CIMA P2 Syllabus A. Managing The Costs Of Creating Value - Introduction to ABC - Notes ^{1 / 11}

In earlier studies, we have discussed two traditional costing methods:

- absorption costing and 
- marginal costing.

What was the main difference?

In absorption costing, both fixed and variable production overheads are charged to production.

In marginal costing, only variable production overheads are charged to production.

Absorption Costing

In absorption costing, overheads were allocated to products using a three-stage procedure

1. Stage 1:

   Overheads are allocated or apportioned to cost centres (usually production and service departments) using suitable basis

2. Stage 2: 

   Service centre costs are reapportioned to production centres

3. Stage 3:
    
   Overheads are absorbed into units of production using an overhead absorption rate

OAR =  Budgeted overheads / Budgeted activity level

The budgeted activity level is usually taken as direct labour hours, machine hours or number of units.

If either or both of the actual overhead cost or activity volume differ from budget, the use of this rate is likely to lead to what is known as under-absorption or over-absorption of overheads.

A company uses an overhead absorption rate of $3.50 per machine hour, based on 32,000 budgeted machine hours for the period.

During the same period, the actual total overhead expenditure amounted to $108,875 and 30,000 machine hours were recorded on actual production.

By how much was the total overhead under or over absorbed for the period?