Absorption Costing
Absorption Costing
It is the costing system in which production cost is taken as cost of sales, and other overheads are
taken as expenses. Under absorption costing, direct costs are allocated to the cost centers as
stated. However the indirect costs or overheads are apportioned on given appropriate basis.
Once the given overheads have been apportioned over cost centers, service department costs are
apportioned among the production departments considering service departments’ overheads are
derived due to production departments. In order to apportion service departments’ overheads,
elimination method is used.
Basis of apportionment
Overhead cost item
Basis of apportionment to cost centre
Floor area occupied
Building related expenses like rent & rates, cleaning, heating &
lighting, repairs, depreciation and insurance of buildings
Number of workers /
All employees’ related costs like canteen, supervison, personnel,
employees
medical and welfare expenses
Cost or book value of
Machine related expenses e.g. depreciation, repairs,
machines in each department
maintenance and insurance of machines
Number of store requisitions
Cost of store keeping, store keeper wages etc
Number of horse power
Power
Under elimination method, one particular service department’s cost is made zero and
apportioned among other production departments and other service departments. The same
method is repeated until all service departments’ costs have been apportioned on production
departments.
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Absorption Costing
Service Departments
Basis of Apportionment to cost centers
Canteen, personnel, inspection,
No. of workers
Medical
Stores
Number of store requisition
Maintenance
Number of maintenance hours/value of asset subject to
maintenance
Overhead Absorption Rate (OAR)
The whole of the overhead cost is not absorbed in preparation of budget, because actual demand
varies in the market and budgets are prepared accordingly. Therefore, overheads are taken equal
to the level of demand for production.
Budgeted Overheads
OAR =
------------------------------Budgeted basis
Budgeted basis can be either labour hours or machine hours depending on the cost centre is
labour or capital intensive respectively. Once OAR is being calculated, it is multiplied with per
unit consumption of hours for machine or labour to calculate overhead costs per unit of cost
center. There are other bases also for OAR depending on the information given in the question.
Over and Under Absorbed
Once the OAR is calculated, they are multiplied with the actual number of machine or labour
hours to calculate the overhead absorbed, which is then compared with actual overheads to
calculate over or under absorbed. If overhead absorbed are greater than actual overheads, then it
is over absorbed, and the difference has to be deducted to reach on actual overheads. If overhead
absorbed are less than actual overheads, then it is under absorbed, and the difference has to be
added to reach on actual overheads.
Under – absorption occurs when actual expenditure is more than budget and / or production is
less than the planned level. However, Over-absorption occurs when actual expenditure is less
than budget and/or actual production is more than the planned level.
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Absorption Costing
Question # 01
03 P2 Q3
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Question # 02
N07P2Q3
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Question#03
N10P2Q3
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Question # 04
N11P2Q3
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Question # 05
May12P22Q3
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Absorption Costing
Question # 06
M12P23Q3
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