Departmental overhead absorption at Sambalpur Garments
Sambalpur Garments has two production departments, Cutting and Stitching. Budgeted overheads are Rs 6,00,000 for Cutting and Rs 4,00,000 for Stitching. Cutting is machine-intensive, with budgeted machine hours of 20,000; Stitching is labour-intensive, with budgeted direct labour hours of 25,000. Actual overheads were Rs 6,40,000 and Rs 3,70,000; actual machine hours were 22,000 and actual labour hours 24,000. Job No. 214 consumed direct materials of Rs 18,000 and direct labour of Rs 12,000. It used 200 machine hours in Cutting and 150 direct labour hours in Stitching. The firm currently uses a single plant-wide overhead rate based on direct labour hours, but the accountant proposes departmental absorption rates. The manager asks whether the change would alter the job cost and how the resulting under- or over-absorption should be handled.
1. Compute departmental overhead absorption rates and the full cost of Job No. 214.
Read the worked answer
Cutting absorption rate = budgeted overhead ÷ budgeted machine hours = Rs 6,00,000 ÷ 20,000 = Rs 30 per machine hour.
Stitching absorption rate = budgeted overhead ÷ budgeted direct labour hours = Rs 4,00,000 ÷ 25,000 = Rs 16 per direct labour hour.
Job No. 214 overhead:
| Department | Base | Rate | Overhead |
|---|---|---|---|
| Cutting | 200 machine hours | Rs 30 | Rs 6,000 |
| Stitching | 150 labour hours | Rs 16 | Rs 2,400 |
| Total | Rs 8,400 |
Full job cost = direct materials Rs 18,000 + direct labour Rs 12,000 + overhead Rs 8,400 = Rs 38,400.
The departmental rates reflect the cause of the overhead: machine time in Cutting and labour time in Stitching. This is more defensible than forcing both departments onto one labour-hour base.
2. Compute under- or over-absorption for each department and state how it should be disposed of.
Read the worked answer
Cutting absorbed = 22,000 actual machine hours × Rs 30 = Rs 6,60,000. Actual overhead = Rs 6,40,000. Over-absorption = Rs 20,000.
Stitching absorbed = 24,000 actual labour hours × Rs 16 = Rs 3,84,000. Actual overhead = Rs 3,70,000. Over-absorption = Rs 14,000.
Total over-absorption = Rs 34,000.
The amount is not automatically a profit. It arises because actual activity was higher than budgeted or actual spending was lower. If it is small, it can be transferred to the costing profit and loss account. If it is large or due to a serious estimating error, the firm should adjust the absorption rates for the next period and investigate the causes. The manager should not use the over-absorption to reduce product cost retrospectively without a clear policy.
3. Compare the job cost under the existing plant-wide labour-hour rate and comment on the suitability of each base.
Read the worked answer
Plant-wide rate = total budgeted overhead ÷ total budgeted direct labour hours = (Rs 6,00,000 + Rs 4,00,000) ÷ 25,000 = Rs 40 per labour hour.
Under this method Job No. 214 absorbs only 150 stitching labour hours × Rs 40 = Rs 6,000. Its cost would be Rs 18,000 + Rs 12,000 + Rs 6,000 = Rs 36,000, compared with Rs 38,400 under departmental rates. The job is under-costed by Rs 2,400 because the 200 machine hours in Cutting are ignored.
The plant-wide labour-hour rate is unsuitable when departments have different cost drivers. Cutting is machine-intensive, so machine hours are the better base. Stitching is labour-intensive, so labour hours are appropriate there. The firm should use departmental rates, but it must also review whether stitching has become partly machine-based; if so, a machine-hour rate or a combined base may be needed. The change improves job costing and pricing, but it requires reliable machine-hour records.