Question

 

1. What are overheads and how is it distinguished from prime costs?

2. Why is a predetermined overhead rate calculated?

3. How do you apply the predetermined rate to an actual job?

4. What is under and over absorbed overhead?

Answer 1

• Answer 1

Overheads are the indirect cost and expenses in the production process that are not directly related to the production of goods.

Examples of overhead can be: Factory lightning, depreciation on factory equipment.

It is distinguished from prime cost as Prime Cost include Direct material and Direct Labor cost.

Hence, Prime Cost includes ONLY direct costs, while Overheads include Indirect costs.

• Answer 2

Predetermined Overhead rate is calculated as:

Budgeted Amount of estimated overheads / Estimated allocation base.

For example, if a Co. budgeted $ 100,000 of overheads to be based on estimated 10,000 direct labor hours, the predetermined Overhead rate would be = 1000000 /10000 = $ 10 per direct labor hour

• Answer 3

The predetermined Overhead rate is applied to an actual job based on ACTUAL AMOUNT OF ALLOCATION BASE.

For example, if we consider ‘Answer 2’ example and assume that a job had 6,000 direct labor hours.

The overhead applied tot that job would be = 6000 DLHs x $ 10 = $ 60,000

• Answer 4

When Applied Overheads are MORE than actual overheads incurred, it is called Over Absorbed Overhead.

When Applied Overheads are LESS than actual overheads incurred, its called Under Absorbed Overhead.

For example, continuing with above example, lets assume Actual overhead incurred for the Job was $ 55,000

Absorbed Overhead to the job = $ 60,000 [Answer 4]

Hence, the Overheads are OVER Absorbed by $ 5000 [60000 – 55000]