OVERHEAD ABSORPTION RATE (OAR)

How to calculate OAR

Example:
The Pottery and Ceramics Company manufactures high-end made-to-order vases. It uses a job
costing system to cost its products. The following information is available:

Units of product 10 000

Prime Cost $
Direct materials 200 000
Direct labour (@50 per hour) 100 000
300 000

Factory overhead incurred $150 000

Machine hours used 30 000

Calculate the overhead absorption rate (OAR) using the following bases:
(a) Units of production
(b) Machine hours
(c) Direct labour hours
(d) Direct labour cost

Solution:

(a) Units of production

OAR = Factory Overhead_ = $150 000
Units of Production 10 000 = $15 per unit

(b) Machine hours

OAR = Factory Overhead___ = $150 000
Total machine hours used 30 000 = $5 per machine hour

(c) Direct labour hours

OAR = Factory Overhead___ = $150 000
Total direct labour hours *20 000 = $0.75 per direct labour hour

* Total direct labour hours = Direct labour cost = $100 000

Cost per hour $0.50 = 20 000 hours

(d) Direct labour cost

OAR = Factory Overhead_ x 100 % = $150 000 x 100 %
Direct labour hours $100 000
= 150 % of direct labour cost

Past paper questions

2011 #1c
2016 #1d
2013 #1a (iii)
PRACTICE QUESTIONS

1) The following figures have been extracted from the books of a manufacturing concern.
All jobs pass through the company's two departments:

Production Department Finishing Department

Direct materials used $6,000 $500
Direct labour cost $3,000 $1,500
Factory overheads $18, 000 $12, 000
Direct labour hours 12,000 5,000
Machine hours 10,000 2,000

The company produces 10, 000 units.

Calculate the Overhead Absorption Rate (OAR) for each department, using the following
bases:

(a) Units of production

(b) Machine hours
(c) Direct labour hours
(d) Direct labour cost

2) Calculate the Overhead Absorption Rate (OAR) for the information given below using the
following bases:

(i) Units of production

(ii) Machine hours
(iii) Direct labour hours
(iv) Direct labour cost

Units of production 15 000

Direct Labour cost (@$1.25 per hour) $ 25 000
Machine hours used 5 000
Total Overhead Cost $125 000