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Accounting for overheads

1.3 Absorption costing

Production overheads are recovered by absorbing them into the cost of a product
and this process is called absorption costing.

Focusing on production overheads, we can look at how the overheads can be
'shared out' to the individual cost units.

 Step 1: Allocation and apportionment of production overhead to production
and service cost centres

 Step 2: Reapportionment of overhead collected in service cost centres (from
step 1) to production cost centres

 Step 3: Absorption of overheads from production cost centres into cost units
using a predetermined overhead absorption rate (OAR)

Note: The terminology is important, i.e. allocation, apportionment and absorption

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