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CA Intermediate · Cost and Management Accounting · Overheads - Absorption Costing Method

A company absorbs factory overhead on a machine hour rate. Which of the following is the most appropriate reason for preferring a machine hour rate over a direct labour hour rate?

A machine hour rate is preferred when production is highly mechanised, because overheads such as depreciation, power and maintenance vary with machine running time. In labour-intensive operations a direct labour hour rate would be more suitable instead.

  1. AProduction is highly automated and machines drive the incurrence of overheadsCorrect
  2. BProduction is mainly manual with little machinery
  3. CLabour wages are the largest element of prime cost
  4. DOverheads are fixed per unit of output regardless of time

Explanation

A machine hour rate suits capital-intensive, automated production where overheads like depreciation, power and maintenance depend on machine running time. In labour-intensive units a labour hour rate is preferred. Options B and C favour a labour-based method.

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