ABSORPTION OF OVERHEADS

-PROF. Arti Modi

What is absorption
The absorption of overheads is also known as the recovery of the overheads. Absorption of overheads is the process of sharing the overhead costs by all the products of a particular department. Absorption of overheads is the application of overheads to each unit of output. In other words, the process of ascertaining the total overhead costs of each unit of output or job by using overhead rate is known as the absorption of overhead. Thus the distribution of the overhead expenses allotted to a particular department over the units of produced in that department is absorption of overheads.

How to find the recovery rate

In order to absorb the overheads by the units if output of a particular department, the overhead absorption rate or overhead rate should be determined. The two popular methods of absorption of overheads are labor hour rate and machine hour rate . The formula to calculate overhead rate under these methods are given below. Labor hour rate = Total Overheads/Total Labor Hours

Machine hour rate = Total Overheads/ Total Machine Hours

 Methods of Absorption of Manufacturing Overheads : Methods of Absorption of Manufacturing Overheads The main methods of absorption of overheads are as follows: Rate per unit of production Direct material cost method Direct labour cost or Direct wages method Direct labour hour or Production hour method Prime cost method

Under and overabsorption

Underabsorption and Overabsorption Overhead costs are fully recovered from production, when actual rate method of absorption is adopted. But if a predetermined rate is used, the actual expenses may be different from the charged or budgeted overhead expenses. If the overheads absorbed are less than the overheads incurred, it is Underabsorption of overheads. If the amount of overheads absorbed is more than the actual overheads incurred it is Overabsorption of overheads.

Causes of under and over absorption

Causes of Underabsorption or Overabsorption of Overheads Error in estimating the overhead. The anticipated output may be different from the actual worked. The hours anticipated may be more or less than the actual hours worked. Due to fluctuations in the prices of material or wage rates, the basis upon which the factory overhead is recovered from production may not be correct. If overheads are not charged to work-in-progress proportionately. Nonrecurring expenditure incurred due to unexpected changes in the methods of production. Seasonal fluctuations in the overhead expenses