Overhead Cost Absorbed (Overhead Cost Recovered)

Definition

Overhead cost absorbed (also known as overhead cost recovered) is an accounting term that represents the share of total overhead costs allocated to the actual units of production during a specific period. This allocation is achieved by multiplying the actual production volume by the predetermined overhead absorption rate. The aim is to ensure that all overhead costs are systematically allocated to production activities, thereby providing a clear picture of production costs and facilitating accurate product costing and pricing strategies.

Examples

Manufacturing Industry:
- A factory has a budgeted overhead absorption rate of $50 per machine hour. If the factory operates for 1,000 machine hours in a period, the overhead cost absorbed would be $50,000 (1,000 machine hours * $50/machine hour).
Service Industry:
- A consulting firm has a budgeted overhead absorption rate of $100 per consultant hour. If the firm’s consultants work 600 hours in a period, the overhead cost absorbed would be $60,000 (600 consultant hours * $100/consultant hour).

Frequently Asked Questions (FAQs)

Q: What is an overhead absorption rate?

A: The overhead absorption rate is a predetermined rate used to allocate overhead costs to production units or service activities. It is typically calculated at the beginning of an accounting period based on budgeted overhead costs and estimated production levels.

Q: How is the overhead absorption rate calculated?

A: The overhead absorption rate can be calculated as follows: \[ \text{Overhead Absorption Rate} = \frac{\text{Budgeted Overhead Costs}}{\text{Budgeted Production Volume or Activity Level}} \]

Q: Why is overhead cost absorption important?

A: Overhead cost absorption is crucial for ensuring that all overhead costs are systematically allocated to products or services, aiding in accurate costing, pricing, and profitability analysis.

Q: What happens if actual production is higher or lower than budgeted production?

A: If actual production is higher than budgeted, more overhead costs will be absorbed, possibly leading to over-absorption (understatement of costs). Conversely, if actual production is lower, this could lead to under-absorption (overstatement of costs).

Overhead Absorption Rate: A predetermined rate used to allocate overhead costs to production or services based on budgeted costs and activity levels.
Under-Absorption: Occurs when the overhead costs absorbed are less than the actual overhead incurred, indicating overestimated production activity.
Over-Absorption: Occurs when the overhead costs absorbed exceed the actual overhead incurred, indicating underestimated production activity.
Cost Allocation: The process of assigning indirect costs to different cost objects such as products, services, or departments.

References to Online Resources

Suggested Books for Further Studies

“Cost Accounting: A Managerial Emphasis” by Charles T. Horngren, Srikant M. Datar, and Madhav V. Rajan
- Widely used in both undergraduate and graduate courses, providing comprehensive coverage of cost accounting topics.
“Managerial Accounting” by Ray H. Garrison, Eric Noreen, and Peter Brewer
- An essential resource for managerial accounting and cost allocation techniques.
“Principles of Accounting” by Belverd E. Needles, Marian Powers, and Susan V. Crosson
- This textbook covers fundamental principles of accounting, including detailed explanations on overhead costs and absorption.

Accounting Basics: “Overhead Cost Absorbed” Fundamentals Quiz

### What is another term for overhead cost absorbed? - [ ] Direct cost - [ ] Variable cost - [x] Overhead cost recovered - [ ] Fixed cost > **Explanation:** Overhead cost absorbed is also known as overhead cost recovered. It refers to the portion of overhead costs allocated to actual production. ### How is the overhead cost absorbed calculated? - [x] By multiplying the actual production by the budgeted overhead absorption rate. - [ ] By dividing actual overhead incurred by actual production. - [ ] By adding fixed and variable costs. - [ ] By using total production costs. > **Explanation:** Overhead cost absorbed is calculated by multiplying the actual production during a period by the budgeted overhead absorption rate. ### Why is the overhead absorption rate predetermined? - [x] To simplify the allocation of overhead costs throughout the period. - [ ] To calculate direct labor costs. - [ ] To allocate direct material costs. - [ ] To determine inventory levels. > **Explanation:** The overhead absorption rate is predetermined to simplify and standardize the allocation of overhead costs to production activities during the accounting period. ### What could result if the actual production exceeds the budgeted production? - [ ] Under-absorption of overhead - [x] Over-absorption of overhead - [ ] No effect on overhead absorption - [ ] Decreased overhead rate > **Explanation:** If actual production exceeds the budgeted production, more overhead costs will be absorbed than expected, leading to over-absorption. ### Which term best describes the situation where overhead costs absorbed are less than the actual overhead incurred? - [x] Under-absorption - [ ] Over-absorption - [ ] Break-even - [ ] Margin of safety > **Explanation:** When overhead costs absorbed are less than the actual overhead incurred, it is termed under-absorption. ### What is the purpose of overhead cost absorption in accounting? - [x] To allocate overhead costs to production accurately. - [ ] To determine sales prices. - [ ] To calculate direct materials costs. - [ ] To avoid any costs. > **Explanation:** The primary purpose of overhead cost absorption is to ensure accurate allocation of overhead costs to production, aiding in product costing and pricing. ### Which costs do the overhead absorption rates typically not include? - [ ] Fixed costs - [ ] Variable overhead costs - [x] Direct labor costs - [ ] Indirect costs > **Explanation:** Overhead absorption rates typically do not include direct labor costs but focus on allocating indirect costs like utilities and rent. ### What does the term 'cost allocation' usually refer to in accounting? - [ ] Allocation of revenues - [ ] Allocation of dividends - [x] Allocation of indirect costs - [ ] Allocation of direct costs > **Explanation:** In accounting, 'cost allocation' usually refers to the process of assigning indirect costs to different cost objects. ### What is a common consequence of under-absorbed overhead? - [ ] Improved product cost accuracy - [x] Overstated production costs - [ ] Greater profit margins - [ ] Reduced need for cost control > **Explanation:** Under-absorbed overhead usually leads to overstated production costs because fewer overhead costs are allocated to production than incurred. ### How does an accurate overhead absorption rate benefit a business? - [ ] Increases production costs - [x] Enhances cost and pricing accuracy - [ ] Reduces indirect costs - [ ] Minimizes direct labor needs > **Explanation:** An accurate overhead absorption rate assists a business in accurately costing and pricing products, leading to better financial and operational decisions.

Thank you for joining us to explore the fundamentals of overhead cost absorbed. This concept is crucial in cost accounting, highlighting the significance of systematically allocating overhead costs for precise product costing and strategic decision-making in production.

$$$$