What is Overhead Absorption?
Overhead absorption is the process of charging indirect manufacturing costs to the products that pass through a factory, using a predetermined absorption rate. It lets businesses calculate a full product cost even when actual overhead is only known at period end.
How It Works
- Estimate total manufacturing overhead for the period.
- Choose an absorption base — machine hours, direct labour hours, or units produced.
- Divide budgeted overhead by the budgeted base to get the absorption rate.
- Apply the rate to each job, batch, or unit as it consumes the base.
- At period end, compare absorbed overhead with actual overhead and book the under- or over-absorbed amount.
Saudi Context
Saudi manufacturers reporting under IFRS must absorb fixed production overhead based on the normal capacity of the production facilities, as required by IAS 2. ZATCA examiners review this allocation closely during VAT and zakat audits when inventory balances are material.
Example
If a workshop budgets SAR 240,000 overhead and 12,000 machine hours, the absorption rate is SAR 20/hour. A job that uses 50 machine hours absorbs SAR 1,000 of overhead, added to its direct material and labour costs.