Business Glossary
What Is Overhead Absorption?
Overhead absorption allocates indirect costs to individual products, typically expressed as a rate per unit or labour hour. It ensures overhead costs are recovered in product pricing — particularly important for UK manufacturing businesses.
The Formula
Absorption Rate = Total Overheads ÷ Total Units Produced (or Direct Labour Hours)
Worked Example — UK SME
A UK manufacturer: annual overheads £180,000, 36,000 units per year. Absorption rate = £5.00 per unit. Direct material and labour cost £28 per unit. Fully absorbed cost = £33. At £45 selling price, fully absorbed margin = 26.7%.
UK Benchmark
📊 UK manufacturers who do not absorb overheads into product costs risk systematic underpricing — particularly on lower-volume lines that consume disproportionate overhead resource.
Common Questions
What is over-absorption and under-absorption?
If actual production exceeds planned, overheads are over-absorbed. If lower, they are under-absorbed — products were undercosted. Under-absorption during slow periods can create apparent losses that are actually volume problems.
Do I need overhead absorption for a small UK manufacturer?
Not at a granular level. A simpler approach: calculate total overhead as a percentage of direct costs and add this to every product’s direct cost. This gives approximate absorption without complex cost accounting.
How does overhead absorption affect pricing?
Pricing below fully absorbed cost is only sustainable short-term if contribution margin is positive. Long-term below-absorption pricing means overheads are not recovered — a route to insolvency for high fixed-cost businesses.
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