This may be analysed under
Level of the business or cost center. Expenditure on some items of production overhead costs will vary directly with activity whereas others will be fixed irrespective of the changes in activity level. For example in a machine orientated cost center, power cost will vary in proportion to machine hours whereas salary of the cost center manager will be fixed.
- Level of expenditure on production overhead
Expenditure level may change from the budgeted level because of a change in the price of an overhead item or a change in the usage of the overhead item
- Activity level and the absorption of production overhead cost
In the table below the variable overhead absorbed per machine hour is constant (Shs.3) irrespective of the activity level. The fixed overhead cost per machine hour depends on the activity level used as the base. If 100 machine hours are used, Shs.5 per machine hour must be charged in order to absorb the fixed overhead cost of Shs.500. if 300 machine hours are used, Shs.1.67 per machine hour is a sufficient charge in order to absorb the total fixed overhead cost.
Figure 5.0 Machining cost center
|Activity levelMachine hrs||Total fixedOverhead costs||Total variable Overhead costs||Total overhead cost||Average Machine||Overhead Hour||Cost per
Production overheads will be absorbed by jobs or products at the pre-determined rater per machine hour.
If the actual number of machine hours used differs from the number used in the calculation of the overhead absorption rate, an over or under absorption will occur.
Note that this problem does not occur with variable overheads since the incidence of the cost (such as power cost) varies with changes in activity.