Ibrahim Sameer (MBA - Specialized in Finance,

B.Com – Specialized in Accounting & Marketing)

 Absorption Costing
 Overheads are made up of indirect materials,
indirect labour and indirect expenses.

 Under absorption costing principles, the

production overheads of a business are absorbed into
the cost of each of the products.
 Allocation & Apportionment of
Overheads
 The first stage of the process is the allocation of
specific overheads to specific cost centres – then joint
overheads are apportioned to each cost centre on an
appropriate basis.

 The overheads of the service cost centres must then

be reapportioned to the production cost centres on an
appropriate basis.
 Absorption of Overheads
 Once all of the production overheads have been
apportioned to the production cost centres an
overhead absorption rate is determined normally
based upon direct labour hours or machine hours.

 The overhead absorption rate is then used to cost each

product depending upon how many relevant hours
each product takes in each production cost centre.
 Predetermined Absorption Rate
(PAR)
 In absorption costing, it is usual to add overheads into
product costs by applying a predetermined
overhead absorption rate. The predetermined rate is
set annually, in the budget.
 Predetermined Absorption Rate
(PAR)
 The absorption rate is calculated by dividing the
budgeted overhead by the budgeted level of
activity.

 For production overheads the level of activity is often

budgeted direct labour hours or budgeted machine.
 Predetermined Absorption Rate
(PAR)
 Management should try to establish an absorption rate
that provides a reasonably ‘accurate’ estimate of
overhead costs for jobs, products or services.
 Over & Under Absorption of
Overheads
 The rate of overhead absorption is based on estimates
(of both numerator and denominator) and it is quite
likely that either one or both of the estimates will not
agree with what actually occurs. Actual overheads
incurred will probably be either greater than or less
than overheads absorbed into the cost of production.
 Over & Under Absorption of
Overheads
 Over absorption means that the overheads charged
to the cost of production are greater than the
overheads actually incurred.

 Under absorption means that insufficient

overheads have been included in the cost of
production.
 Accounting for Over & Under
Absorption
 Under absorption

 Dr Income statement

 Cr Production overhead control

 Over absorption

 Dr Production overhead control

 Cr Income statement
 Accounting for Over & Under
Absorption
 The process of charging an entire expenses to a single
cost centre is called allocation.

 The process of sharing an expense amongst a number

of cost centre is called apportionment.
Q&A