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    The Overhead Absorption Rate Accounting Essay

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    The last 20 old ages has been brought up a new type of accounting system, the activity based costing, and from twelvemonth to twelvemonth is being accepted by more concerns internationally, but some companies have non alter their cost accounting systems and they utilizing that which developed many old ages ago.

    Activity based costing is modern bing method and is used as planning and control tool and identifies the relationship between costs, activities and goods, more accurately than traditional costing methods.

    Traditional costing method is overhead soaking up rate where incorporating all fabrication costs incurred to bring forth those merchandises, evaluate or valuing a concern ‘s entire stock.


    Activity Based Costing is a modern costing method where costs are owed to merchandises and services and it is by and large used as planning and control tool. It was developed as an estimate to work out the jobs related with traditional cost direction systems, which are likely to hold the inability to exactly set up the production and service costs, or afford helpful information for operating determinations. Directors with these scarcenesss can be exposed to do determinations based on inexact informations.

    Activity Based Costing allows directors to impute cost to activities and merchandises more precise than traditional cost accounting methods. Furthermore, merely activity costs are recognised, the cost of each activity is ascribed to each merchandise to the extent that the merchandise or service uses the activity. Activity Based Costing enables directors to acknowledge high operating expense costs per unit and happening ways to cut down the costs.

    Besides can give elaborate information to back up one-year budgets and specify client profitableness. It besides direction can see how public presentation can be maximised and apprehend growing schemes. However, in using activity based costing, where the client demands that the costs are linked with the services, it revealed that the biggest disbursals are driven by the ”profitable ” client. It is important to obtain that by identified costs drivers ; the activities are estimable and pertinent.

    The activity has direct and indirect relationship to the cost of making concern and the part attributable to the activities consumed are allot to each client.


    Activity based costing system is based on premiss that activities make a merchandise and besides has been developed late to overmaster the drawbacks of traditional costing system which suffers from certain drawbacks.

    Based on the activity needed for bring forthing an point, activity based costing is the intent of the point cost. To bring forth a merchandise or the cost consume for service, required some activities. From the disbursals consumed by all those activities which implemented for the devising of finished goods and sale, the consequence is that is really of import. Some research surveies showed that the use of activity based bing on operating expenses distribution and allotment for merchandise cost is lifting.

    Activity based bing based on cost driver which needed for bring forthing merchandises or presenting services, determine the merchandise cost. Furthermore, bing of multi-products manufactured by concerns and executing clients ‘ orders effectual more the activity based costing.

    Besides for finding and commanding the operating expense cost, the activity based costing is an effectual direction estimate. By utilizing activity based bing techniques, overhead analysis can be made more accurate for a big scope of goods, for profitableness analysis, for goods bing and for finding and control of the operating expenses suitableness.


    Businesss with activity based bing benefits can understand costs and cut downing disbursals. Businesss have to compare the merchandise ‘s monetary value and merchandising record to see if it is deserving to bring forth the point, and one of the benefits of activity based costing is the better analysis of good and bad merchandises. A chief job with some points is overhead costs, but this method shows better those costs and helps to diminish overhead costs.

    Furthermore, a more accurate merchandise creative activity cost is another benefit of activity based costing. Analysts through this bing method can number the per-product cost and, therefore, more practical measurings are used for rating.

    However, concerns before create a merchandise, will analyse overhead costs to happen out if there are adequate available budgets to do the merchandise. Activity based costing as with the per-product monetary value, is able to bring forth a batch of factors that straight influence cost, such as production costs, labour hours and portion supplies. Businesss until the merchandise made, can analyse these factors and happen ways to cut down them to curtail the merchandise ‘s monetary value when production does starts.

    Finally, concerns after a merchandise is created, analyze the merchandise to happen out if they are doing a net income and do certain that they are non losing money. Besides, better analysis of a merchandise is another benefit of activity based costing, and helps concerns to see if it is deserving to maintain bring forthing the point, because activity based bing method analyze better the merchandise ‘s monetary value and uses a batch of factors when specifying profitableness.


    Activity based costing system is a strong tool for determination devising and hence, helps directors to pull off overhead and understand profitableness of the points and clients. However, activity based costing has a numerical of drawbacks. These drawbacks are discussed briefly below:

    Activity based bing most of import disadvantage is that even though activity based costing is a scientific estimate ; the method of executing is complex, clip consuming, and dearly-won. The process of informations entry and informations aggregation demands indispensable resources, and stays dearly-won to keep.

    Another disadvantage is that studies of activity based bing do non follow to by and large recognized accounting rules ( GAAP ) , and from that, because concerns following activity based bing demand to maintain two cost systems and accounting books, one for interior use and the other for outer studies, filings, and statutory conformity. This is a complicated covering of attempts.

    Furthermore, a chief disadvantage of activity based costing is that it is non likely to divide some overhead costs such as the main executive ‘s salary on a per-product footing use. Similarly, employees seldom dedicate 100 % of their working hours to productive actions ; and non all productive actions or the process of the concern that increase the value of the merchandise. For illustration, for the clip employee take part in consciousness run, taking to indispensable ‘cost leaks ‘ ; the activity based bing method fails to account. There is no important manner to depute such ‘business prolonging ‘ costs to merchandises on a commensurate footing, and merchandises and services portion such costs every bit.

    Finally, vastly attending to detail and command might shadow the larger image or do the concern lose position of strategic aims in a chase for little nest eggs, doing the concern “ penny wise and lb foolish. ” For illustration, one distribution channel might place from activity based costing as non-profitable, or an review as non-value adding. To accomplish some other strategic aims, imparting or procedures might be non-remunerative, but placed in the first topographic point.

    Overhead Absorption Rate


    Overhead soaking up costing is a traditional costing method by incorporating all fabrication costs incurred to bring forth those merchandises, evaluate or valuing a concern ‘s entire stock. These fabrication costs are the direct stuffs, direct labour, fixed fabricating operating expense and variable fabrication operating expense.


    Overhead soaking up rate is the process of administering the operating expense costs by all the goods of a specific section. Besides operating expenses are applied in each production installation. Furthermore, overhead soaking up is the process of determining the entire operating expense costs in each production installation by utilizing overhead rate. Thus the allotment of the operating expense disbursals distributed to a specific section over the units of produced in that section is soaking up of operating expenses.

    Overhead soaking up rate should be determined, in order to absorb the operating expenses by each production installation of a specific section. Overhead soaking up rate has two chief methods which are the labour hr rate and the machine hr rate. For the computation of overhead soaking up rate under these two methods the expression is:

    Labor hr rate = Total Overheads/Total Labor Hours

    Machine hr rate = Total Overheads/ Total Machine Hours

    Advantages & A ; Disadvantages

    Overhead soaking up rate has a batch of benefits which are traveling to be discussed below.

    Identify fixed cost in merchandise cost, as it is appropriate for specifying monetary value of the merchandise. Based on overhead soaking up rate the monetary value obtains that all costs are covered.

    Overhead soaking up rate will demo the computation of net income correctly that variable costing, where production is done to hold gross revenues in future.

    Matching costs with gross for a specific accounting period required to follow soaking up bing with accrual and fiting accounting constructs.

    For stock rating intents and for the intents to fix external studies has been identified the soaking up costing.

    Absorption bing evades dividing costs into fixed and variable informations.

    Directors from the allotment of fixed operating expenses mill to cost centres, have been more cognizant and responsible for the cost and services applied to others.

    Overhead soaking up rate except from benefits has more drawbacks which are:

    For determination doing soaking up costing is non helpful. It examines fixed fabricating overhead as goods cost which raise the cost of production. This does non assist directors to have particular offers for the goods monetary value. Variable bing method can be work out the managerial jobs which concern to determination devising.

    Absorption costing is non utile in planning and control of cost and maps, and in repairing the liability for incurrence of costs. Besides for directors it is non practical to be responsible for the costs where they have non control.

    Some merchandise costs by bring forthing for stock can be removed from the income statement. By raising production, directors can temporarily better profitableness.


    An illustration of a company that used activity based costing is DHL. DHL was formed in 1969 and is the Godhead of the air express industry and specialising in lading and package bringing, and today has the leading in its sector.

    DHL used activity based bing foremost in 1988 and subsequently in the late 1890ss to shift it as the base for the concern to travel frontward to better the efficiency.

    A reappraisal of the organisation ‘s largest international client histories is the consequence of that the activity based bing theoretical account Lashkar-e-Taiba costs to go existent. From this reappraisal the company finds out the chief countries for development and led it to better profitableness.

    The consequence of utilizing activity based costing is that DHL has the footing to dialogue with their whole client base and their client profitableness programme is one of the anchor of the company. DHL created a set of tools, which can happen from this the pricing of international stamps. Besides, they create a costing system which is efficient and trustable and is based around a standard cost theoretical account, which used worldwide to number the profitableness of their clients.


    As we can see above activity based costing system and by and large modern bing methods are more accurately than traditional costing methods. This explained in the illustration of DHL, where the company used activity based costing in late 1890ss to better their profitableness and they did it successfully.

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