Overhead Absorption Rates

learner92

This may be a silly question but I would really appreciate any help I could get, I am using the BPP book and this is what is says:

Mars Ltd has two production departments, mixing and stirring in which it makes a variety of products. Budget overheads are £10,000 £15,000 respectively. And the following budgeted information has also been collected

Direct labour hours: Mixing = 20,000. Stirring = 5,000
Direct Machine Hours: Mixing = 2,000. Stirring = 60,000
Number of Units: Mixing = 10,000. Stirring = 10,000

Calculate appropriate OAR for both mixing and stirring department.

Can some explain to me what I have to do?

P.S. In the answer sections the answers are 50p per labour hour and 25p per labour hour, but I don't understand why or how?

Does this mean that the workers only get paid 50p an hour? And it only cost 25p an hour to run the machines?

Thanks A lot to anyone that helps me out, I really appreciate it.

N4T

Hi,

The formula to use is
OAR = Budgeted overhead/ Budgeted level of activity

For Mixing dept you would absorb using direct labour hours as it is more labour intensive. ( i.e using 20,000 labour hours as oppose to only 2,000 machine machine hours and 10,000 production units - choose the highest)

Therefore OAR is £10,000 / 20,000 labour hours = £0.50 per labour hour

For Stirring dept you would absorb using direct machine hourd as it is more machine intensive ( i.e using 60,000 (highest of the three options)

Therefore OAR is £15,000 / 60,000 machine hours = £0.25 per machine hour.

No, it does not mean how much the workers are being paid or how much the machine costs to run.

Basically there are indirect costs (overheads) which you can't easily attribute to a particular area of the business. Costs such as rent, electricity, canteen.....

OAR is a method of absorbing or allocating these indirect costs into cost centres...in this example Mixing and stirring departments.

I hope this helps.