Q.Explain the different methods of absorbing (recovering) factory overheads and state the situation in which each is most suitable.

Once all factory overhead rests in the production departments, it must be charged to the products passing through them, and there are six standard methods for doing so.

Absorption charges the overhead of a production department to the cost units passing through it, using an overhead absorption rate = overhead ÷ quantity of the base. The six methods differ only in the base used.

1. Production unit (cost unit) method. Rate = overhead ÷ number of units produced. Simple, but fair only where all units are identical (a single, uniform product); with a varied product mix it charges every unit the same overhead regardless of effort.
2. Percentage on direct material cost. Rate = (overhead ÷ direct material cost) × 100. Weakness: material prices fluctuate and bear little relation to the time a job spends in the factory, so material-heavy jobs are over-charged.
3. Percentage on direct labour (wages) cost. Rate = (overhead ÷ direct wages) × 100. Simple and popular; reasonable where labour dominates, but it mixes time with wage rates and ignores machine time.
4. Percentage on prime cost. Rate = (overhead ÷ prime cost) × 100, prime cost being direct material + direct labour (+ direct expenses). Combines the material and labour bases but inherits both their weaknesses.
5. Direct labour hour rate. Rate = overhead ÷ direct labour hours. Sound where work is labour-intensive, because overhead largely accrues with time, and labour hours measure time directly (unlike wages).
6. Machine hour rate. Rate = overhead ÷ machine hours. Most appropriate where work is machine-intensive, since most factory overhead (power, depreciation, repairs) is caused by machine running.

Students often confuse 'percentage on direct labour cost' (based on wages, in rupees) with 'direct labour hour rate' (based on hours) — the two are different methods with different bases. They also forg …