Cost and Management Accounting · Overheads - Absorption Costing Method

Overhead Absorption Methods and Rates for CA Intermediate Cost and Management Accounting

Updated 4 October 2026 · Fact-checked

Overhead absorption charges apportioned overheads to cost units using a predetermined rate. Rate = budgeted overheads ÷ budgeted base, where the base can be units, direct material, direct wages, prime cost, labour hours or machine hours. Choose the base that best reflects how the overhead is incurred, then multiply the rate by actual base used.

Understand Overhead Absorption Methods and Rates

After you allocate and apportion overheads, they sit in production and service departments. Absorption is the last step. You charge these overheads to products, jobs or services, so that each cost unit carries its fair share.

You cannot wait for actual overheads at the year end. Prices and quotes are needed now. So you use a predetermined overhead rate: budgeted overheads divided by a budgeted base. Then you apply it to actual activity. The difference between overhead absorbed and actual overhead is under- or over-absorption, a separate topic.

The base matters. A base should have a clear link with the overhead. Machine-heavy work suits machine hours. Labour-intensive work suits labour hours. Percentage bases such as direct material or direct wages are simple but weak, because material cost or wage rate may not drive overheads. Unit-based rate suits identical products.

A blanket rate is one rate for the whole factory: total factory overheads ÷ total base. It is simple but unfair when departments differ in character. A departmental (or cost centre) rate is calculated for each department separately and applied to the time each job spends there. It is more accurate and is preferred when products use departments in different proportions.

A machine hour rate is a special case. You collect the overheads linked to the machine (depreciation, power, repairs, insurance, rent share) in a machine cost centre, then divide by machine hours. Separate fixed and variable parts, since fixed costs are spread over normal hours and variable costs are charged per running hour.

Key rules to remember

Predetermined overhead absorption rate: Rate = Budgeted overheads ÷ Budgeted base (units, hours or cost); Use budgeted figures for the same period in numerator and denominator. Apply the rate to the actual base.
Percentage of direct material: Rate = (Overheads ÷ Direct material cost) × 100; Use only when overheads vary with material cost.
Percentage of direct wages: Rate = (Overheads ÷ Direct wages) × 100; Suits labour-intensive work with similar wage rates.
Percentage of prime cost: Rate = (Overheads ÷ Prime cost) × 100; Prime cost = direct material + direct labour + direct expenses.
Direct labour hour rate: Rate per hour = Overheads ÷ Direct labour hours; Better than the wage percentage when wage rates differ.
Machine hour rate: Rate per hour = Machine overheads ÷ Machine hours; Compute fixed and variable parts separately when normal hours differ from actual hours.
Absorbed overhead: Absorbed = Rate × Actual base; Compare with actual overhead to find under- or over-absorption.
Blanket rate: Total factory overheads ÷ Total factory base; One rate for all jobs.

How to solve Overhead Absorption Methods and Rates questions

Use this order for any question on overhead absorption rates.

1Read what is asked: a rate, overhead charged to a job, or a comparison of methods.
2Identify the overhead pool: total factory (blanket) or each department separately.
3Complete any apportionment and reapportionment first, if the question gives raw data.
4Pick the base given or most suitable: machine hours for mechanised departments, labour hours for manual ones.
5Calculate the rate using budgeted figures, showing numerator and denominator.
6Multiply the rate by the job's actual base in each department and add up.
7Add the overhead to prime cost to build the total cost or price if required.
8Comment briefly if asked, for example why the departmental rate is more accurate.

Quickest way: Rate, then multiply, then total

When to use it: Under time pressure in both MCQs and written numericals.

MCQ: write rate = overhead ÷ base, compute it first, then multiply by the job's base. Eliminate options that use the wrong base, for example wages instead of hours.
MCQ: if asked which is more accurate, the departmental rate beats the blanket rate when departments differ.
Written: draw a small table with columns Department, Overhead, Base, Rate, Job hours, Overhead charged.
Written: state the formula, then substitute. Step marks come from the formula and the working.
Check the answer: total absorbed on all jobs at the actual base should equal rate × total base.

Common mistakes in Overhead Absorption Methods and Rates

Using actual overheads instead of budgeted overheads to find the rate
Students forget that absorption uses a predetermined rate.
Fix: Use budgeted overheads and budgeted base unless the question asks for an actual rate.
Dividing overheads by the wrong base, such as total hours instead of machine hours
The question gives several kinds of hours.
Fix: Underline the base asked for and use only that column of data.
Applying a blanket rate when departmental data is given
It is quicker, so students skip the departmental split.
Fix: If jobs pass through departments differently, compute the departmental rates and apply each to the hours in that department.
Including all machine costs in a single rate without separating fixed and variable parts
Students ignore that fixed costs are spread over normal hours.
Fix: Compute each cost per hour, using normal working hours for fixed costs and running hours for variable costs.
Ignoring non-productive time in machine hours
Students use total available hours.
Fix: Deduct set-up, maintenance and idle time if the question says these hours are not productive, as the rate is based on effective hours.
Forgetting to add the absorbed overhead to prime cost in a job cost question
The rate is the last calculation, so the final total is left out.
Fix: End with a cost statement showing prime cost, overhead and total cost.

Worked examples

Example 1

A factory has budgeted overheads of ₹6,00,000 for the year. Budgeted direct labour hours are 40,000 and budgeted machine hours are 20,000. Job 101 uses 120 direct labour hours and 50 machine hours. Calculate the overhead charged to Job 101 under (a) the labour hour rate and (b) the machine hour rate.

Show the solution

Labour hour rate = ₹6,00,000 ÷ 40,000 = ₹15 per hour.
Overhead on Job 101 under labour hours = 120 × ₹15 = ₹1,800.
Machine hour rate = ₹6,00,000 ÷ 20,000 = ₹30 per hour.
Overhead on Job 101 under machine hours = 50 × ₹30 = ₹1,500.

Answer: Labour hour basis: ₹1,800. Machine hour basis: ₹1,500.

Example 2

A company has two departments. Cutting: overheads ₹2,40,000, machine hours 12,000, direct labour hours 4,000. Finishing: overheads ₹1,80,000, direct labour hours 6,000. Job X uses 30 machine hours and 10 labour hours in Cutting, and 40 labour hours in Finishing. Job Y uses 10 machine hours and 20 labour hours in Cutting, and 80 labour hours in Finishing. Calculate overhead for each job using departmental rates (machine hours in Cutting, labour hours in Finishing). Compare with a blanket rate on total direct labour hours of both departments.

Show the solution

Cutting rate = ₹2,40,000 ÷ 12,000 = ₹20 per machine hour.
Finishing rate = ₹1,80,000 ÷ 6,000 = ₹30 per labour hour.
Job X = (30 × ₹20) + (40 × ₹30) = ₹600 + ₹1,200 = ₹1,800.
Job Y = (10 × ₹20) + (80 × ₹30) = ₹200 + ₹2,400 = ₹2,600.
Blanket rate = (₹2,40,000 + ₹1,80,000) ÷ (4,000 + 6,000) labour hours = ₹4,20,000 ÷ 10,000 = ₹42 per labour hour.
Job X labour hours = 10 + 40 = 50, so blanket overhead = 50 × ₹42 = ₹2,100.
Job Y labour hours = 20 + 80 = 100, so blanket overhead = 100 × ₹42 = ₹4,200.
Comparison: the blanket rate overcharges Job X by ₹300 (₹2,100 − ₹1,800) and Job Y by ₹1,600 (₹4,200 − ₹2,600), because it ignores the different overhead rates of the two departments.

Answer: Departmental rates: Job X ₹1,800 and Job Y ₹2,600. Blanket rate on labour hours: Job X ₹2,100 and Job Y ₹4,200. The blanket rate is less accurate because it ignores the different rates of the two departments.

Exam tips

Always state the formula before substituting, as step marks are given for method.
In a machine hour rate question, list each cost with a basis for per-hour calculation, and deduct non-productive hours only where stated.
If the question gives departments, assume a departmental rate is expected unless a blanket rate is asked for.
For theory, give a reason with each base: when it suits and its limitation.
Round the rate sensibly, and avoid rounding in the middle of a calculation if the final answer is large.

Practice questions from Overheads - Absorption Costing Method

Overhead Absorption Methods and Rates in other exams

The same ground in other exams, if you are preparing for more than one or want another angle on it.

Overhead Absorption Methods and Rates: frequently asked questions

What is the difference between a blanket rate and a departmental rate?

A blanket rate is one rate for the whole factory, calculated on total overheads and total base. A departmental rate is calculated for each department separately. The departmental rate is more accurate when jobs use departments in different proportions.

How do I calculate a machine hour rate?

Collect the overheads of the machine, such as depreciation, power, repairs and share of rent. Divide fixed costs by normal working hours and variable costs by running hours. Add the per-hour figures to get the machine hour rate.

When should I use the labour hour rate instead of the wage percentage rate?

Use the labour hour rate when wage rates differ among workers, because time better reflects overhead consumption. The wage percentage method charges more overhead to higher paid workers even if they take the same time.

Is the absorption rate based on actual or budgeted figures?

It is normally based on budgeted overheads and budgeted base, so that costs can be known during the period. The rate is applied to actual base used. Differences are handled later as under- or over-absorption.