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Hi everyone,
I’m trying to understand the logic behind accounting for the “premium paid to direct workmen” during the overtime period as “overhead production”.
For instance, workers at factory working 8 hours at normal hourly rate of 10$ and 2 extra hours at one time and half because of increase in activity. In my opinion, the hourly overtime of15$ should be wholly accounted for direct production cost.
Also, can we attribute the increase in production as a purpose to meet the demand of customers, so we assume that overtime worked is for filling a specific request by customer ? Therefore is overtime premium a direct cost ?
Thanks in advance
Normal wages of direct workers are always Direct Cost under normal circumstances. However, if there’s overtime payment, then we classify the wages of overtime into basic rate & overtime premium. The basic rate is Direct cost (as i said above) while the premium is then declared either Direct cost or Production overhead (not overhead production).
Consider this, in your example, if there were no Overtime premium and the direct workers were only paid $10 for the overtime hours, how would we account for these?
The answer is, as i said, these are basic rates and will definitely be included in Direct Cost.
Now lets say there was an overtime premium of $5. How should we account for these?
Answer is, we’ll have to consider the reason behind happening of overtime hours. If the reason is that a customer specifically ordered us to complete his/her work earlier and we have to work overtime for that, then he/she is the reason behind this overtime work and he should be the one paying for them. Thats why we’ll charge him/her the amount.
If, on the other hand, the reason is internal i.e. the company is unable to complete its production in the given time and has to cover it via overtime, then company is the reason behind that overtime and it should pay for it (or bear it, whatever).I can’t explain better than Sir John Moffat. Kindly refer to his free F2 lectures.
Both scenarios imply that overtime were worked solely to meet timely the customers demands.
However, in the second scenario where reasons behind working overtime are internal e.g. machines were suddenly broken down, then i assume that normal wages would be considered as indirect cost since it forms part of idle cost . Conversely, overtime premium might be a direct cost.I still have some grey areas on this topic but i will present my question in Ask the Tutor section.
Thanks a lot secondstar !
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