What methods adopted for overhead absorption

The method adopted for overhead absorption varies from industry to industry and from one

undertaking to another. Some firms use separate rates for each type after classifying the overhead expenses into several types. The choice of a most equitable method is very important as the method adopted, if unsuitable, will distort costs and will be useless for control and decision making purposes. Type of industry, nature of product and process of manufacture, organization setup, individual requirement and policy of management are the factors which affect the choice of an overhead rate. Besides these, a satisfactory overhead rate should be simple, easy to operate, practical, accurate, economic in application, fairly stable and related to time factor. It should be preferably department rates as compare to blanket rates, homogeneous cost unit and should lay stress on the main production element of the concern.

The main factor should be taken into consideration before formulating overhead rates or deciding upon the basis for applying overheads to product.

Equitable apportionment of overhead.- the overhead rate should be such that overhead should be equitable apportioned to the cost centres or cost units. The amount of overheads recovered should also be equivalent to the amount of overheads incurred.

Simple and easy to understand- the overhead rate should be simple to calculate and easy to understand. It should not require unnecessary or additional clerical work.

Relation with time factor.- overhead rate should have some relation to the time taken by various jobs for completion. Thus, if a job takes twice as much time as another job, the first job should be charged twice the amount charged to the second job. It is because of this reason that direct wages percentage rate is preferred over direct material cost percentage rate.

Separate rates for manual or machine work.- the work done by manual labor should be distinguished from work done by machine and different overhead rates should be applied for manual and machine work.

Different overhead rates for different departments.- different overhead rates should be ascertained for different departments where the nature of the work done by one department is different from the work done by other department or departments.