Question

You have been asked to suggest a method of deducing the full cost of various production orders of Basil Ltd. This method will be used as a basis for setting prices. The production orders vary greatly in size and nature from one to the next.The following information has been taken from the budget for the forthcoming financial year:Direct labour £400,000Direct materials £100,000Overheads£450,000Direct materials10,000 kgDirect labour hours50,000 hoursMachine hours45,000 hoursThe business is not departmentalised for accounting purposes.All direct labour is paid the same hourly rate. Basil Ltd has currently receiveda new orderwhich has the following costs:Direct materials450 kgDirect labour hours2,000 hoursMachine hours500 hoursRequired:(a) Prepare full costingsfor new order using the following methods allocating total overheads:-overhead rate based on labour hour basis-overhead rate based on machine hour basis(b)State briefly which of the two bases of overheads you prefer and why.

Answer 1

Solution:

a.

Full costings-Overhead rate based on labour hour basis:

1.Direct materials (450*10) 4,500 (Note 1)

2.Direct labour (2000*8) 16,000   (Note 2)

3.Overheads (2000*9) 18,000 (Note 3)

4.Total cost (1+2+3) 38,500

Full costings-Overhead rate based on Machine hours basis:

1.Direct materials (450*10) 4,500

2.Direct labour (2000*8) 16,000

3.Overheads (500*10) 5,000 (Note 4)

4.Total cost (1+2+3) 25,500

Note:

1.Materials cost per kg = 100000/10000 = 10

2.labour hour rate = 400000/5000 = 8

3.Overhead rate based on Direct labour hours = 450000/5000 = 9

4.Overhead rate based on Machine hours = 450000/45000= 10

b.

From above,

Labor Hour Rate Distribution of Overhead is better than Machine Hour rate.

As the labor hours seems to be a higher cost and it is more relevant. Machine hours are lower and total cost seems to be lower. It may not cover the Actual cost.But a final decision can be made when actual cost is known.

-----------------HOPE THIS IS HELPFUL