑎𝑑𝑠 ₹70,000

𝐷𝑖𝑟𝑒𝑐𝑡 𝐿𝑎𝑏𝑜𝑟 𝐶𝑜𝑠𝑡 𝑃𝑒𝑟𝑐𝑒𝑛𝑡𝑎𝑔𝑒 = × 100 ⇒ × 100 = 70%
𝐷𝑖𝑟𝑒𝑐𝑡 𝐿𝑎𝑏𝑜𝑟 ₹1,00,000

(ii) Computation of Machine Hour Rate (Department B)

𝑇𝑜𝑡𝑎𝑙 𝐹𝑎𝑐𝑡𝑜𝑟𝑦 𝑂𝑣𝑒𝑟ℎ𝑒𝑎𝑑𝑠 = ₹90,000 + ₹10,000 = ₹1,00,000

₹1,00,000
𝐹𝑎𝑐𝑡𝑜𝑟𝑦 𝑂𝑣𝑒𝑟ℎ𝑒𝑎𝑑𝑠 𝑓𝑜𝑟 𝑒𝑎𝑐ℎ 𝑀𝑎𝑐ℎ𝑖𝑛𝑒 = = ₹20,000
5 𝑀𝑎𝑐ℎ𝑖𝑛𝑒𝑠

𝑁𝑢𝑚𝑏𝑒𝑟 𝑜𝑓 𝑀𝑎𝑐ℎ𝑖𝑛𝑒 𝐻𝑜𝑢𝑟𝑠 = (52 𝑊𝑒𝑒𝑘𝑠 × 40 𝐻𝑜𝑢𝑟𝑠) − 80 𝐻𝑜𝑢𝑟𝑠 = 2,000 𝐻𝑜𝑢𝑟𝑠

𝐹𝑎𝑐𝑡𝑜𝑟𝑦 𝑂𝑣𝑒𝑟ℎ𝑒𝑎𝑑𝑠 ₹20,000

𝑀𝑎𝑐ℎ𝑖𝑛𝑒 𝐻𝑜𝑢𝑟 𝑅𝑎𝑡𝑒 = ⇒ = ₹10 𝑃𝑒𝑟 𝐻𝑜𝑢𝑟
𝑀𝑎𝑐ℎ𝑖𝑛𝑒 𝐻𝑜𝑢𝑟𝑠 ₹2,000

Illustration 12 (5.20)
Meerut manufacturing company makes several product lines which are processed through three
production departments viz. X, Y and Z.
The information concerning the relevant data for a year is as follows—
Factory Overheads Direct Labor Hours Direct Labor Cost
(including share of
service department)
Department X ₹1,24,000 80,000 ₹1,60,000
Department Y ₹2,30,000 1,15,000 ₹2,41,500
Department Z ₹5,46,000 1,05,000 ₹1,99,500
Production records at the end of the year indicated the following for the product line ‘Krish’—
Units produced are 20,000.
Department X Department Y Department Z
₹ ₹ ₹
Prime Cost 45,000 10,500 59,500
Direct Labor Hours 10,000 5,000 30,000
You are required to—
(a) Calculate the departmental and plant-wise over-head rates based on direct labour.
(b) Compute the cost of ‘Krish’ line for the year by using (i) Plant-wise rate and (ii) department
rates; and
(c) Comment on the results.
[B. Com (Pass), University of Delhi, 1994]
Solution
(a) Departmental and plant-wise overheads rates based on direct labor hours
𝑂𝑣𝑒𝑟ℎ𝑒𝑎𝑑𝑠 1,24,000
𝐷𝑒𝑝𝑎𝑟𝑡𝑚𝑒𝑛𝑡 𝑋 = ⇒ ⇒ ₹1.55
𝐷𝑖𝑟𝑒𝑐𝑡 𝐿𝑎𝑏𝑜𝑟 𝐻𝑜𝑢𝑟𝑠 80,000
𝑂𝑣𝑒𝑟ℎ𝑒𝑎𝑑𝑠 2,30,000
𝐷𝑒𝑝𝑎𝑟𝑡𝑚𝑒𝑛𝑡 𝑌 = ⇒ ⇒ ₹2.00
𝐷𝑖𝑟𝑒𝑐𝑡 𝐿𝑎𝑏𝑜𝑟 𝐻𝑜𝑢𝑟𝑠 1,15,000
𝑂𝑣𝑒𝑟ℎ𝑒𝑎𝑑𝑠 5,46,000
𝐷𝑒𝑝𝑎𝑟𝑡𝑚𝑒𝑛𝑡 𝑍 = ⇒ ⇒ ₹5.20
𝐷𝑖𝑟𝑒𝑐𝑡 𝐿𝑎𝑏𝑜𝑟 𝐻𝑜𝑢𝑟𝑠 1,05,000

𝑇𝑜𝑡𝑎𝑙 𝑂𝑣𝑒𝑟ℎ𝑒𝑎𝑑𝑠 ₹9,00,000

𝑃𝑙𝑎𝑛𝑡 − 𝑤𝑖𝑠𝑒 𝑟𝑎𝑡𝑒 = ⇒ ⇒ ₹3
𝑇𝑜𝑡𝑎𝑙 𝐷𝑖𝑟𝑒𝑐𝑡 𝐿𝑎𝑏𝑜𝑟 𝐻𝑜𝑢𝑟𝑠 3,00,000 𝐻𝑜𝑢𝑟𝑠
(b) cost of ‘Krish’ line for the year by using (i) Plant-wise rate and (ii) department
rates
(i) COMPUTATION OF COST OF ‘KRISH’ LINE USING PLANT-WISE RATE
PRIME COST (₹45,000+₹10,500+₹59,500) ₹1,15,000
Add: Factory Overheads (45,000 𝐻𝑜𝑢𝑟𝑠 × ₹3) ₹1,35,000
FACTORY COST OR COST OF PRODUCTION ₹2,50,000

(ii) COMPUTATION OF COST OF ‘KRISH’ LINE USING DEPARTMENTAL WISE RATE

X (₹) Y (₹) Z (₹)
PRIME COST 45,000 10,500 59,500
Add: Factory Overheads
𝑋 = 10,000 × ₹1.55, 𝑌 = 5,000 × ₹2.00, 𝑍 = 30,000 × ₹5.2 15,500 10,000 1,56,000
FACTORY COST OR COST OF PRODUCTION 60,500 20,500 2,15,500
(c) Comments
If the departmental rates are used, total factory overheads are absorbed to the extent of ₹1,81,500
while by application of plant-wise rate, overheads are absorbed to the extent of ₹1,35,000. It shows an
over-absorption of overheads by ₹46,500 by the use of departmental rates.

Illustration 13 (5.21)
The following information for the month of April is extracted from the cost records of Break and Buy
Ltd. which specialises in the manufacture of automobile spares. The parts are manufactured in
Department A and assembled in Department B.
Particulars Total Department A Department B
₹ ₹ ₹
Direct Material 65,000 50,000 15,000
Direct Labor 90,000 40,000 50,000
Factory Rent 15,000 -- --
Supervision 6,000 2,500 3,500
Depreciation on Machines 5,000 -- --
Power 4,000 -- --
Repairs to Machines 2,000 1,600 400
Indirect Labor 4,000 2,000 2,000
Direct Labor Hours worked 80,000 30,000 50,000
Machine Hours worked 30,000 25,000 5,000
Machine Horse Power (H. P.) 400 353 47
Book value of Machines 50,000 40,000 10,000
Floor Space (Square Feet) 20,000 10,000 10,000
Total Department A Department B
₹ ₹ ₹
Materials 3,200 2,700 500
Labor 7,500 3,000 4,500
Direct Labour Hours worked on batch B-401 were 2,500 in Department A and 5,000 in Department B.
Machine Hours worked in this batch were 1,250 in Department A and 600 in Department B. Allocate
overhead expenditure and calculate the cost of each unit in batch B-401 which consists of 1,000 units.
Solution
COST SHEET OF BATCH B-401
Particulars Total Department A Department B
Materials 3,200.00 2,700.00 500.00
Labor 7,500.00 3,000.00 4,500.00
Overheads 2,980.90 1,456.50 1,524.40
TOTAL COST 13,680.90 7156.50 6524.40
 𝑇𝑜𝑡𝑎𝑙 𝑐𝑜𝑠𝑡 13,680.90
𝐶𝑂𝑆𝑇 𝑃𝐸𝑅 𝑈𝑁𝐼𝑇 = ⇒ ⇒≅ 13.68
𝑁𝑢𝑚𝑏𝑒𝑟 𝑜𝑓 𝑢𝑛𝑖𝑡𝑠 𝑚𝑎𝑛𝑢𝑓𝑎𝑐𝑡𝑢𝑟𝑒𝑑 1,000

DEPARTMENTALIZATION OF OVERHEAD RATES

Particulars Basis Total Department Department
A B
STANDING CHARGES: ₹ ₹ ₹
Factory rent Floor Space (1:1) 15,000 7,500 7,500
Supervision Actual 6,000 2,500 3,500
Indirect labor Actual 4,000 2,000 2,000
TOTAL STANDING CHARGES 25,000 12,000 13,000
RUNNING CHARGES:
Depreciation Plant value (4:1) 5,000 4,000 1,000
Power Horse-Power (353:47) 4,000 3,530 470
Repairs of machine Actual 2,000 1,600 400
TOTAL RUNNING CHARGES 11,000 9,130 1,870

CALCULATION OF MACHINE AND LABOR HOUR RATE

Department A Department B
₹12,000 ₹13,000
Labor hour rate = ₹0.40 = ₹0.26
30,000 𝐻𝑜𝑢𝑟𝑠 50,000 𝐻𝑜𝑢𝑟𝑠
₹9,130 ₹1,870
Machine hour rate = ₹0.3652 = ₹0.374
25,000 𝐻𝑜𝑢𝑟𝑠 5,000 𝐻𝑜𝑢𝑟𝑠

OVERHEAD ALLOCATION TO BATCH B-401

DEPARTMENT A:
Standing charges (2,500 × 0.40) 1000.00
Running charges (1,250 × 0.3652) 456.50
TOTAL 1,456.50
DEPARTMENT B:
Standing charges (5,000 × 0.26) 1,300.00
Running charges (600 × 0.374) 224.40
TOTAL 1,524.40

Illustration 14 (5.22)
An engineering firm has three departments. The budgeted expenses for the ensuing year are—
Particulars Department A Department B Department C
₹ ₹ ₹
Material 10,000 10,000 7,970
Direct Wages 13,664 8,784 7,930
Direct Expenses 176 228 90
Works Expenses 9,760 6,588 6,110
Administration Expenses 2,688 2,560 1,989
Direct Labor Hours 7,808 5,856 4,888
Works expenses are charged to output at a man-hour rate and administration expenses are charged as
a percentage on works cost. What price should be charged to Job 61, to include a profit of 10% on cost,
on which the direct costs are as follows—
Particulars Department A Department B Department C
₹ ₹ ₹
Material 420 300 240
Direct Wages 450 300 335
Direct Expenses 10 -- --
Direct Labor Hours 240 216 200
Solution
COMPUTATION OF DIRECT LABOR HOUR RATE
Particulars Department A Department B Department C
Works expenses ₹9,760 ₹6,588 ₹6,110
Direct labor hours 7,808 5,856 4,888
Direct labor hour rate ₹1.25 ₹1.125 ₹1.25

COMPUTATION OF PERECNTAGE OF ADMINISTRATIVE OVERHEADS TO WORKS COST

Particulars Department A Department B Department C
Materials 10,000 10,000 7,970
Direct wages 13,664 8,784 7,930
Direct expenses 176 228 90
Works overheads 9,760 6,588 6,110
WORKS COST 33,600 25,600 22,100
Administrative overheads 2,688 2,560 1,989
Percentage of administrative
overheads to works cost 2,688 2,560 1,989
𝐴𝑑𝑚𝑖𝑛𝑖𝑠𝑡𝑟𝑎𝑡𝑖𝑣𝑒 𝑂𝑣𝑒𝑟ℎ𝑒𝑎𝑑𝑠 × 100 × 100 × 100
33,600 25,600 22,100
=
𝑊𝑜𝑟𝑘𝑠 𝐶𝑜𝑠𝑡 ⇒ 8% ⇒ 10% ⇒ 9%
× 100

COMPUTATIONS OF SELLING PRICE FOR JOB 61

Particulars Department A Department B Department C
Direct materials 420 300 240
Direct labor 450 350 335
Direct expenses 10 0 0
PRIME COST 880 650 575
Works overheads:
240 Hours @ ₹1.25 300
216 Hours @ ₹1.125 243
200 Hours @ ₹1.25 250
WORKS COST 1,180 893 825
Administrative overheads:
8% of ₹1,180 94.4
10% of ₹893 89.3
9% of ₹825 74.3
TOTAL COST 1,274.4 982.3 899.3

COMPUTATION OF SALES PRICE

TOTAL COST OF JOB 61 (₹1,274.4 + ₹982.3 + ₹899.3) ₹3156.60
ADD: PROFIT @ 10% ON COST ₹315.60
SALES PRICE ₹3,471.60

Illustration 15 (2023 Exam)

The following information relates to the activities of a production department in a certain factory.
Material consumed : ₹72,000
Direct wages : ₹60,000
Hours of machine operation : 20,000
Labor hours worked : 24,000
Overheads chargeable to Dept. : 48,000
For a particular order carried out in the department during 2023, the relevant data were:
Material used : ₹4,000
 Labor hours : 1,650
Direct wages : ₹3,300
Machine hours : 1,200
Prepare a comparative statement of cost for this order by using the following 3 methods of recovery of
overheads: (i) Direct labor hour method; (ii) Direct labor cost method; and (iii) Machine hour rate
method.
[B. Com., University of Delhi, 2023]
Solution
First of all, calculate various rates using the information given in the statement in the following
manner:
1. Direct Labor Hour Rate = Factory Overheads / Direct Labor Hours = ₹48,000 / 24,000 Hours
= ₹2 Per Hour
2. Direct labor Cost Method = Factory Overheads /Direct labor Cost  100 = ₹48,000 / ₹60,000 
100 = 80%
3. Machine Hour Rate = Factory Overheads / Machine Hours = ₹48,000 / 20,000 Hours = ₹2.4
Per Hour
After calculating the various factory overheads absorption rates using the methods as mentioned
in the question, the factory overheads shall be absorbed for the given job.
Note: All the above methods have already been calculated in detail in the chapter Overheads.
COST SHEET
Material (i) Direct Labor Hour (ii) Direct Labor Cost (iii) Machine Hour Rate
Method method Method
Material 4,000 4,000 4,000
Labor 3,350 3,350 3,350
PRIME COST 7,300 7,300 7,300
Add: Overheads 3,300 2,640 2,880
[WORKING NOTE – 1] [WORKING NOTE – 2] [WORKING NOTE – 3]
TOTAL COST 10,600 9,940 10,180
Working Notes:
1. Direct Labor Hours  Direct Labor Hour Rate = 1,650 Hours  ₹2 per Hour = ₹3,300
2. Direct Labor Cost  80% = ₹3,300  80% = ₹2,640
3. Machine Hours  Machine Hour Rate = 1,200 Hours  ₹2.4 Per Hour = ₹2,880

Over and under absorpotion

Where overheads are charged to different cost unit on the basis of a predeterrnined overhead rate, at
the end of the accounting period the total overheads charged will be roughly equal to actual
overheads incurred during that period. In case the amount of overheads recovered from production is
more than the actual overheads, there is said to be “over absorption of overheads”. In a reverse case it
is termed as “under-absorption of overheads”. The under-recovery or over- recovery may be on
account of any one or more of the following reasons—
(i) Wrong estimation of overhead expenses.
(ii) Wrong estimation of output or hours to the worked.
(iii) Under or over-utilisation of production capacity.
Disposal of under or over-absorption of overheads
Any of the following methods may be adopted for disposal of under or over-absorption of
overheads, depending upon the circumstances—
1. Carrying over of overheads
The amount of under or over-absorbed overheads may be carried over to the next period in the
following circumstances—
(a) In case of seasonal factory the balance of overheads for a period (month, quarter or half-year)
may be carried forward to the next on the presumption that it will be counter-balanced at the end of
the accounting year.
(b) In case of business where output is affected by business cycles and overhead rate has been
pre-deterrnined for a period of more than one year, the balance of a year may be transferred to next
year’s accounts and so on.
(c) In case of a new project in the initial years the balance of one year may be transferred to the next
on the presumption that there will be more output in the next year which will absorb more overheads.
2. Use of supplementary rate
In case it is observed that the actual and absorbed overheads cannot coincide (because of serious
error in estimating overheads or selection of base or changed circumstances) and the difference is
quite large, a supplementary rate may be found out. The cost of each job, order or process may be
adjusted by applying this supplementary rate. The rate may be calculated as follows—
𝐴𝑚𝑜𝑢𝑛𝑡 𝑜𝑓 𝑜𝑣𝑒𝑟 𝑜𝑟 𝑢𝑛𝑑𝑒𝑟 𝑎𝑏𝑠𝑜𝑟𝑏𝑒𝑑 𝑜𝑣𝑒𝑟ℎ𝑒𝑎𝑑𝑠
𝑆𝑢𝑝𝑝𝑙𝑒𝑚𝑒𝑛𝑡𝑎𝑟𝑦 𝑟𝑎𝑡𝑒 =
𝐴𝑐𝑡𝑢𝑎𝑙 𝑏𝑎𝑠𝑒
Example
Over-absorbed overheads ₹5,000
Actual hours (Base) 10,000
The supplementary rate will be 50 paise per hour.
In case of under-absorption of overheads the rate is termed as positive, while in case of over-
absorption of overheads, it is termed as negative. In case of under-absorption the cost of the job or
product is increased by adding it to overheads charged on the basis of a positive supplementary rate
and in case of over-absorption the cost of the job or product is decreased by deducting the extra
amount of overheads charged by applying a negative supplementary rate.
3. Transfer to costing profit and loss account
In case the difference between actual or absorbed overheads is not very large or the difference is due
to abnormal circumstances, such difference should be transferred to the costing profit and loss
account at the end of the accounting year.

Illustration 16 (5.25)
X Ltd. which absorbs overheads at a pre-determined rate, provides you the following information—
Overheads actually incurred ₹1,50,000
Overheads absorbed ₹1,00,000
Goods sold 12,000 units
Stock of finished goods 11,000 units
Stock of work-in-progress 10,000 units (20% complete)
Unabsorbed overheads were due to rising price levels.
Required: How would under-absorbed overheads be treated in cost accounts?
[B. Com. (Pass), University of Delho, 2008]
Solution
Overheads incurred = ₹1,50,000
Overheads absorbed = ₹1,00,000
UNDER ABSORPTION = ₹50,000

Equivalent production (12,000+11,000+2,000) = 25,000 units

Under absorption to be recovered = ₹50,000

SUPPLEMENTARY RATE = ₹50,000/25,000 Units=₹2 Per Unit

UNDER ABSORBED AMOUNT WILL BE CHARGED TO—

Cost of sales (12,000 𝑈𝑛𝑖𝑡𝑠 × ₹2) = ₹24,000
Finished Stock (11,000 𝑈𝑛𝑖𝑡𝑠 × ₹2) = ₹22,000
 Work-in-progress (2,000 𝑈𝑛𝑖𝑡𝑠 × ₹2) = ₹4,000
TOTAL = ₹50,000

Illustration 17 (15 (Surender Singh))

A cost center in a factory furnishes the following working conditions—
Normal working week 40 Hours
Numbers of machines 15
Number of weekly loss of hours on maintenance, etc. 4 Hours Per Machine
Estimated annual overheads ₹1,55,520
Estimated direct wages rate ₹3 Per Hour
Number of weeks worked per year 48
Actual results in respect of a 4-week period are—
Overheads incurred ₹15,000
Wages incurred ₹7,000
Machine hours produced 2,200
You are required to (A) calculate the overhead rate per machine hour and (B) calculate the amount of
under or over-absorption of both wages and overheads.

Solution
(A) Number of machines 15
Effective hours per week (40 Hours-4 Hours Maintenance) 36
Number of weeks per year 48
Effective hours per year 15 𝑀𝑎𝑐ℎ𝑖𝑛𝑒𝑠 × 36 𝐻𝑜𝑢𝑟𝑠 × 48 𝑊𝑒𝑒𝑘𝑠 = 25,920 𝐻𝑜𝑢𝑟𝑠
Annual overheads ₹1,55,520
Overhead rate per machine hour ₹1,55,520/25,920 Hours=₹6 Per Hour

(B) Overheads absorbed 2,200 𝐻𝑜𝑢𝑟𝑠 × ₹6 𝑃𝑒𝑟 𝐻𝑜𝑢𝑟 = ₹13,200

Overheads incurred ₹15,000
Overheads under-absorbed ₹1,800

Wages absorbed 15 𝑀𝑎𝑐ℎ𝑖𝑛𝑒𝑠 × 40 𝐻𝑜𝑢𝑟𝑠 × 4 𝑊𝑒𝑒𝑘𝑠 × ₹3 𝑃𝑒𝑟 𝐻𝑜𝑢𝑟 = ₹7,200

Wages incurred ₹7,000
Wages over—absorbed ₹200

Illustration 18 (14 (Surender Singh))

The factory overhead costs of four production departments of a company engaged in esecuting orders
for the accounting year 2021-22 are:
Department ₹
A 19,500
B 4,500
C 4,000
D 2,500
Overheads have been absorbed as per the following rate/methods for different departments:
Department
A @ ₹1.5 per machine hour for 14,000 hours
B @ 1.30 per direct labour hour for 3,000 hour
C @ 80% of direct labour cost
D @ ₹2 per piece for 950 pieces
Find out the amount of under or over-absorbed overheads department-wise.
(B. Com., University of Delhi, 2010 (SOL))

Solution
Department Actual overheads (₹) Absorbed overheads Under/over
 (₹) abosorption
A 19,500 ₹1.514,000 Hours ₹1500 Over Absorption
Hours=₹21,000
B 4,500 ₹1.3 Per Hour3,000 ₹600 Under Absorption
Hours=₹3,900
C 4,000 80% of ₹6,000=₹4,800 ₹800 Over Absorption
D 2,500 ₹2950 Pieces=₹1,800 ₹700 Under Absorption

Illustration 19 (Surender Singh)

The following particulars are available in respect of a department of a concern for a month:
Actual overheads 10,000 Hours
Predetermined overhead recovery rate ₹6 Per Machine Hour
On analysis of under-absorbed overheads, it was noted that 70% of under-absorption is due to
defective planning and 30% is due to increase in expenditure. The department produced 20,000 units
in a month, out of which 15,000 units were sold and 5,000 units remained in stock.
You are required to show treatment of under or over-absorbed overheads in cost accounts.
(B. Com., University of Delhi, 2004 (Suppl.))
Solution
Overheads incurred (₹1,00,000-₹20,000) = ₹80,000
Overheads absorbed (10,000 Hrs₹6 Per Hr) = ₹60,000
UNDER ABSORPTION = ₹20,000

TREATMENT OF UNDER-ABSORBED OVERHEADS:

Under-absorbed overheads due to defective planning (₹20,00070%) ₹14,000
Shall be transferred to costing profit and loss account

Under-absorbed overheads due to increase in expenditure (₹20,00030%) ₹6,000

shall be charged to cost using supplementary rate

SUPPLEMENTARY RATE = ₹6,000/20,000 Units=₹0.30 Per Unit

UNDER ABSORBED OVERHEADS WILL BE CHARGED TO:

Cost of sales (15,000 𝑈𝑛𝑖𝑡𝑠 × ₹0.30) = ₹4,500
Finished Stock (5,000 𝑈𝑛𝑖𝑡𝑠 × ₹0.30) = ₹1,500
TOTAL = ₹50,000

Capacity levels and overhead costs

Capacity of an undertaking refers to its ability to utilize resources available at its disposal. Better
utilization of capacity means better utilization of resources. The determination of capacity levels is an
important consideration in correct ascertainrnent of cost of a product service. This is because capcaity
level acts as a base for determination of overhead rate which is needed to assign overhead costs. But
before discussing it further, let us first be familiar with various terms relating to different capacity
concepts. Cost Accounting Standard 2 (CAS 2) issued by the Institue of Cost Accountants of India
defines different capacity as follows—
(i) Licensed Capacity: It is the prduction capacity of the plant for which license has been issued by an
appropriate authority.
(ii) Installed Capacity: It is the maximum productive capacity according to the manufacturer’s
specification of machines/equipment.
(iii) Practical or Achievable Capacity: It is the maximum productive capacity of a plant reduced by
the predictable and unavoidable factors of interruption pertaining to internal causes.
Thus, practical capacity is the installed capacity minus the inevitable interruptions due to time lost for
preventive maintenance, repair, set-ups, normal delays, weekly off-days and holidays, etc. Pratical
capacity does not eonsider the external factors causing reduction in production, e.g. lack of orders.
(iv) Normal Capacity: It is the production achieved or achievable on an average over a period or
season under normal circumstances.
Normal capacity is practical capacity minus the loss of productive capacity due to external factors like
lack of demand. It is determined based on the productive capacity achieved over a period of time, say
average of three normal years out of five years or expected to be achieved over a period of time, say
next three to five years.
(v) Actual Capaity Utilization: It is the volume of production achieved in relation to installed
capacity.
(vi) Idle Capacity: It is the difference between installed capacity and the actual capacity utilization
when actual capacity utilization is less than the installed capacity.
(vii) Excess Capacity Utilization: It is the difference between installed capacity and the actual
capacity utilization when actual capacity utilization is more than installed capacity.
(vii) Abnormal Idle Capacity: It is the difference between practical capacity and the normal capacity
or actual capacity utilization whichever is higher.
Absorption of Production Overheads and Production Capacity
Absorption of overheads depends upon the capacity level. In other words, capacity consideration
influence overhead absorption rate. Overhead rates will be different at differalt capacity levels. Hence,
efficient utilization will help the firm in reducing the cost of a product.
For the purpose of absorption, overheads shall be analyzed into variable overheads and fixed
overheads. The variable production overheads shall be absorbed to products or services based on
actual capacity utilization. Thus,
𝑉𝑎𝑟𝑖𝑎𝑏𝑙𝑒 𝑂𝑣𝑒𝑟ℎ𝑒𝑎𝑑𝑠
𝑉𝑎𝑟𝑖𝑎𝑏𝑙𝑒 𝑂𝑣𝑒𝑟ℎ𝑒𝑎𝑑𝑠 𝐴𝑏𝑠𝑜𝑟𝑝𝑡𝑖𝑜𝑛 𝑅𝑎𝑡𝑒 =
𝐴𝑐𝑡𝑢𝑎𝑙 𝑄𝑢𝑎𝑛𝑡𝑢𝑚 𝑜𝑓 𝐵𝑎𝑠𝑒
The fixed production overheads shall be absorbed in the production cost on the basis of the normal
capacity utilization of the plant, whichever is higher. Thus,
𝐹𝑖𝑥𝑒𝑑 𝑂𝑣𝑒𝑟ℎ𝑒𝑎𝑑𝑠 𝐴𝑏𝑠𝑜𝑟𝑝𝑡𝑖𝑜𝑛 𝑅𝑎𝑡𝑒
𝐹𝑖𝑥𝑒𝑑 𝑂𝑣𝑒𝑟ℎ𝑒𝑎𝑑𝑠
=
𝑁𝑜𝑟𝑚𝑎𝑙 𝑜𝑟 𝐴𝑐𝑡𝑢𝑎𝑙 𝑄𝑢𝑎𝑛𝑡𝑢𝑚 𝑜𝑓 𝐵𝑎𝑠𝑒, 𝑤ℎ𝑖𝑐ℎ𝑒𝑣𝑒𝑟 𝑖𝑠 ℎ𝑖𝑔ℎ𝑒𝑟
When pre-determined overhead rate is being used to absorb overhead cost, same will be calculated
taking normal capacity as the base for the period.
However, if actual production is less than normal, there will be under absorption of fixed overheads
and and when actual producuon is more than nomal, it will result into overabsorption of overheads.
Example
SR Limited provides you the following details of its operations for the year 2018.
Production capacity per hour (As per manufacturer’s specifications) 5 Units
Number of working hours per day 8
Holidays in the year:
Sundays 52 Days
Other Holidays 16 Days
Preventive weekly maintenance is done on Sundays and annual maintenance is done within 16 days of
other holidays.
Normal idle time for tea breaks, lunch, personal needs, etc. 1 Hour Per Day
Average production based on sales expectancy in past 5 years 9,500 Units
Actual production for the year 9,800 Units
Fixed overhead costs for the year ₹5,52,000
You are required to calculate overhead absorption rates based on installed (Maximum) capacity,
practical capacity, normal capacity and actual capacity. Also, find out idle capacity and its costs.
Solution
Determination of various capacities in terms of production units—
𝐼𝑛𝑠𝑡𝑎𝑙𝑙𝑒𝑑 (𝑀𝑎𝑥𝑖𝑚𝑢𝑚) 𝐶𝑎𝑝𝑎𝑐𝑖𝑡𝑦 = 365 𝐷𝑎𝑦𝑠 × 8 𝐻𝑜𝑢𝑟𝑠 × 5 𝑈𝑛𝑖𝑡𝑠 ⇒ 14,600 𝑈𝑛𝑖𝑡𝑠
𝑃𝑟𝑎𝑐𝑡𝑖𝑐𝑎𝑙 𝐶𝑎𝑝𝑎𝑐𝑖𝑡𝑦 = (365 − 52 − 16) 𝐷𝑎𝑦𝑠 × (8 − 1) 𝐻𝑜𝑢𝑟𝑠 × 5 𝑈𝑛𝑖𝑡𝑠 ⇒ 10,395 𝑈𝑛𝑖𝑡𝑠
𝑁𝑜𝑟𝑚𝑎𝑙 𝐶𝑎𝑝𝑎𝑐𝑖𝑡𝑦 = 9,500 𝑈𝑛𝑖𝑡𝑠
𝐴𝑐𝑡𝑢𝑎𝑙 𝐶𝑎𝑝𝑎𝑐𝑖𝑡𝑦 = 9,800 𝑈𝑛𝑖𝑡𝑠
Calculation of Fixed Overhead Absorption Rae Per Unit
Capacity Level Base (Units) Fixed Overhead Absorption Rate (₹)
(Fixed Overhead/Base)
Maximum 14,600 ₹37.81 (₹5,52,000÷14,600)
Practical 10,395 ₹53.10 (₹5,52,000÷10,395)
Normal 9,500 ₹58.11 (₹5,52,000÷9,500)
Actual 9,800 ₹56.33 (₹5,52,000÷₹9,800)
Idle Capacity
𝐼𝑑𝑙𝑒 𝐶𝑎𝑝𝑎𝑐𝑖𝑡𝑦 = 𝐼𝑛𝑠𝑡𝑎𝑙𝑙𝑒𝑑 (𝑀𝑎𝑥𝑖𝑚𝑢𝑚) 𝐶𝑎𝑝𝑎𝑐𝑖𝑡𝑦 − 𝐴𝑐𝑡𝑢𝑎𝑙 𝐶𝑎𝑝𝑎𝑐𝑖𝑡𝑦 ⇒ 14,600 − 9,800
⇒ 4,800 𝑈𝑛𝑖𝑡𝑠
Cost of Idle Capacity (Fixed Overheads)
(i) When overhead absorption rate is based on maximum capacity
= (14,600 − 9,800) × ₹37.81 = ₹1,81,488
(ii) When overhead absorption rate is based on practical capacity
= (10,395 − 9,800) × ₹53.10 = ₹31,595

Note: Different capacity levels can also be calculated in terms of production hours. Further, if pre-
determined overhead rate is used then the problem of under and over absorption of overheads will
arise.

Treatment of certain items in overheads

There are certain items of overheads, the treatment of which vary from concern to concern depending
upon the size of the concern, the method of production used and the policy followed by management.
Let us examine such items more closely and study how they are to be treated in cost accounts.
Interest on Capital
There is a great deal of controversy about the inclusion of interest on capital in the cost accounts.
There are arguments both in favour and against it. These are listed below:
Arguments for Inclusion in Cost Accounts:
1. Interest should also a part of cost of production as wages. If wages are the reward for labor,
then interest is the reward for capital.
2. Interest is a charge for using an important factor of production i.e. capital. Hence for calculation
of real profit, interest on capital (whether paid or provided) should be charged to cost units.
3. When capital invested in different activities vary considerably then result of such activities
cannot be compared meaningfully until and unless interest factor is taken into account.
4. The cost of maintaining different levels of stock for different items of stocks cannot be
ascertained correctly without taking into account the interest on capital invested in stocks.
5. The purpose of allowing larger credit period is to increase sales. But the cost and benefits of
allowing a credit period depends upon cost of investment in debtors i.e. interest cost.
6. Interest is a relevant cost for many managements. For example, decision regarding
replacement of manual operations by machines.
Argument Against Inclusion in Cost Account:
1. The arguments that wages are the reward of labor and interest is the reward of capital, holds
good in economics and not in cost accounting.
2. Interest is a part of finance cost; hence it should be excluded from cost accounts.
 3. Rate of interest fluctuates frequently. Comparison of activities cannot be done meaningfully if
investments in them are made at different interest rates.
4. Sometimes, it is difficult to find out the amount of capital on which the interest is to charged.
Inclusion of this also creates unnecessary complications in management decision making.
After considering the above arguments both for and against the inclusion of interest in cost accounts,
it can be concluded that
(i) interest should be treated as finance cost only in financial accounts and therefore, should
be excluded.
(ii) It should be taken into consideration for the purpose of planning, cost comparison, control
and managerial decision making.
Depreciation
Depreciation is the diminution in the value of a fixed asset due to constant use and or passage of time.
Since these assets are required for the purpose of manufacturing a product or rendering a service,
therefore this diminution in the value of these fixed assets i.e., depreciation is charged to the cost of
production or cost of rendering the service. In order to charge the depreciation on the fixed asset, first
of all its depreciable value is calculated by adding the freight and installation charges to the original
cost minus estimated scrap value at the end of its useful life.
The useful life should also be known either in terms of years or production hours. There are various
methods that can be used for calculating depreciation such as straight-line method, written down
value method, sum of years digits method, annuity method, production hours or production units’
method. The choice of method usually depends upon the type of asset and the nature of business. But,
in cost accounts, mostly straight-line method or production hours method is used because of their
simplicity and convenience.
Research and Development Cost
According to the Institute of Coast Accountant of India, research and development cost is the cost for
undertaking research to improve quality of a new product or manufacturing process; improvement of
existing products, process and equipment; finding new uses for known products, etc. Development
cost includes the cost incurred for commercialization/implementation of research findings.
Development costs are usually incurred on successful research.
Treatment of Research and Development Cost:
1. Treatment of Research Cost: For the purpose of treatment, research may be divided into two
categories i.e.
(a) Basic or fundamental research; and
(b) Applied Research
(a) Basic or Fundamental Research: Generally basic or fundamental is a continuous process in
most of the organizations. This is aimed increasing the general fund of knowledge in the
business area. However, it facilitates applied research. It is treated as a
production/administration/selling and distribution overhead costs depending upon the
functional area of research. If the expenditure is heavy then it be treated as deferred revenue
expenditure, to be absorbed in overhead cost over future periods say 3 to 5 years.
(b) Applied Research:
(i) If conducted for existing products or methods: The cost incurred in charged to the
overheads. However, if it is incurred for a particular product then it should be charged t
that product directly.
(ii) If conducted for new products and methods: These costs can be collected separately
product-wise or project-wise. The successful research costs can be added in the
development cost of the product/project. However, cost of research ending in failure are
written off by charging to costing profit and loss account either on actual or deferred basis.
2. Treatment of Development Cost: Cost of successful research (applied research) together
with the development cost should be treated as deferred revenue expenditure, to be charged to
factory overheads over certain period of time depending upon the size and benefit of the
expenditure. However, if the cost is related to specific product, it should be charged directly.
Royalties and Patent Fees
If royalties and patent fees are payable on the basis of output, the amount should be regarded as a
direct expense and therefore, included in the prime cost of the product concerned. But, if they are
payable on the basis of units sold, the same is treated as a selling expense and so included in selling
and distribution overheads.
Drawing and Design Office Expenses
If drawing and design office is treated as a separate service centre then its costs are apportioned to
the user departments in proportion of the service rendered. If drawings or designs are prepared for a
specific job, drawing costs will be treated as direct expense and charged to the job concerned. In case
drawings made are enclosed with sales tenders, the cost of drawings will be treated as selling
overheads. But, if the services are of a general nature meant for the concern as a whole, the expenses
are treated as production overheads and apportioned to production departments on the basis of
service rendered.
Fringe Benefits
Besides basic wages and cash allowances like DA, HRA and CCA, some indirect monetary benefits in
terms of certain facilities like medical, transport, canteen, housing, creche, etc. are given to industrial
workers. These are collectively called fringe benefits. Expenses on these facilities are may either be
incurred as welfare measure or motivation tool. These are not related to quantity of work done.
Hence, the costs of such benefits will be treated as production overheads and allocated to different
departments on the basis of number of workers employed.
Costing Office Expenses
These are generally charged to administration overheads. Sometimes, these may be apportioned to
various functions like production, administration and selling and distribution on the basis of
estimated benefits obtained by each.
Defective/Spoiled Work
If the defective work and spoilage is inherent in the process of manufacture, such loss should be
included in the cost of production. It is treated as normal loss and charged as an overhead. If these are
due to abnormal factors like fire, accident, machine break-down etc., the net loss (minus sale value
realized by selling the spoiled work/scrap) should be charged to Costing Profit and Loss Account.
Defective work is sometimes sent back to department for correction. In that case, cost of rectifying the
defect may be treated as production overheads.
Packing Material Cost
CAS - 9 of ICAI defines packing materials as “packing materials are the materials used to hold, identify,
describe, store, protect, display, transport, promote and make the product marketable and
communicate with the consumers. Packing materials are classified into primary and secondary
packing materials.
Primary Packing Material: Packing material which is essential to hold the product and bring it to the
condition in which it can be used or sold to a customer. For example, in medicines, oil, confectionary
items, liquid products, gases, etc. Cost of primary packing material is treated as a part of cost of
production. If this can be identified with cost units, it will be part of material cost otherwise it can be
assigned to cost units on the basis of quantity consumed.
Secondary Packing Material: It is material that enables to store, transport, inform the customers,
promote and otherwise make the product marketable. Cost of secondary packing meant for sales
promotion activity to attract customers can be treated as selling overhead. If it is used to store,
transport or delivery of goods to customers’ place, it is treated as distribution overhead.
Patterns and Dies
The patterns, moulds or dies are made for a particular job or work order. Hence, their costs should be
charged to that job or work order as direct expenses and included in its prime cost. However, if these
are meant for production in general, their cost (or depreciation) should be treated as an item of
factory overheads.
Bad Debts
Opinion among accountants differs on treatment of bad debts in cost accounts. Some accountants
treat it as a purely financial loss and exclude it from the cost accounts. However, bad debts are bound
to occur even in the normal course of business. Bad debts within the normal limit treated as selling
overheads. But bad debts over and above the normal limit can be directly transferred to profit and
loss account as a financial loss.
Cash Discount
Cash discount is the discount allowed for prompt payment by debtors. It is regarded as a financial cost
and, therefore, excluded from the cost accounts.