Cambrige AS and A Level Accounting Notes (9706)/ ZIMSEC Advanced Accounting Level Notes: 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:

- 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
to be spend making the estimated units to be produced**140 000 hours** - 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

Cost Element | Workings | Desk$ | Workings | Chair$ |

Materials | (3kgx$4) | 12 | (2kgx$4) | 8 |

Labour | (4hrsx$2) | 8 | (1hrx$2) | 2 |

Overheads | (4kgx$5) | 20 | (1hrx$5) | 5 |

Total Cost Per Unit | 40 | 15 |

- 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**

To access more topics go the ZIMSEC Advanced Level Accounting page

To access more topics go to the Cambridge AS/A level page