Question

A manufacturing company has prepared the following budgeted information for year 2: K

Direct material 800,000

Direct labour 200,000

Direct expenses 40,000

Production overhead 600,000

Administrative overhead 328,000

Budgeted activity levels include: Units

Budgeted production 600,000

Machine hours 50,000

Labour hours 40,000

It has recently spent heavily upon advanced technological machinery and reduced its workforce. As a consequence it is thinking about changing its basis for overhead absorption from a percentage of direct labour cost to either a machine hour or labour hour basis. The administrative overhead it to be absorbed as a percentage of factory cost.

Required: (a) Prepare predetermined overheads absorption rates for production overheads based upon the three different basis for absorption mentioned above.

(b) Select the overhead absorption rate that you think the organisation should use giving reasons for your decision.

(c) The company has been asked to price job AX. This required the following:

Direct material K3,788

Direct labour K1,100

Direct expenses K 422

Machine hours 120

Labour hours 220

Compute the selling price for this job using the absorption rate selected in (b) above, given that the company profit margins is equal to 10% of the price

Answer 1

SOLUTION

(a) Percentage of direct labour cost method = (£600 000 / £200 000) x 100

= 300% of direct labour cost

Direct labour hour method = (£600 000/40 000 direct labour hours)

= £15 per direct labour hour

Machine hour method = (£600 000/50 000 machine hour)

= £12 per machine hour

(B) The question states that the company has become machine-intensive and implies that in the long term there is a closer association between overhead expenditure and machine hours than the other two methods. Therefore the best measure of overhead resources consumed by jobs or products is machine hours.

(C) Job Ax (£)

Direct material 3788

Direct labour 1100

Direct expenses 422

Prime cost 5310

Production overhead (120 machine hours £12) 1440

Factory cost 6750

Administrative overheads (20% £6750) 1350

Total cost 8100

Profit (£8100/0.90 £8100) 900

Selling price 9000

Workings

Administration overhead absorption rate = Total admin. Overheads/total factory cost

= £328 000 / £1 640 000

= 20% of factory cost