An overhead absorption rate is a rate calculated in absorption costing when sharing overhead costs to cost units. It is found by dividing the overhead cost of a cost centre by a base or activity level. The base for example can be machine hours, labour hours, a percentage of direct labour or the number of units produced in the cost centre.
Illustration: If the overhead in a cost centre amounted to €100,000 and the operating hours amounted to 10,000 hours the overhead absorption rate would be calculated as follows:
In this illustration a product would be charged €10 of overhead for every operating hour used.
b)The main bases used in calculating overhead absorption rates are:
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Number of units |
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Direct machine (operating) hours |
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Direct labour hours |
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Percentage direct labour cost |
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Percentage direct material cost |
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Percentage prime cost |
c)Appropriate bases:
i. Accounting services. |
Rate per direct labour hour |
ii. Hairdressers. |
Rate per direct labour hour or number of clients |
iii. Automated manufacturing business. |
Rate per machine hour |
iv. Hotels. |
Rate per unit or rate per hour |
v. Leisure centres. |
Rate per operating hour or rate per client |