AQA A-Level Accounting: Absorption and activity based costing (7127) – Revision Notes

For full explanations and longer worked examples, use the absorption and activity based costing study guide.

These notes cover section 3.12, Absorption and activity based costing, of the AQA A-level Accounting (7127) specification, version 1.1 (October 2026), for A-level exams from June 2019 onwards. The course is untiered and this section is assessed on Paper 2. All businesses and figures are invented.

Links: course hub · printable checklist · practice questions · free 10-minute diagnostics · marginal costing notes

3.12 Key terms

Term	Meaning
Allocation	Charging a whole cost to the one product or cost centre that caused it (direct costs to products; a department’s own supervisor to that department)
Apportionment	Sharing an indirect cost between cost centres on a fair basis
Absorption	Charging cost-centre overheads to products using an overhead absorption rate (OAR)
Under-absorption	Overheads absorbed < actual overheads; deduct the difference from profit
Over-absorption	Overheads absorbed > actual overheads; add the difference to profit
Cost pool	A group of overheads caused by one activity (set-ups, inspections, ordering)
Cost driver	The factor that makes a pool’s cost change (number of set-ups, inspections, orders)
Attribution	Charging each pool to products by their use of its cost driver

Allocation vs apportionment. Allocation needs no sharing: the cost belongs to one place. Apportionment always needs a basis because the cost is shared.

Apportionment bases

Overhead	Basis
Rent, rates, heating, lighting, building insurance	Floor area
Machinery depreciation and insurance	Cost or value of machinery
Machine power	Machine hours
Canteen, welfare, personnel	Number of employees

Apportion with: share = total overhead × (department’s basis ÷ total basis). Always check that the shares add back to the total.

Formulas

What you need	Formula
OAR	Budgeted cost-centre overheads ÷ budgeted activity (machine hours, labour hours or units)
Overheads absorbed by a product	OAR × hours (or units) the product uses in that cost centre
Total cost per unit	Direct materials + direct labour + direct expenses + overheads absorbed
Overheads absorbed in the period	OAR × actual activity
Under/(over)-absorption	Actual overheads − overheads absorbed
Cost driver rate (ABC)	Cost of pool ÷ total quantity of driver
Overheads attributed (ABC)	Driver rate × driver quantity used by the product
Price with mark-up	Total cost × (1 + mark-up %)
Price with margin	Total cost ÷ (1 − margin %)
Profit difference (absorption vs marginal)	Change in inventory units × fixed production overhead per unit

Method in steps

Absorption costing

1. Allocate overheads that belong to one department.
2. Apportion shared overheads on suitable bases.
3. Total each production department and check the grand total.
4. OAR: machine hours for machine-intensive departments; labour hours for labour-intensive ones.
5. Product cost = direct costs + (OAR × hours used) in each department.

Activity based costing

1. Allocate direct costs to products.
2. Group overheads into cost pools; pick a cost driver for each.
3. Driver rate = pool ÷ total driver quantity.
4. Attribute: rate × each product’s driver quantity.
5. Total each product’s overheads, divide by units, add to direct costs.

Worked reminders

Pell Printing, Finishing department (absorption):

Budget: overheads £54 000, 4 500 direct labour hours
OAR = 54 000 ÷ 4 500 = £12 per direct labour hour
Actual: 4 300 hours, overheads £53 100
Absorbed = 4 300 × 12 = £51 600
51 600 − 53 100 = −1 500  → under-absorbed £1 500 (reduce profit)

Wren Bakery, deliveries cost pool (ABC):

Pool £18 000; driver = number of deliveries; 600 deliveries in total
Driver rate = 18 000 ÷ 600 = £30 per delivery
Cakes use 420 deliveries: 420 × 30 = £12 600
Cakes made 9 000 → 12 600 ÷ 9 000 = £1.40 per cake

Why under- or over-absorption happens:

• actual activity differs from budgeted activity (more hours absorb more overhead)
• actual overhead spending differs from the budget
• both at once, sometimes partly cancelling out.

When ABC changes the answer most

ABC gives very different costs from absorption when:

• products differ a lot in batch size, so set-ups and orders are not linked to volume
• overheads are a large share of total cost
• a low-volume, complex product shares a factory with a high-volume, simple one.

In that case a labour-hour or machine-hour rate under-costs the low-volume product and over-costs the high-volume one. Prices set from absorption cost can then sell the complex product at a loss.

Inventory and profit: the three methods

	Marginal	Absorption	ABC
Inventory valued at	Variable production cost	Full production cost (OAR)	Full production cost (driver rates)
Fixed production overheads	All charged in the period	Part carried forward in inventory	Part carried forward in inventory
Inventory rising	Lowest profit	Higher profit	Higher profit (amount depends on which products are in inventory)
Inventory falling	Highest profit	Lower profit	Lower profit
Production = sales	Same profit	Same profit	Same profit

Must-know distinctions

• Mark-up vs margin: mark-up is a % of cost; margin is a % of selling price. A 25% mark-up and a 20% margin give the same price.
• Budgeted vs actual activity: budgeted activity sets the OAR; actual activity gives overheads absorbed.
• Under vs over: under-absorbed means products were charged too little, so profit falls when it is corrected.
• Absorption vs ABC: absorption uses one volume-based rate per department; ABC uses several rates, one per activity, many not linked to volume.
• Full cost vs marginal cost: full cost suits long-run pricing and inventory valuation; marginal cost suits short-term decisions.

Benefits and limitations in brief

Method	Benefits	Limitations
Absorption	Prices aim to cover all production costs; fixed production costs matched with the inventory they made; simple	Arbitrary apportionment; volume-based rates distort costs; producing for inventory raises profit; under/over-absorption
ABC	More accurate product costs and prices; shows which products really earn profit; drivers can be managed	Costly to set up and maintain; judgement in choosing pools and drivers; some costs have no clear driver
Marginal	No apportionment; profit follows sales; contribution suits short-term decisions	Inventory excludes fixed production overheads; prices on marginal cost may not cover fixed costs; cost splitting needs estimates

Quick self-test

1. Define apportionment.
2. Rent of £48 000 is shared between departments X (600 m²), Y (1 000 m²) and Z (400 m²). Apportion it.
3. A department has budgeted overheads of £87 500 and 12 500 budgeted machine hours. Calculate the OAR.
4. Using question 3, actual machine hours were 13 000 and actual overheads £89 900. Calculate the under- or over-absorption and its effect on profit.
5. A unit uses £22 of materials, £18 of labour and 1.5 machine hours at the OAR in question 3. Calculate its total cost and the price at a 30% mark-up.
6. Total cost is £64. Calculate the price for a 20% margin.
7. A purchasing pool costs £36 000 for 240 orders. Product K uses 90 orders and 3 000 units are made. Calculate the purchasing cost per unit of K.
8. Suggest a cost driver for (a) machine set-up costs (b) despatch costs.
9. Production 6 000 units, sales 5 200, no opening inventory, fixed production overheads absorbed at £5 per unit. By how much does absorption profit differ from marginal profit?
10. Which method gives the lowest closing inventory value, and why?
11. Give two reasons why overheads may be under-absorbed.
12. A product’s ABC cost is £42 and its absorption cost £32. It is priced at a 25% mark-up on absorption cost. Calculate the profit or loss per unit measured against ABC cost.

Answers

1. Sharing an indirect cost between cost centres on a fair basis.
2. X £14 400; Y £24 000; Z £9 600 (total £48 000).
3. 87 500 ÷ 12 500 = £7.00 per machine hour.
4. Absorbed 13 000 × 7 = £91 000; 91 000 − 89 900 = £1 100 over-absorbed; profit rises by £1 100.
5. 22 + 18 + (1.5 × 7) = £50.50; × 1.3 = £65.65.
6. 64 ÷ 0.8 = £80.
7. Rate 36 000 ÷ 240 = £150; 90 × 150 = £13 500; ÷ 3 000 = £4.50 per unit.
8. (a) Number of set-ups. (b) Number of despatches (deliveries).
9. Inventory rises by 800 units; 800 × 5 = £4 000 higher under absorption.
10. Marginal costing, because its inventory excludes fixed production overheads.
11. Actual activity below budget; actual overhead spending above budget.
12. Price 32 × 1.25 = £40; 40 − 42 = loss of £2 per unit.

Where marks are usually lost

• Using budgeted activity, not actual activity, to find overheads absorbed.
• Treating under-absorption as extra profit: it reduces profit.
• Applying a mark-up when the question gives a margin, or the reverse.
• Dividing an ABC pool by the units made instead of by the total driver quantity.
• Stopping at total attributed overheads and not dividing by units.
• Not checking that apportioned shares add back to the original overhead.
• Choosing labour hours as the OAR for a clearly machine-intensive department without explanation.
• Stating that absorption profit is always higher than marginal profit; it depends on the change in inventory.
• Listing benefits of ABC without applying them to the business in the question.

Official syllabus

AQA A-level Accounting (7127) specification, version 1.1, October 2026, for A-level exams June 2019 onwards (AQA). Section 3.12 Absorption and activity based costing.