Solution to the problem set on “Treatment of Overheads”

Solution to the “Illustration no. 1”

In this method, overhead costs are segregated by means of an equation. This equation for a
straight line is:
Y = mX + c
Y= Total semi-variable cost
Where X= Volume of output
c= Fixed cost
m= Slope of variable cost like, i.e. variable cost per unit of output.

For the purpose of separating fixed and variable components of the cost, the overhead cost is
determined at various levels of output and pairs of values of X and Y are fitted in the above
formula in order to compute the values of m and c. For example:

From the data in Illustration 4.1, we take any two months and find out fixed and variable
components.
Let us take Jan. and Feb., make two equations.
Y = mX + c
For Jan. 2,200 = 80m + c .….(i)
For Feb. 1,600 = 40m + c …..(ii)

Subtracting equation (ii) from (i)

We get 600 = 40m
m = 600/40 = 15
Therefore, variable cost per unit = Rs. 15

Put the value of m in equation (i), we get

2,200 = 80 ×15 + c
c = Rs. 1,000

Thus fixed cost is Rs. 1,000 and variable cost in January is Rs. 1,200 (i.e 2,200 -1,000)
In this way, we can place the value of m in any month’s equation and derive the variable and
fixed components.
This method provides a simple and accurate means of separating fixed and variable overhead
costs.

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 Solution to the “Illustration no. 2”
Overhead Distribution Summary

Total Production departments. Service departments.

Item Basic of Rs. A B C X Y
apportionment Rs. Rs. Rs. Rs. Rs.
Direct wages Actual 2,000 — — — 1,000 1,000
Direct materials Actual 2,500 — — — 1,500 1,000
Stores overheads Direct materials 400 120 100 80 60 40
Motive power Kwh 1,500 480 360 360 120 180
Lighting No. of points 200 40 60 60 20 20
Labour welfare No. of employees 3,000 1,000 750 750 250 250
Depreciation Assets value 6,000 2,500 1,500 1,000 500 500
Repairs and Maintenance Assets value 1,200 500 300 200 100 100
General overheads Direct wages 10,000 3,500 3,000 2,500 500 500
Rent and taxes Area occupied 600 200 150 150 50 50
Total 27,400 8,340 6,220 5,100 4,100 3,640
Department X 4:3:3 (Given) 1,640 1,230 1,230 (—) 4,100
Department Y Direct wages (7:6:5) 1,416 1,213 1,011 (—) 3,640
Total 27,400 11,396 8,663 7,341 — —
Note: Direct wages and direct materials of service departments are indirect costs and thus included in the overheads.

Solution to the “Illustration no. 3”

Computation of Machine Hour Rates

Items Basis Total Machine I Machine II Machine III

Rs. Rs. Rs. Rs.
Department of machinery Machine value 1,2000 6,000 2,400 3,600
Dep. Of building Space 2,880 576 1,152 1,152

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Machine repairs Machine value 4,000 2,000 800 1,200
Insurance -do- 800 400 160 240
Indirect wages No. of workers 6,000 1,200 2,400 2,400
Power Power units 6,000 3,000 1,000 2,000
Lighting Light points 800 80 240 480
Misc. expenses Direct wages 4,200 840 1,680 1,680
Total 36,680 14,096 9,832 12,752
Hours worked 200 300 300
Machine hour rate (simple) 70.48 32.77 42.51
Wages per hour (Direct wages ÷ hours) 6.00 8.00 8.00
Comprehensive machine hour rate (including direct wages) 76.48 40.77 50.51

Solution to the “Illustration no. 4”

Maximum capacity
= Total days in the year × No. of hours worked per day.
= 365 × 8 = 2,920 hours.

Practical capacity = Maximum capacity – Normal loss

Maximum capacity 2,920 hrs
Less: Sundays (52 days × 8 hrs.) 416
Holidays (20 days × 8 hrs.) 160
Loss due to cleaning, oiling etc. 160 736 hrs.
Practical capacity 2,184 hrs.

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Normal capacity = Normal sales + Units per hour
= 2,500 units ÷ 2 units per hour = 1250 hours
Capacity based on sales expectancy = 2,400 units ÷ 2 units per hour
= 1200 hours.
Overhead absorption rate per hour based in practical capacity. (For fixed cost only)

¿ overhead cost (Rs) Rs . 37,128

¿ = =Rs . 17 per hour ,
Practical capacity (hours ) 2,184 hours

Idle capacity = Practical capacity – Capacity based on sales expectancy

= 2,184 – 1,200 = 984 hrs.
Cost of idle capacity = Idle capacity × Overhead rate
= 984 hrs × Rs. 17 = Rs. 16,728
Note: Idle capacity has been taken as the difference between practical capacity and capacity based on sales expectancy. It may also be taken
as the difference between practical capacity and actual capacity, if information in this respect is available.
Solution to the “Illustration no. 5”

Under absorbed overhead = Actual overhead – Absorbed overhead

= Rs 4,26,890 – 3,66,250 = Rs. 60,640
Total cost incurred = Rs. 230,732 + 840,588 = 1,41,480 = Rs. 12,12,800

Supplementary Rate Unabsorbed amount

¿ × 100
Total cost

60,640
¿ ×100=5 % of cost
12,12,800

As there is under-absorption of overhead, it is a plus rate i.e. the cost of finished goods, work in progress and cost of goods sold will be
increased by 5% as shown below:

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Finished goods = Rs. 2,30,732 × 5% = Rs. 11,536.60
Work in progress = Rs. 1,41,480 × 5% = Rs. 7,074.00
Cost of goods sold = Rs. 8,40,588 × 5% = Rs. 42,029.40
Total 60,640.00

Solution to the “Illustration no. 6”

Amount of factory overhead cost absorbed is calculated as follows:

Rs.
X @ Rs. 5 per machine hour for 10,000 hours 50,000
Y @ 75% of direct labour cost of Rs 1,20,000 90,000
Z @ Rs. 4 per piece for 15,000 piece 60,000
Total overhead absorbed 2,00,000

Statement Showing Department – wise Under/over Absorption

Department Actual overhead Absorbed overhead Under absorption Over absorption

Rs. Rs. Rs. Rs.
X 48,950 50,000 — 1,050
Y 89,200 90,000 — 800
Z 64,500 60,000 4,500 —

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 Total 2,02,650 2,00,000 4,500 1,850

Net under- = 4,500 - 1,850 = Rs. 2,650

absorption
Or 2,02,650 – 2,00,000 = Rs. 2,650