Absorption of Production Overhead Costs

Absorption of overheads refers to the sharing out of overhead costs to the various cost centers that used the overheads. It is used when the overheads cannot be allocated or attributed to a specified cost centre.

The aim is to establish the overhead cost per unit of output having allocated and or apportioned overhead costs. The next stage should be to absorb them into the cost of production.

What are the bases of overhead absorption and what factors are considered in their selection?

The first stage in absorption is to establish the absorption rate

What is an overhead absorption rate and what types are there?

NB: Overheads incurred are normally absorbed on the basis of estimated or budgeted figures. The following basis may be applied leading to the following types of rates.

i. Percentage of direct material cost = overhead cost x 100

                                                                 Direct material cost

ii. Percentage of direct labour cost = overhead cost x 100

                                                               Direct labour cost

iii. Direct prime cost = overhead cost x 100

                                              Prime cost

iv. Labour hours = overhead cost

                                 Labour hours

V . Units of output = overhead cost

                                     Units of output