# Overhead Rates in Absorption Costing

Before studying ABC, recall the different types of overhead absorption rates used in traditional absorption costing.

## Classification

Type of Rate	Numerator	Denominator	Remark
Normal (Actual) Rate	Actual OHs	Actual Base	Computed after the period ends; cannot be used for quoting prices in advance.
Pre-Determined Rate	Budgeted OH	Budgeted Base	Fixed in advance based on the budget; used for charging OH to production during the period.
Blanket (Single Plant-wide) OH Rate	OH of the entire factory	Total base for the factory	One rate applied across the whole organisation.
Departmental OH Rate	OH of the department	Total base for the department	Each department has its own rate — more accurate than a blanket rate.

## Why we move beyond these rates

Blanket and even departmental rates assume that all products in a department consume overheads in the same proportion as the chosen base (labour hours, machine hours, etc.). When products differ significantly in complexity, batch size, setups, inspections, or handling, this assumption distorts product costs.

ABC addresses this by allocating overheads to activities and then charging the cost of each activity to products based on the activities they actually consume.

Worked example

### Example 1

Illustration of hierarchy

A factory has 3 departments (A, B, C). Each department performs several activities (setup, inspection, material handling, etc.).

Blanket rate approach: One overall ₹/labour-hour rate is applied to all products of the factory.
Departmental rate approach: Separate ₹/labour-hour rates for Departments A, B, and C.
ABC approach: Within each department, costs are pooled by activity (Setup pool, Inspection pool, …) and charged to products using a cost-driver rate per activity.

⚠️ Common exam mistakes

Treating 'Blanket rate' and 'Departmental rate' as the same — Blanket is plant-wide (one rate); Departmental is department-wise (multiple rates).
Using actual rates for product costing during the period — actuals are known only at period-end; use pre-determined rates for in-period charging.
Assuming Departmental rates always give accurate product cost — they still rely on a single base (e.g. machine hours) per department.

Reference:

Now that you've read this — what's next?

Move from understanding → mastery in 3 clicks. Each option below picks up from this lesson's topic.

🔥 Drill 5 Qs on this → ✍️ Adaptive practice →