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.
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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