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I came across a question. If budgeted overheads are $450,000 and budgeted labor cost is $200,000 then calculate absorption rate on the basis of labor cost.
I calculated this in percentage.
$450,000 / $200,000 = 2.25 $
$2.25 * 100 = 225 % of direct labor cost
The correct answer is 225 % of direct labor cost.
But I don’t quite understand this. Why doesn’t the question provide a level of activity such as budgeted labor hours. And now that it has provided us with labor cost, what is the relationship between labor cost and labor hours? Why are we calculating this answer as a percentage?
Thank you for your help!
It is because the question says that is to be absorbed as a % of labour cost. The company can absorb on any basis they think is suitable, more commonly it will be on labour hours but it certainly does not have to be 🙂