Overhead Absorption Rates (Cambridge International A-Level Accounting)

Calculation of overhead absorption rates

Spec point — the causes and the calculation of under absorption and over absorption of overheads

How do I calculate the overhead absorption rates?

• Overhead absorption rates (OAR) are calculated differently for machine-intensive departments and labour-intensive departments:

  • For machine-intensive departments:

    • $\mathrm{OAR}=\frac{\mathrm{Total} \mathrm{budgeted} \mathrm{overheads}}{\mathrm{Budgeted} \mathrm{machine} \mathrm{hours}}$

  • For labour-intensive departments:

    • $\mathrm{OAR}=\frac{\mathrm{Total} \mathrm{budgeted} \mathrm{overheads}}{\mathrm{Budgeted} \mathrm{labour} \mathrm{hours}}$

How do I calculate the overheads absorbed?

• Overheads absorbed is the portion of overhead allocated to the product or service

• For machine-intensive departments:

  • $\mathrm{Overheads} \mathrm{absorbed}=\mathrm{OAR} \mathrm{per} \mathrm{machine} \mathrm{hour}\times\mathrm{Actual} \mathrm{machine} \mathrm{hours}$

• For labour-intensive departments:

  • $\mathrm{Overheads} \mathrm{absorbed}=\mathrm{OAR} \mathrm{per} \mathrm{labour} \mathrm{hour}\times\mathrm{Actual} \mathrm{labour} \mathrm{hours}$

Worked Example Machinery depreciation: $20 000

Total machine hours: 2 000 hours

Calculate the overhead absorption rate.

Answer:

20 000 ÷ 2 000 = 10

Final answer: OAR is $10 per hour

Under-absorption & over-absorption

What is under-absorption?

• Under-absorption occurs when the actual overheads exceed the overheads absorbed

• This can be caused by:

  • actual expenditure being higher than the budgeted expenditure
  • actual production being lower than budgeted production

What is over-absorption?

• Over-absorption occurs when the overheads absorbed exceed the actual overheads

• This can be caused by:

  • actual expenditure being lower than the budgeted expenditure
  • actual production being higher than budgeted production

How can under-absorption and over-absorption be calculated?

• Under-absorption and over-absorption can be calculated by:

  • $\mathrm{Actual} \mathrm{overheads}-\mathrm{Overheads} \mathrm{absorbed}$

    • If the result is positive then under-absorption has occurred
    • If the result is negative then over-absorption has occurred

Worked Example Budgeted overheads = $50 000

Budgeted machine hours = 10 000 hours

Actual machine hours worked = 9 000 hours

Actual overheads incurred = $48 000

Calculate and determine whether under-absorption or over-absorption has occurred.

Answer:

• Calculate the OAR $50 000 ÷ 10 000 = $5 per machine hour
• Calculate the overheads absorbed $5 × 9 000 = $45 000
• Actual overheads - Overheads absorbed $48 000 - $45 000 = $3 000

Final answer: Overheads are under-absorbed by $3 000