EnglandAccountingSyllabus dot point

How are overheads charged to products, and when does activity based costing give a fairer cost than a single absorption rate?

Absorption and activity based costing: the allocation, apportionment and reapportionment of overheads, the calculation of overhead absorption rates and their use to cost a unit, the identification of cost pools and cost drivers in activity based costing, and the comparison of the two approaches.

A focused answer to AQA A-Level Accounting 3.12, covering the allocation, apportionment and reapportionment of overheads, the calculation and use of overhead absorption rates, the identification of cost pools and cost drivers in activity based costing, and the comparison of absorption costing with activity based costing.

Generated by Claude Opus 4.812 min answerUpdated 2026-06-02

Reviewed by: AI editorial process; not yet individually human-reviewed

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What this dot point is asking
Why overheads are the problem
The three stages of absorption costing
Activity based costing
Comparing the two approaches
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What this dot point is asking

AQA wants you to charge overheads to products by absorption costing - allocating, apportioning and reapportioning overheads, then calculating and applying an overhead absorption rate - and to do the same job with activity based costing using cost pools and cost drivers, then compare the two. This is unit 3.12. It extends the marginal-and-absorption topic by going deep on how overheads actually reach a unit, and ABC is a popular AO3 evaluation question on Paper 2.

Why overheads are the problem

Direct materials and direct labour are easy to trace to a unit. Overheads (indirect costs such as rent, supervision, machine maintenance and quality control) are not, yet absorption costing requires every cost to reach a unit. The whole topic is about finding a fair way to share overheads.

The three stages of absorption costing

Once every overhead sits in a production cost centre, it is absorbed into units. The choice of basis matters: a machine-intensive centre absorbs on machine hours, a labour-intensive centre on labour hours.

Over-absorption arises when absorbed overhead (actual hours times the rate) exceeds actual overhead; under-absorption is the reverse. The difference is adjusted in the income statement.

Absorption costing a unit

Set the absorption rate

A production centre budgets $84{,}000$ of overheads and $12{,}000$ machine hours. The machine-hour rate is

\frac{84{,}000}{12{,}000} = 7 \text{ per machine hour.}

Cost a job

A job uses $40$ of direct materials, $30$ of direct labour and $5$ machine hours. Absorbed overhead $= 5 \times 7 = 35$ . Total absorption cost $= 40 + 30 + 35 = 105$ .

Check for over- or under-absorption

If the centre actually works $11{,}500$ hours, it absorbs $11{,}500 \times 7 = 80{,}500$ . If actual overheads were $82{,}000$ , overhead is under-absorbed by $82{,}000 - 80{,}500 = 1{,}500$ , charged as an extra expense in the income statement.

Activity based costing

Absorption costing uses one volume-based rate per centre. That works when overheads really do rise with volume, but many modern overheads (set-ups, ordering, inspection) are driven by complexity, not volume. Activity based costing addresses this.

The method has three steps: group overheads into cost pools by activity; calculate a cost driver rate $= \frac{\text{cost pool}}{\text{total driver volume}}$ ; charge each product its driver usage times the rate. The result reflects the demands each product places on each activity, not just the hours it spends in production.

Absorption versus ABC for two products

The data

Total set-up overhead is $90{,}000$ , caused by $300$ set-ups. Product X (high volume) needs $60$ set-ups; Product Y (low volume, complex) needs $240$ set-ups. Each product uses the same $1{,}500$ machine hours, and total machine hours are $3{,}000$ .

Absorption costing (machine-hour rate)

The set-up overhead is absorbed on machine hours: rate $= \frac{90{,}000}{3{,}000} = 30$ per hour. Each product absorbs $1{,}500 \times 30 = 45{,}000$ , so set-up cost is split equally even though Y causes four times as many set-ups.

Activity based costing (cost driver rate)

The driver is set-ups: rate $= \frac{90{,}000}{300} = 300$ per set-up. Product X is charged $60 \times 300 = 18{,}000$ ; Product Y is charged $240 \times 300 = 72{,}000$ .

The insight

Absorption costing overcosts X by $27{,}000$ and undercosts Y by $27{,}000$ . ABC charges the set-up cost to Y, the product that actually causes it, so a pricing or product-mix decision is based on a truer cost.

Comparing the two approaches

Absorption costing is simpler and cheaper to run, and it satisfies the requirement to value inventory at full production cost for the financial statements. ABC is more accurate where overheads are large and not volume-driven, and where there is a mix of high- and low-volume products, so it supports better pricing and product-mix decisions. Its cost is the effort of identifying activities, pools and drivers, which may not be justified if overheads are small or genuinely volume-related.

Try this

Q1. Budgeted overheads are $60{,}000$ and budgeted labour hours are $15{,}000$ . Calculate the overhead absorption rate per labour hour. [2 marks] $\frac{60{,}000}{15{,}000} = 4$ per labour hour.

Q2. State what a cost driver is in activity based costing. [1 mark] The factor that causes the cost of an activity (a cost pool) to change, such as the number of set-ups or orders.

Exam-style practice questions

Practice questions written in the style of AQA exam questions on this dot point, with worked answer explainers. The year tag is the paper they imitate, not the source.

AQA 20206 marksA department's budgeted overheads are

84,000 and it expects to work 12,000 machine hours. A job uses

40 of direct materials, $30 of direct labour and 5 machine hours. Calculate the overhead absorption rate and the total absorption cost of the job.

Show worked answer →

A two-stage absorption calculation; marks are for the rate and for applying it to the job.

Overhead absorption rate per machine hour: budgeted overheads over budgeted machine hours, 84,000 over 12,000 = 7 per machine hour (2 marks).

Overhead charged to the job: 5 hours times 7 = 35 (1 mark).

Total absorption cost: direct materials 40 + direct labour 30 + overhead 35 = 105 (3 marks). Markers reward the correct choice of activity base (machine hours), the rate, and the full build-up of prime cost plus absorbed overhead.

AQA 20228 marksExplain how activity based costing differs from traditional absorption costing, and analyse one situation in which it gives a more accurate product cost.

Show worked answer →

An 8-mark "Explain and analyse" answer needs the mechanism of each method and a developed example of when ABC is better.

Explain the difference. Traditional absorption costing charges all overheads to products using a single volume-based rate, usually per labour or machine hour. Activity based costing first groups overheads into cost pools by activity (for example machine set-ups, ordering, quality inspection), identifies the cost driver that causes each pool, and charges products by their use of each driver (4 marks).

Analyse when ABC is more accurate. Where a low-volume, complex product causes many set-ups and inspections but few machine hours, a single machine-hour rate undercosts it and overcosts the high-volume simple product. ABC charges the set-up and inspection costs to the product that actually causes them, so pricing and product-mix decisions are based on truer costs (4 marks). Markers reward an example where overhead consumption is not proportional to volume.

Related dot points

Sources & how we know this

AQA A-level Accounting (7127) specification — AQA (2017)