Costing.

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Mayur Ejrekar

Mayur Ejrekar (Querist)
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24 December 2013 Can anyone of the CAs/ICWA explain what is overhead absorption and how is it calculated?

Sanket

Sanket (Expert)
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24 December 2013 Overhead absorption is the amount of indirect
costs assigned to cost objects. Indirect costs are
costs that are not directly traceable to an activity
or product. Overhead absorption is a necessary
part of the requirement by both the GAAP and
IFRS accounting frameworks to include overhead
costs in the recorded amount of inventory that is
shown in a company's financial statements.

Sanket

Sanket (Expert)
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24 December 2013 Overhead absorption involves the following steps:
1. Classify indirect costs. Depending on the type of
allocation desired, some costs may be included in
overhead and others may not. For example,
overhead absorption for a product would not
include marketing costs, but marketing costs
might be included in an internal cost report for a
distribution channel.
2. Aggregate costs. Shift the identified costs into
cost pools. Each cost pool should have a different
allocation base. Thus, the indirect costs related
to a facility might be aggregated into a cost pool
that is allocated based on square footage used.
3. Determine allocation base . This is the basis upon
which overhead is assigned to a cost object. For
example, facility costs may be assigned based on
square footage used, while labor-related indirect
costs may be assigned based on direct labor
used.
4. Assign overhead. Divide the allocation base into
the total amount of overhead included in a cost
pool to arrive at the overhead rate.

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