Absorption of Overheads or Cost Recovered – Definition, Procedure and Formula:
Once total production overheads (calculation of overhead absorption rate) of production cost centers are calculated through allocation and apportionment, they are transferred to, i.e., absorbed by, the cost units or products which are produced by those cost centers. The cost charged to production is known as the absorption of overheads or cost recovered, is determined for each cost center by using the formula:
In the above formula the actual production is expressed in the same terms as the absorption rate is calculated. Thus, if an absorption rate is expressed as a rate per unit, then actual activity is also expressed in units. If the rate is expressed as a percentage of direct material cost, then activity must also be expressed in material cost terms.
The procedure of cost absorption is the transfer of the department or cost center production overheads to the product or cost unit by using cost absorption or recovery rates.
A single rate is calculated for each cost center, but different methods may be used for each cost center of the business depending upon the characteristics of that cost center, for example, whether it is capital or labor intensive.