ASCM-L09 — Overhead Absorption Rates (OAR)

Understanding how departmental overheads are absorbed into products and services using appropriate absorption bases.

Learning Objectives

By the end of this lesson students should be able to:

• define overhead absorption rate (OAR)

• calculate OAR using different bases

• absorb overheads into products

• distinguish actual and absorbed overheads

• identify under- and over-absorption

• answer examination-style questions

CONCEPT OVERVIEW

Why Absorb Overheads?

After overheads have been allocated and apportioned to departments, they must be charged to products.

This process is known as overhead absorption.

Purpose of OAR

Overhead Absorption Rates help businesses:

✓ determine product costs

✓ prepare quotations

✓ value inventory

✓ calculate profits

✓ improve cost control

ADVANTAGES & LIMITATIONS

Advantages

✓ Provides full product cost

✓ Supports pricing decisions

✓ Enables inventory valuation

✓ Improves cost control

✓ Easy to apply

Limitations

✓ Uses estimates

✓ May cause under/over absorption

✓ Allocation bases may be subjective

✓ Less accurate in complex environments

OVERHEAD ABSORPTION RATE

Definition

An Overhead Absorption Rate (OAR) is a predetermined rate used to charge overheads to products or jobs.

General Formula

OAR=Budgeted Activity LevelBudgeted Overheads

WORKED EXAMPLES

Example 1 — Labour Hour OAR

Budgeted Overheads:
£48,000

Budgeted Labour Hours:
12,000

OAR

£48,000 ÷ 12,000

£4 per labour hour

Example 2 — Machine Hour OAR

Budgeted Overheads:
£75,000

Budgeted Machine Hours:
15,000

OAR

£5 per machine hour

Example 3 — Absorbing Overheads

OAR:
£5 per machine hour

Machine Hours Used:
300

Overheads Absorbed:

300 × £5

£1,500

UNDER & OVER ABSORPTION

Under-Absorption

Occurs when:

Actual Overheads

Absorbed Overheads

Not enough overhead has been charged to production.

Over-Absorption

Occurs when:

Absorbed Overheads

Actual Overheads

Too much overhead has been charged to production.

Example

Actual Overheads:
£52,000

Absorbed Overheads:
£50,000

Under-Absorption:

£2,000

ACCOUNTING TREATMENT

Under-Absorbed Overheads

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Over-Absorbed Overheads

Reduce Cost of Sales

Transfer to Income Statement

Structured Practice

Level 1 — Concept Check

Define:

a) Overhead Absorption Rate

b) Under-Absorption

Level 2 — Application

Explain why a machine-intensive factory is likely to use machine hours as an absorption basis.

Level 3 – Examination Style Question

1. 1. Budgeted Overheads:
    £90,000
    Budgeted Machine Hours:
    18,000
    Actual Machine Hours Worked:
    400
    Calculate:
    a) OAR
    b) Overheads Absorbed
    (4 marks)
    📌 Additional structured questions are available in the 🎯 Question Papers + YouTube Explanation section.

∗ Additional structured questions are available in the Question Papers and YouTube Explanation section. Students should practise regularly and review video explanations for procedural clarity.

Enrolled students may submit questions from recognised textbooks, past examination papers or other genuine academic material for expert clarification through the Student Doubt Support facility.

ACADEMIC SUPPORT NOTE

📌 OAR calculations are among the most frequently examined AS Cost Accounting topics.

Students should master:

✓ OAR Formula

✓ Labour Hour Rates

✓ Machine Hour Rates

✓ Absorbed Overhead Calculations

✓ Under-Absorption

✓ Over-Absorption

🎥 Full worked examples are available in the YouTube Learning Library.

📩 Students may submit overhead absorption doubts through the Student Doubt Support facility.

Proficiency Check

Learn → Practise → Apply → Evaluate

1. Can you calculate OAR accurately?

2. Can you select an appropriate absorption basis?

3. Can you calculate absorbed overheads?

4. Can you identify under-absorption?

5. Can you identify over-absorption?

6. Can you explain their accounting treatment?

If unsure, revisit:

• OAR Formula

• Absorption Bases

• Under & Over Absorption

• Worked Examples

Detailed Activity Solutions

Solution to Level 3 question

OAR

£90,000 ÷ 18,000

£5 per machine hour

Overheads Absorbed

400 × £5

£2,000

HOW THIS TOPIC APPEARS IN THE EXAMINATION

Common examination tasks include:

✓ OAR Calculations

✓ Labour Hour Rates

✓ Machine Hour Rates

✓ Overhead Absorption

✓ Under & Over Absorption

✓ Interpretation Questions

Self-Assessment Checklist

□ I understand OAR

□ I can calculate OAR accurately

□ I can absorb overheads correctly

□ I can identify under-absorption

□ I can identify over-absorption

□ I can answer examination questions confidently

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GUESS PAPERS

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