# Absorption of Overheads
## Where it sits in overhead accounting
Absorption is the last step of overhead accounting. After all production-department overheads are known, absorption charges them onto each unit of product produced in that department.
## The two steps
1. Calculate the absorption rate
$$\text{Absorption Rate} = \frac{\text{Overheads}}{\text{Base Quantity}}$$
2. Charge overheads to products
$$\text{Charged} = \text{Absorption Rate} \times \text{Base Quantity consumed by that product}$$
## Choosing the base
- The base quantity can differ for each production department.
- Pick the base that reflects the factor predominantly driving overhead in that department (machine-intensive → machine hours; labour-intensive → labour hours, etc.).
- This is a management judgement and must be exercised carefully — it directly affects stock valuation and profit.
> Doubt Buster: In the cost sheet, use overheads absorbed, not overheads incurred.
## The six absorption rates
| Rate | Formula | Expressed as |
|---|---|---|
| Labour Hour Rate | Overheads ÷ Labour Hours | Per labour hour |
| Machine Hour Rate | Overheads ÷ Machine Hours | Per machine hour |
| Material Cost Rate | Overheads ÷ Material Cost | % of direct material cost |
| Labour Cost Rate | Overheads ÷ Labour Cost | % of direct labour cost |
| Prime Cost Rate | Overheads ÷ Prime Cost | % of prime cost |
| Production Unit Rate | Overheads ÷ Production Units | Per unit |
Tip: The first two give a rate per hour; the next three give a percentage; the last gives a rate per unit.