FUNDAMENTALS OF COSTING

ASSIGNMENT

SUBMITTED BY,
Raveena V
MY.BU.U3COM17030

BCOM(H)
 METHODS OF ABSORPTION OF OVERHEAD

1. MACHINE HOUR RATE

 Machine hour rate is the cost of running a machine per hour.

 In industries like chemicals, engineering, steel and other heavy industries

where the work is done mostly by machine, it is desirable to adopt the
machine hour rate method.

 Because, in such industries factory overheads largely consist of expenses

relating to the maintenance and operation of machines. Machine hour rate
refers to the amount of factory overheads incurred for running a machine for
an hour.

 Machine hour rate= overhead expenses/machine hours

 The machine hour rate is calculated by dividing the total amount of factory
overheads incurred in running a machine during a particular period by the
total number of working hours of that machine during that period.
TWO TYPES OF MACHINE HOUR RATE

1. Simple or ordinary machine hour rate

2. Composite or comprehensive machine hour rate.

SIMPLE MACHINE HOUR RATE

 Total machine expenses or the total variable expenses like power, fuel,
repairs and depreciation of the machine which are directly connected with
the operation of the machine per hour.

COMPOSITE MACHINE HOUR RATE

 Total variable expenses per hour plus the total fixed, constant or standing
charges per hour not directly connected with the operation of the machine,
but are the general factory overhead of the department.
ADVANTAGES OF MACHINE HOUR RATE

1. Machine hour rate method is a scientific, practical and accurate method of

absorption of factory overheads in industrial undertakings where the work is done
predominantly by machines.

2. This method takes into account time factor and hence gives accurate results.

3. It provides useful data for estimating the cost of a job, setting standards and
for fixing selling prices for quotations.

4. It helps the management to decide how far machine work is preferable to

manual work.

5. It makes distinction between skilled and unskilled labour in the absorption of

factory overheads into production. 6. It helps to compare relative efficiencies and
the costs of operating different machines.

7. It brings to light the existence and the extent of idle time of machines, if
separate machine hour rates are established for fixed overheads and variable
overheads.

8. This is an ideal method of absorption where production is carried out on

machines.

9. Cost reports prepared with the help of such rate are dependable and can help
the management in decision-making.

DISADVANTAGES OF MACHINE HOUR RATE

1. It involves additional work in assessing the working hours of machines and thus
it is a costly method.

2. It does not take into account expenses that are not proportional to the working
hours of machines.

3. It gives inaccurate results if manual labour is equally important.

4. It is difficult to estimate the machine hours especially when production
programme is not available in advance.

5. This method is not suitable where most of the production work is done by
manual work.
2. SALES PRICE METHOD
 Under this method budgeted overhead expenenses are divided by the sales
price of unit of production inorder to calculate the overhead recovery rate.

 Overhead recovery rate= budgeted overhead expenses/ sale value of

units of production.

 This method is more suitable for apportioning of administration, selling and

distribution research, development and design cost to cost of production.

 It can also be used with advantage for the preparation of joint product cost.