PREDETERMINED ABSORPTION RATES

Rates that are already been ascertained to:

• Enable product costs to be calculated when production is completed;

• Facilitate planning and control since actual costs can only be known after the close of the costing period and

• Applies where there are seasonal activities and if actual cost is used, it will produce fluctuating unit costs.

These predetermined rates are obtained from:

• the estimation of the total overheads and the level of activity for the forthcoming period.

FORMULA FOR PREDETERMINED ABSORPTION RATE AS FOLLOWS:

Budgeted Overhead for the period

Budgeted units of base for the period

ILLUSTRATIONS ON THE VARIOUS ABSORPTION METHODS

Details of ABC Engineering Ltd:

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Budgeted production overheads        $70,000

Budgeted direct material cost            $10,000

Budgeted direct labour cost               $40,000

Budgeted labour hours                       $30,000

Budgeted machine hours                    $20,000

Budgeted output (units)Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â Â 5,000

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A job was produced with the following details:

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Material cost            $10

Labour cost               $30

Labour hours              20

Machine hours            10

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Compute the different types of Overhead Absorption:

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(a) Direct Material Cost Percentage Rate:

Budgeted production overhead x 100

Budgeted direct material cost

=$70.000Â x 100

$10,000

=700%

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Overhead absorbed by the job= $10 x700% =$70

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(b) Direct Labour Cost Percentage Rate:

Budgeted  overhead x 100

Budgeted direct material cost

=$70.000Â x 100

$40,000

=175%

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Overhead absorbed by the job= $30 x175% =$52.50

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(c) Prime Cost Percentage Rate:

Budgeted overhead x 100

Prime cost

=$70.000Â x 100

$50,000($10,000+$40,000)

=140%

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Overhead absorbed by the job= $40($10+$30) x140% =$56

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(d) Direct Labour Hour Rate:

Budgeted overhead

Budgeted labour hours

=$70.000

30,000

=$2.34

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Overhead absorbed by the job= 20 hours  x$2.34 =$46.80

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(e) Machine Hour Rate:

Budgeted  overhead

Budgeted machine hours

=$70.000

20,000

=$3.5 per machine hour

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Overhead absorbed by the job= 10 hours x $3.5 =$35

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(f) Cost Unit Rate:

Budgeted overhead

Budgeted output

=$70.000

5,000

=$14 per unit

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Overhead absorbed by the job= $14 x 1unit =$14