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Sukhpreet Kaur, Lovely Professional University Unit 9: Absorption of Overheads

Unit 9: Absorption of Overheads Notes

CONTENTS

Objectives
Introduction
9.1 Definition of Overhead Absorption
9.2 Determination of Overhead Rates
9.3 Methods of Absorption
9.4 Under and Over Absorption of Overheads

9.5 Summary
9.6 Keywords
9.7 Review Questions
9.8 Further Readings

Objectives

After studying this unit, you will be able to:
z z Define the overhead absorption;
z z Learn about the methods of absorption;

z z Understand the under and over absorption.
Introduction

A managerial accounting cost method of expensing all costs associated with manufacturing a
particular product. Absorption costing uses the total direct costs and overhead costs associated
with manufacturing a product as the cost base. Generally accepted accounting principles (GAAp)
require absorption costing for external reporting.

9.1 Definition of Overhead Absorption

According of ICMA, London, “Overhead absorption is the allotment of overhead to cost units”.
The apportionment of overhead expenses of the cost centres to cost units on some equitable
basis is referred to as overhead absorption. Generally, all products, jobs, processes or services
pass through one or more producing cost centre. The overhead expenses relating to a cost centre
are ultimately to be charged to the products, jobs, etc., which pass through that centre. Thus,
charging of overheads of a cost centre to the cost units in such a way that the cost of each unit of
production of the cost centre includes an equitable share of the total overhead of that cost centre.
This is known as Absorption of overheads.
9.2 determination of Overhead Rates

The rate at which overheads are to be absorbed in cost units is referred to as overhead absorption
rate. There are several methods in use for determining overhead rates. Fixing of overhead rates
is necessary for absorption of overheads to cost units on a logical and equitable basis. The total

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