CIMA P1 Syllabus A. Cost Accounting For Decision And Control - Absorption Costing - Notes ^{1 / 10}

Absorption Costing

Under absorption costing, fixed overheads are dealt with by calculating a budgeted overhead absorption rate (OAR).

The Overhead Absorption Rate (OAR)

OAR = Budgeted overheads  / Budgeted level of activity

The following can be used as the basis to absorb overheads:

1. number of units

2. labour hours

3. machine hours

Illustration 1

The Company produces product A only.

Product A takes 100 machine hours to produce.

Budgeted overheads are $100,000.

Required:
Calculate the OAR.

• Solution:

  Budgeted overheads are $100,000.
  Budgeted machine hours for the period were 100.

  OAR = $100,000 / 100 machine hours
  OAR = $1,000 per machine hour

Illustration 2

The Company produces product A and B.

Product A takes 60 machine hours to produce.
Product B takes 40 machine hours to produce.

Budgeted overheads are $100,000.

Required:
Calculate the OAR.

• Solution:

  Budgeted overheads are $100,000.
  Budgeted machine hours for the period were 60 + 40 = 100.

  OAR = $100,000 / 100 machine hours
  OAR = $1,000 per machine hour

  Therefore, Product A will absorb $1,000 x 60  = $60,000
  Product B will absorb $1,000 x 40 = $40,000

Actual overheads (-) Absorbed overheads = Under/Over absorption

Over-absorption occurs if more overheads are absorbed than have actually been incurred

Under-absorption occurs if fewer overheads are absorbed than have actually been incurred.