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Hi , I hope you are well? Could you please explain why absoprtion costing is used ? and why is labour hours used as a basis ?
Thank you
Hopefully this will help:
Absorption costing is a way of putting through an estimate of overheads rather than waiting for actual invoices to come in. You can absorb on machine hrs, labour hrs or per unit – these are the main methods.
So pretend you have budgeted at $210,000 overheads to make two products X & Y in total you estimate to use 100,000 machine hours that means an estimated OAR of $2.10 per unit.
So when you make your units only 70,000, you put through your estimate of $2.10 * 70,000 = $147,000
Your actual invoice comes in at the end of the period and it comes to $152,000 so you have under absorbed by $5,000 another way of thinking of this is under guessed.
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