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Advantages And Disadvantages Of Direct Labor Cost

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Let us understand this with the help of an example.
Illustration: Consider the following data for the production department of XYZ Ltd.
Direct materials consumed Rs. 1,50,000
Direct wages Rs. 1,00,000
Factory overheads Rs. 3,00,000
Labour hours 60,000 hours
Machine hours 50,000 hours

For one of the orders carried out in the department, the relevant data are as follows:
Direct material consumed Rs. 28,000
Direct wages Rs. 22,000
Machine hours worked 10,000 hours
Labour hours worked 14,000 hours
Calculate the factory overhead absorption rate as percentage of direct material cost.
Solution:
Percentage of Direct Material= (Factory overhead for the period)/(Direct material cost for the period) x 100 …show more content…

33,000
The advantages and disadvantages of percentage of direct labour cost are listed in the following table:
Advantages Disadvantages
It is simple and economical to apply. This method does not differentiate between skilled and unskilled labours.
It gives importance to time factor for overhead absorption. The method does not recognise differences between manual and mechanical production.
Labour rates are more stable than material prices. The method does not recognise differences between fixed and variable expenses.
Relevant labour data are easily available from sources. This method ignores the time factor when work is done on the basis of piece rate method.

Percentage of Prime Cost
As the name suggests, in this method, factory overheads are absorbed on the basis of prime cost. That is, this method combines both direct material cost and direct labour cost. Overhead rate is obtained by dividing total factory overheads by prime cost. …show more content…

This method ignores the additional labour required for recording time booking and timekeeping.
It considers time factor. It ignores certain factors such as machine use.
It is suitable where labour plays a major role.

Machine Hour Rate
Machine hour rate is the cost of running a machine per hour. It is calculated by dividing the amount of expenses to be absorbed by the number of machine hour. This rate is calculated separately for each machine or class of similar machines. Mathematically,
Machine hour rate= (Overhead to be absorbed)/(No.of machine hours)

To calculate absorption rate, the machine hour rate is predetermined. Overheads are now calculated as:
Overheads to be charged to a product/job = No.of hours for which machine is used for the product or job x machine hour rate
This method is mostly used in the industries where machine use is higher than manual labour.
For example, factory overheads are Rs. 30,000 and machine hours are 4,000. Machine hour rate will be 30,000/4,000 = Rs. 7.50 per

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