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Accounting for overheads

Absorption

4.1 Overhead absorption

The last stage in absorption costing is the absorption of the overheads into the cost
units produced in the production cost centres. This is sometimes referred to as
overhead recovery.

Production Production
cost centre1 cost centre 2

Cost units

The absorption can be done on a number of bases, the most common are:

 physical units produced

 labour hours worked

 machine hours operated.

Different production cost centres may use different bases.

4.2 Overhead absorption rate

An overhead absorption rate is used to calculate the amount of overhead to be
picked up by each unit.

Budgeted production overhead
Overhead absorption rate (OAR) = ––––––––––––––––––––––––––––––
Budgeted quantity of absorption base
(units/labour hours/machine hours)

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