absorption rate

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The rate or rates calculated in an absorption costing system in advance of an accounting period for the purpose of charging the overheads to the production of that period. Absorption rates are calculated for the accounting period in question using the following formula:budgeted overhead/budgeted production.

budgeted overhead/budgeted production.

In absorption costing production may be expressed in a number of different ways; the way chosen to express production will determine the absorption rate to be used. The seven major methods of measuring production, together with their associated absorption rate, are given in the table below. The rate is used during the accounting period to obtain the absorbed overhead by multiplying the actual production achieved by the absorption rate.

These rates have been used by accountants for over a century and they are still widely applied. Many, however, would argue that they cannot provide the accurate cause-and-effect allocations of costs that modern managers require; for this a system of activity-based costing must be used. See also traditional costing system.

Production measure

Absorption rate

units, weight, or volume

rate per unit, weight, or volume

direct labour hours

rate per direct labour hour

machine hours

rate per machine hour

direct labour cost

% on direct labour cost

direct material cost

% on direct material cost

prime cost

% on prime cost

standard hours

rate per standard hour

Subjects: Accounting.

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