Methods of Absorption - II - Factory Overheads Distribution Prime Cost Percentage:

The prime cost basis unites the aggregate of direct materials cost and direct labor cost and uses this aggregate a basis for charging overhead. The formula used in ascertaining the rate is: Factory Overhead

Prime cost

x 100

Illustration:

If in a case the factory overhead is $150,000 and prime cost is $300,000. Calculate the prime cost percentage rate.Solution:

150,000 x 100300,000

= 50 % of Prime Cost

Merits:

This method is simple to function. It integrates both materials and labor incharging overhead to every job or article. The prime cost data is easilyaccessible devoid any extra difficulty of accretion.

Demerits:

1. Two factors that is, materials and labor both of which has manydemerits influence the charging of factory overhead to jobs and articles.

Demerits:

2. Where the cost of materials is a larger part of the prime cost, the time factor (direct labor costs) will be uncared for which is more connected to the factory overhead.

3. It pays no attention to time factor in absorbing factory overhead.

4. It can be helpful to only a few sections where the type of labor and value of materials used are invariable.

Unit of Production Basis

The unit of production method is the simplest and most direct method of charging factory overhead. The unit may be a kilogram, a foot, an article or whatever unit of measure is used for the article. As a formula, the calculation is as follows:

Factory OverheadUnits of Production

Illustration:

If for instance, let us presume the factory overhead as $500,000 and the company plans to make 300,000 units during the subsequent period; compute the unit charge as a share of factory overhead. Also calculate the total unit charge for an order of 5,000 completed units.

Solution :Unit Charge = $500,000 / 300,000 units = $1.67Total unit charge for 5,000 units = 5,000 x 1.67 = $8,333