Overheads :: Budgeted, Incurred, Absorbed : Budgeted Rates, Absorption Rates

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Budget » Budgeted  
 
A budget is a depiction of the future activity in quantitative terms. The budget may be for a particular period or a production process.
Eg: 01. The production budget gives the details relating to the production that is planned to be achieved over the budgeted period.
02. The production cost budget gives the details relating to the cost that would be incurred for achieving the budgeted production. This budgeted production cost includes both the variable overhead as well as the fixed overhead.

• Budgeted/Normal Activity

The activity that is budgeted to be achieved over the budgeted period or process is called Budgeted Activity. The activity may be measured in terms of output, input, labor/labour time worked, machine hours worked, etc. Since the budgeted activity would be the activity that should be achieved under normal circumstances, it is also called normal activity.

The two most common measures of budgeted activity that we deal with in analysing overhead variances are

» Budgeted Output

The output that is budgeted to be achieved over the budgeted period or process.

This is the output that would have to be achieved if things go according to plans.

» Budgeted Time

The time for which the production process is budgeted to be carried on over the budgeted period or process.

This is the time for which production process would have to be carried on if things go according to plans.

• Budgeted (Overhead) Rates

The rates considered for absorption of overheads in preparing the budgets are what are called budgeted rates. These are nothing but the standard (pre-determined) rates of absorption of overheads (since budgets are always based on the standards).

The two types of absorption rates that we consider in variance analysis are

» Budgeted Rate Per unit

=
Budgeted (Overhead) Cost
Budgeted Output
This rate is generally identifiable from the budgeted data that is presented.

Rate per unit would be interpreted as

  • "Variable overhead Rate" per unit for analysing Variable Overhead Variances
  • "Fixed overhead Rate" per unit for analysing Fixed Overhead Variances
  • "Total overhead Rate" per unit for analysing Total Overhead Variances

» Budgeted Rate per hour (unit time)

=
Budgeted Overhead Cost
Budgeted Hours (Time)
This rate is identifiable from the budgeted data that is presented.

Rate per hour (unit time) would be interpreted as

  • "Variable overhead Rate" per hour (unit time) for analysing Variable Overhead Variances
  • "Fixed overhead Rate" per hour (unit time) for analysing Fixed Overhead Variances
  • "Total overhead Rate" per hour (unit time) for analysing Total Overhead Variances

• Budgeted (Overhead) Cost

The amount of overhead cost that is budgeted to be incurred during a period or process i.e. for the Normal/Budgeted activity.

It is obtained as the product of the Budgeted Activity and the Budgeted Rate (i..e the Pre determined rate of absorption of overhead).

» Budgeted Cost =

= Budgeted Output × Budgeted Rate per unit.

This is relevant when the overheads are being absorbed on per unit basis.

= Budgeted Time × Budgeted Rate per hour (unit time).

This is relevant when the overheads are being absorbed on per hour basis.

» Budgeted Overhead Cost would be interpreted as

  • Budgeted Variable Overhead Cost for analysing "Variable Overhead Variances"

        The rate in such a case would be "Variable Overhead Rate" per unit/hour.

  • Budgeted Fixed Overhead Cost for analysing "Fixed Overhead Variances"

        The rate in such a case would be "Fixed overhead Rate" per unit/hour.

  • Budgeted Total Overhead Cost for analysing "Total Overhead Variances"

        The rate in such a case would be "Total overhead Rate" per unit/hour.

Actual » Incurred  
 
This pertains to the actual data is obtained

• Actual Activity

This is the activity that is actually achieved during the production period or process. It may be measured in terms of output, input, labor/labour time worked, machine hours worked, etc.

The two most common measures of activity that we deal with in analysing overhead variances are

» Actual Output

The output that has actually been achieved over the production period or process.

» Actual Time

The time for which the production process is actually carried on over the production period or process.

• Actual (Overhead) Cost » Incurred (Overhead) Expenditure

This is the actual overhead expenditure/cost incurred. This can be ascertained only after the incurrence of the cost i.e. at the end of the period or process in consideration.

The total overhead incurred is segregated into

  • Variable Overhead Expenditure/Cost
  • Fixed Overhead Expenditure/Cost
  • Semi-Variable Overhead Expenditure/Cost

• Where there are Semi-Variable Costs

If semi-variable overheads form a part of the total overhead cost/expenditure, it is segregated into two One a fixed part and the other a variable part.

Since there are no tools to analyse semi-variable overheads separately, we add up the fixed part of the expense to Fixed Overhead Cost and the variable part of the expense to the Variable Overhead Cost respectively, for the purpose of variance analysis.

Therefore,

  • Fixed Overhead Cost/Expenditure Incurred
          = Fixed Overhead Cost/Expenditure + Fixed part in semi-variable overhead Cost/Expenditure
  • Total Variable Overhead Cost/Expenditure Incurred
          = Variable Overhead Cost/Expenditure + Variable part in semi-variable overhead Cost/Expenditure

The actual overhead cost/expenditure incurred would be interpreted as

  • Variable Overhead cost/expenditure incurred for analysing "Variable Overhead Variances"
  • Fixed Overhead cost/expenditure incurred for analysing "Fixed Overhead Variances"
  • Total Overhead cost/expenditure incurred for analysing "Total Overhead Variances"

Absorbed Overhead  
 
Absorbed overhead is the amount of overhead cost that is absorbed into total cost based on the predetermined rates of absorption of overheads. The overhead absorbed is always dependent on the actual activity.
  • Where the overheads are being absorbed on a unit basis, the amount of overhead absorbed is dependent on the actual number of units produced.

    Overhead Absorbed = Actual Units Produced × Rate of Overhead Absorption (per unit)

  • Where the overheads are being absorbed on a per hour basis, the amount of overhead absorbed is dependent on the actual number of hours worked for producing the output.
  • Overhead Absorbed = Actual time (No. of hours) worked × Overhead Absorption Rate (per hour)

The overhead cost/expenditure absorbed would be interpreted as

  • Absorbed Variable Overhead cost/expenditure for analysing "Variable Overhead Variances"
  • Absorbed Fixed Overhead cost/expenditure for analysing "Fixed Overhead Variances"
  • Absorbed Total Overhead cost/expenditure for analysing "Total Overhead Variances"

There are other basis also for absorbing overheads. Since only the per unit and per hour basis are used extensively, we limit the discussion to these two bases only.

Finding absorbed overhead using a basis other than that used for absorption  
 
The basis for absorption of overheads is something that is decided upon by the organisation based on a number of factors. Therefore, to know the amount of overhead absorbed we should know the basis of absorption that had been adopted.

This implies that

  • Where overheads have been absorbed on per unit basis,
          Absorbed Overhead = Actual Units Produced × Rate of Overhead Absorption (per unit)
  • Where overheads have been absorbed on per hour basis,
          Absorbed Overhead = Actual time (No. of hours) worked × Overhead Absorption Rate (per hour)

If we use a basis different from the one that had been used for absorbing overheads, the figure of absorbed overhead that we arrive at would be erroneous.

However, there is a possibility to find the overhead absorbed using the per hour basis when they are absorbed on per unit basis and vice versa.

Thus,

  • Where overheads have been absorbed on per unit basis,
    Overhead Absorbed = Actual Units produced × Overhead Absorption Rate/unit
    (Or) = Standard Time (in hrs) for Actual Output × Overhead Rate/hour
  • Where overheads have been absorbed on per unit time (hour) basis,
    Overhead Absorbed = Actual Time (in hrs) × Overhead Absorption Rate/hour
    (Or) = Standard Output for Actual Time × Overhead Absorption Rate/unit

Illustration » Problem + Working Notes  
 
Consider the following data relating to a production process for a period.

Budget Actual
Cost Rs. 5,00,000 Rs. 5,40,000
Output 50,000 units 52,000 units
Time 5,00,000 hours 5,80,000 hours

• Working Notes

» Budgeted Rate per unit

=
Budgeted Overhead Cost
Budgeted Output
=
Rs. 5,00,000
50,000 units
= Rs. 10/unit

» Budgeted Rate per hour

=
Budgeted Overhead Cost
Budgeted hours
=
Rs. 5,00,000
5,00,000 hrs
= Rs. 1/hr

Illustration » Solution (Overheads Absorbed On per unit basis)  
 
Calculating absorbed overhead based on

» Unit Rate

Overhead Absorbed = Actual Units produced × Overhead Rate/unit
= 52,000 units × Rs. 10/unit
= Rs. 5,20,000

» Unit (time) hourly Rate

Standard Time for actual output =
Actual Output
Budgeted Output
× Budgeted Time
=
52,000 units
50,000 units
× 5,00,000 hours
= 5,20,000 hours

Overhead Absorbed = Standard Time (in hrs) for Actual Output × Overhead Rate/hour
= 5,20,000 hours × Rs. 1/hour
= Rs. 5,20,000

Illustration » Solution (Overheads Absorbed On per hour basis)  
 
Calculating absorbed overhead based on

» Unit (time) hourly Rate

Overhead Absorbed = Actual Time produced × Overhead Rate/hour
= 5,80,000 hours × Rs. 1/hour
= Rs. 5,80,000

» Unit Rate

Standard Output for actual Time =
Actual Time
Budgeted Time
× Budgeted Output
=
5,80,000 hours
5,00,000 hours
× 50,000 units
= 58,000 units

Overhead Absorbed = Standard Output for Actual Time × Overhead Rate/unit
= 58,000 units × Rs. 10/unit
= Rs. 5,80,000

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