Step 4： Overhead absorption

It is a process whereby overhead costs allocated and apportioned to production cost centers are added to unit.

The most common bases of absorption:

? unit

? direct labour hour

? machine hour

? percentage of direct labour costs

? percentage of prime cost

Absorption rate:

 An absorption rate is the rate at which overheads are added to costs

absorption (recovery) rate  =

Predetermined overhead absorption rate =

                   (O.A.R.)     

Step 1 Estimate total overhead for the period.

Step 2 Estimate the activity level for the period.

           (This could be total Hours, Units, or Direct Costs or whatever it is upon which the overhead absorption rates are to be based.)

Step 3 Divide the estimated overhead by the budgeted activity level.

Step 4 absorb the overhead into the cost unit by applying the calculated OAR.

Example: Athena Co makes two products, the Greek and the Roman. Greeks take 2 labour hours each to make and Romans take 5 labour hours. What is the overhead cost per unit for Greeks and Romans respectively if overheads are absorbed on the basis of labour hours?

Estimate the overhead likely to be incurred for the coming period.

     Budgeted total O/H= $50,000

Estimate the activity level for the period. (This could be total units, total hours, or any OAR basis which should be fair)

     Budgeted labour hours = 100,000

OAR =

                                                      = $0.5 per direct labour hour

Absorb overhead into the cost unit by applying the calculated absorption rate:

Choosing appropriate absorption rate:

(1) direct labour hour basis

(2) a machine hour rate

(3) a rate per unit (當(dāng)產(chǎn)品indentical時(shí))

(4) percentage of direct labour costs or direct material costs

(5) percentage of prime cost

(6) blanket absorption rate

(7) departmental absorption rate

The choice of an OAR is a matter of judgement and common sense. Many factories use a direct labour hour rate or machine hour rate in preference to a rate based on a percentage of costs.