Absorption of Overheads: More than one product one department worked example

• We have already looks at the theory of overhead absorption here
• We have also looked at allocation and apportionment here
• We have also looked at the theory of how to calculate overhead absorption rates (OARs) and why
• Now we will look at a scenario where a business has only one department(factory) and makes two or more products in this factory (department)
• In such cases we have to first determine a basis for absorption first
• At A level the examiners will most certainly decide for you but in the real world management have to decide for themselves

The Question

Zurb Pvt Ltd produces desks and chairs in the same factory.Each desk uses 3 kg of wood at a cost of $4 per kg, and takes 4 hours to produce.Each chair uses 2 kg of wood at a cost of $4 per kg., and takes 1 hour to produce.Labour is paid at the rate of $2 per hour. Fixed costs of production are estimated to be $700,000 p.a.The company expect to produce 30,000 desks and 20,000 chairs p.a.

• NB (Overheads are to be absorbed on a labour hour basis)

Required:

1. Calculate the cost per unit for desks and chairs

Solution

• A few things to note before we present the solution:
• Since we only have one department an overhead analysis sheet is not really required
• Now the solution
• The first thing is to calculate the Absorption Rate to be used
• To do this we need to Determine the Total Labour Hours:
  • Chairs:(20 000 × 1 hr)= 20 000 hours
  • Desks: Desks (30 000 × 4hr)= 120 000 hours
• This gives a total of 140 000 hours to be spend making the estimated units to be produced
• The Absorption Rate can be calculated using the formula:
• \dfrac{\text{70 000}}{text{140 000}}
• This yields a rate of $5/hour
• What this means is that each product made must absorb $5 for each hour it takes to make it in the factory
• The cost per unit for both chairs and desks would thus be

• The above table is known as a cost card
• Do not confuse direct labour cost with overhead absorption here direct labour costs are not absorbed

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