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Absorption costing is the cost accounting system in which the overheads of an organization are charged to the production by means of the process of absorption. Costs are first allocated or apportioned to the cost centres, where they are absorbed into the cost unit using absorption rates.
There are four main stages as follows:
Collect indirect costs in cost centres on the basis of allocation or apportionment
Determine an overhead absorption rate (OAR) for each production cost centre (eg cost per direct labour hour)
Charge indirect costs to products using the OAR and a measure of the product’s consumption of the cost centre’s cost (eg number of direct labour hours)
Calculate the cost per unit.
