What is the correct definition of the overhead absorption rate (OAR)?

What is the correct definition of the overhead absorption rate (OAR)?

• A. Absorption rate used only for service centres
• B. Production overhead divided by activity level (number of units produced)
• C. The difference between actual overhead and absorbed overhead
• D. The overhead absorption rate is the ratio of overheads to direct costs

Answer: (B)

Overhead absorption rate is the amount of overhead cost allocated to each unit of output (or other chosen activity base). It is computed by dividing the total production overhead by the chosen activity level, such as the number of units produced. This creates a cost per unit that can be applied to actual output to absorb overhead into product costs. For example, if the estimated production overhead is 200,000 and expected output is 10,000 units, the OAR is 20 per unit. If you actually produce 12,000 units, the absorbed overhead would be 240,000. This isn’t the difference between actual and absorbed overhead (that would be a variance). It isn’t the ratio of overheads to direct costs. And it isn’t restricted to service centres; the concept applies to allocating overhead to products using the chosen activity base.

Overhead absorption rate is the amount of overhead cost allocated to each unit of output (or other chosen activity base). It is computed by dividing the total production overhead by the chosen activity level, such as the number of units produced. This creates a cost per unit that can be applied to actual output to absorb overhead into product costs.

For example, if the estimated production overhead is 200,000 and expected output is 10,000 units, the OAR is 20 per unit. If you actually produce 12,000 units, the absorbed overhead would be 240,000.

This isn’t the difference between actual and absorbed overhead (that would be a variance). It isn’t the ratio of overheads to direct costs. And it isn’t restricted to service centres; the concept applies to allocating overhead to products using the chosen activity base.