Cost Accounting · Overheads

Overhead Absorption Methods and Overhead Rates

Updated 10 October 2026 · Fact-checked

Overhead absorption charges the overheads of a cost centre or factory to products using a predetermined rate. Rate = budgeted overheads ÷ budgeted base, where the base is machine hours, labour hours, units or a percentage of cost. Absorbed overhead = rate × actual base used by the product.

Understand Absorption of Overheads and Overhead Rates

Overheads cannot be traced to one unit of product. Rent, supervision and power serve many products together. So you must absorb them: spread them over products on a fair basis.

The tool is the overhead absorption rate. You pick a base (such as machine hours) that reflects why the overhead is incurred. You divide the overhead pool by the total base to get a rate per unit of base. Then you multiply that rate by the base each job or product uses.

A predetermined rate uses budgeted figures. You fix it before the period starts so costs and quotations can be prepared without waiting for actual data. Using actual figures would make the rate change every month. The difference between overhead absorbed and overhead actually incurred is under or over absorption, which is a separate topic.

A blanket rate is one rate for the whole factory. A departmental rate is a separate rate for each production department or cost centre. Blanket rates are simple and suit a factory where all products pass through the same departments in similar proportions. Departmental rates are more accurate when products use departments differently.

Choose the base by the nature of the department. Machine-driven departments use machine hours. Labour-driven departments use labour hours. Percentage methods are simple but weaker, because they link overhead to cost values rather than to effort or time.

Key rules to remember

Predetermined overhead rate: Rate = Budgeted overheads ÷ Budgeted base (hours, units or value); Use budgeted overhead and budgeted base for the same period and the same cost centre.
Machine hour rate: Rate per machine hour = Overheads of the machine or department ÷ Machine hours; Use hours the machine is expected to work, not the hours it is available. Deduct normal idle time such as setup and repairs.
Direct labour hour rate: Rate per labour hour = Budgeted overheads ÷ Budgeted direct labour hours; Suited to labour-intensive departments.
Percentage of direct material: Rate % = Budgeted overheads ÷ Budgeted direct material cost × 100; Use when overheads relate mainly to materials, such as storage and handling.
Percentage of direct wages: Rate % = Budgeted overheads ÷ Budgeted direct wages × 100; Works only if wage rates are uniform across workers.
Percentage of prime cost: Rate % = Budgeted overheads ÷ Budgeted prime cost × 100; Prime cost = direct materials + direct labour + direct expenses.
Rate per unit: Rate per unit = Budgeted overheads ÷ Budgeted output units; Suited only to uniform products.
Overhead absorbed: Absorbed overhead = Rate × Actual base used; For a percentage rate, apply the percentage to the actual cost of the job.

How to solve Absorption of Overheads and Overhead Rates questions

Use this order for any absorption question, whether it asks for a rate, a job cost or a comparison of methods.

1Read what is given: budgeted or actual figures, and whether a blanket or departmental rate is wanted.
2Identify the overhead pool. After apportionment and re-apportionment, take the total overhead of each department.
3Choose the base that matches the question. If a method is named, use it. Otherwise use machine hours for machine-driven work and labour hours for labour-driven work.
4Compute the base in hours or rupees. For machine hours, deduct normal idle time and setup if the question says so.
5Divide the overhead by the base to get the rate. Show the working.
6Multiply the rate by the actual base used by the job or product.
7Add the absorbed overhead to the cost sheet or job cost, then write one line of interpretation if asked.

Quickest way: Rate first, then multiply

When to use it: Use this in MCQs and in the final part of a numerical when the overhead pool and base are given.

Underline the overhead total and the base figure.
Divide once to get the rate and keep it unrounded if it is not exact.
Multiply by the job's base figure.
For two departments, calculate each rate separately and add the two charges.
Check the answer: a job's absorbed overhead equals its share of the budgeted base × the pool, so it should be a sensible fraction of the pool. Also, if actual activity equals budget, total absorbed overhead equals the budgeted pool.

Common mistakes in Absorption of Overheads and Overhead Rates

Using actual overheads or actual hours to find the rate
Students forget the rate is predetermined.
Fix: Use budgeted figures for the rate. Use actual hours only when applying the rate to a job.
Using total available machine hours
The question gives available hours first and the working hours are hidden in the details.
Fix: Deduct normal idle time, setup and maintenance hours before dividing.
Applying a wage percentage rate to a job's total cost
Percentage rates are confused with each other.
Fix: Apply the rate only to the base it was built on: direct wages, material or prime cost.
Using one blanket rate when departments are given separately
It looks quicker.
Fix: If the question gives departmental overheads and hours, compute a rate per department and add the charges.
Mixing fixed and variable overheads in a machine hour rate without checking the question
Some questions ask for separate rates and some ask for a total rate.
Fix: Read the requirement. If it asks for fixed and variable rates, compute them separately and then add them.
Dividing by units when the base is hours, or the reverse
Rushing and picking the nearest number.
Fix: Write the unit next to every figure, such as ₹ per hour, before you multiply.

Worked examples

Example 1

A department 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 X uses 120 labour hours and 60 machine hours. Calculate the overhead absorbed by Job X using (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 X by labour hours = 120 × ₹15 = ₹1,800.
Machine hour rate = ₹6,00,000 ÷ 20,000 = ₹30 per hour.
Overhead on Job X by machine hours = 60 × ₹30 = ₹1,800.

Answer: Overhead absorbed by Job X is ₹1,800 under both methods. The two methods happen to agree here because Job X uses labour and machine hours in the same 2:1 ratio as the department as a whole.

Example 2

A factory has two departments. Department A has budgeted overheads of ₹3,60,000 and budgeted machine hours of 12,000. Department B has budgeted overheads of ₹2,40,000 and budgeted direct labour hours of 8,000. Total budgeted direct wages of the factory are ₹6,00,000. A job uses 50 machine hours in A and 40 labour hours in B, and has direct wages of ₹4,000. Calculate the overhead charged to the job using departmental rates, and compare it with a blanket rate on direct wages.

Show the solution

Department A rate = ₹3,60,000 ÷ 12,000 = ₹30 per machine hour.
Overhead from A = 50 × ₹30 = ₹1,500.
Department B rate = ₹2,40,000 ÷ 8,000 = ₹30 per labour hour.
Overhead from B = 40 × ₹30 = ₹1,200.
Total by departmental rates = ₹1,500 + ₹1,200 = ₹2,700.
Total overheads = ₹3,60,000 + ₹2,40,000 = ₹6,00,000.
Blanket wage rate = ₹6,00,000 ÷ ₹6,00,000 × 100 = 100% of direct wages.
Overhead by blanket rate = 100% × ₹4,000 = ₹4,000.
Difference = ₹4,000 − ₹2,700 = ₹1,300.

Answer: Departmental rates charge ₹2,700. The blanket rate charges ₹4,000, which is ₹1,300 more. The blanket rate overcharges this job because its wage cost is high compared with the time it uses in the departments, so the departmental rates are the fairer measure.

Exam tips

Write the formula and the figures before you divide. Step marks are given even if the final arithmetic slips.
If the question asks to compare methods, show every rate in a small list and finish with one line on which is more suitable and why.
For a machine hour rate on a single machine, list the overheads one by one: depreciation, power, repairs, insurance and so on. Then total them and divide by working hours.
In MCQs check the base. Many wrong options come from using the wrong hours or the wrong percentage base.
State clearly that rates are predetermined from budgets, and mention under or over absorption when actual overheads differ.

Practice questions from Overheads

Absorption of Overheads and Overhead Rates in other exams

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

Absorption of Overheads and Overhead Rates: frequently asked questions

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

A blanket rate is one overhead rate for the whole factory. A departmental rate is a separate rate for each department. Departmental rates are more accurate when products use departments in different proportions.

How do you calculate a predetermined overhead rate?

Divide budgeted overheads by the budgeted base for the same period. The base can be machine hours, labour hours, units or a cost value. Then multiply the rate by the actual base used by a job.

Why is a predetermined rate used instead of an actual rate?

Actual overheads are known only after the period ends, and they fluctuate. A predetermined rate lets you cost jobs and give quotations at once. The gap between absorbed and actual overheads is then dealt with as under or over absorption.

When should I use a machine hour rate?

Use it where machines do most of the work and overheads such as depreciation and power depend on machine running time. It gives a fairer charge than labour-based methods in such departments.