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  Absorption of overheads

Introduction to Absorption of overheads

The word "absorption" consider to charging of overheads of a cost centre to dissimilar cost units in such type of way that each cost unit bears a suitable portion of its share of overheads. This is completed by means of overhead rates. The word '"Overhead Rate"' consider to the rate at that the overheads are to be charged to different cost units. It might be in the form of a percentage or a rate per unit. For example, if the overheads of a department are Rs. 10,000, the sum wages paid for different jobs done in the department are Rs. 40,000 and the overheads are to be charged as a percentage of wages to dissimilar jobs, the overhead rate will be 25% of wages. The share of overheads of each job done in the department will now be computed on this basis.

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Blanket and departmental overhead rates: Overheads might be absorbed either on the base of one single rate (termed as blanket rate) calculated for the whole factory or on the basis of separate rates for every individual department/cost centre. In which one product is manufactured or in which work performed in dissimilar departments is more or less on a uniform pattern, blanket rate might be applied, plant wide, that is over the complete plant.

Dissimilar overhead rates are employed for absorption of dissimilar categories of overheads. Though, the following factors should be considered for determining the rate of overheads absorption.

(i) The rate should be like would not give increase to large variation among the amount of recovered overheads and actual overheads, or else the cost of jobs or products determined on such type of basis would not be right.

(ii) The calculation of overhead rates should not need unnecessary clerical labour. For instance, the apportionment of works manager's salary as per to time spent through him on dissimilar jobs would not be of very much use. It will be good to distribute it on the basis of wages charged to dissimilar jobs since this basis is more suitable, although not more equitable, than the former basis.

(iii) Time factor should be provided due consideration when determining overhead rate in those cases in which dissimilar jobs need different time for their completion. For instance, the overheads of a machine cost centre should be charged to dissimilar jobs on the base of hours for which the machine cost center has worked for each of them. So it will be suitable to charge overheads in such type of case on an hourly rate method.

(IV) Dissimilar jobs need different degrees of skill. So it will not be suitable to charge all jobs with similar overhead rate. This factor should be taken care of when determining the rate.

(v) The overhead rate should also be associated to the method of production followed. For instance, in a department where work is done generally through machines, the machine hour rate should be accepted as a rate for the recovery of overheads. When in a department in which work is done mainly by manual labour, the overhead should be absorbed on a labour hour rate basis.

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