Absorption Costing

Section 1 of 8

Introduction to Absorption Costing

Introduction to Absorption Costing

Absorption costing charges every unit of output with a fair share of total fixed (indirect) production overheads, so that the full cost of production is recovered in the selling price.

Required by IAS 2 for inventory valuation in published financial statements
Contrasts with marginal costing, which treats fixed overheads as a period cost

Types of overhead cost

Type	Description	Examples
Allocated	Directly attributable to one department	Supervisor's wages in one dept
Apportioned	Shared across departments on a fair basis	Rent, depreciation, lighting

The 5 stages of absorption costing

Allocate overheads directly attributable to one cost centre
Apportion shared overheads across all departments using suitable bases
Reapportion service department costs to production departments
Calculate the OAR (overhead absorption rate) for each production department
Absorb overhead into products using the OAR × actual activity

Common apportionment bases

Overhead	Basis
Rent and rates	Floor area (sq m)
Building insurance	Floor area (sq m)
Heating and lighting	Floor area (sq m)
Equipment depreciation	Net book value (NBV)
Equipment insurance	Net book value (NBV)
Supervisory wages	Number of employees
Canteen costs	Number of employees

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