OxfordAQA A-Level Accounting: Absorption and activity based costing (9615)

This guide teaches section 3.2.2 Absorption and activity based costing of the OxfordAQA International AS and A-level Accounting (9615) specification, Version 1.2, for International AS exams May/June 2025 onwards and International A-level exams May/June 2026 onwards. The whole section is International A-level only, and it is assessed on Paper 4: Accounting for analysis and decision making. All figures are in dollars and every business is fictional.

Use it with the revision notes and the practice questions. Contribution and marginal costing profit are taught in the marginal costing guide; paper layouts are in exam preparation. Links: course hub · printable checklist · free 10-minute diagnostics.

What 3.2.2 covers

Specification content (International A-level only)	Skills you need
The use of absorption costing to calculate the total cost of a product	Know the five listed terms; allocate direct costs, apportion indirect costs, calculate overhead absorption rates
The use of activity based costing (ABC) to calculate the total cost of a product	Allocate direct costs; attribute indirect costs to products through pools and drivers; know the terms cost pool, cost driver, attribution
Use of absorption and ABC to calculate the selling price of a product	Turn a total cost into a price with a mark-up or a margin
The benefits and limitations of absorption, ABC and marginal costing	Contrast inventory values and profits from all three methods, then judge each one

Absorption costing

Under absorption costing a product’s total cost is its direct costs (materials, labour, direct expenses) plus a share of the production overheads of each department it passes through.

The vocabulary

• Allocation charges a cost in full to the one product or cost centre it belongs to: direct costs to products, or a department’s own indirect wages to that department.
• Apportionment divides an indirect cost that several departments share, using a basis that reflects how much each one benefits.
• Absorption loads each production department’s overhead total onto the units it works on, at an overhead absorption rate (OAR).
• Under-absorption: overheads charged to output are less than overheads actually incurred.
• Over-absorption: overheads charged to output exceed overheads actually incurred.

Choosing bases

Shared overhead	Sensible basis
Factory rent, rates, lighting, heating	Floor area occupied
Machinery depreciation or insurance	Cost (or carrying amount) of machinery
Power used by machines	Machine hours
Staff welfare, supervision, personnel	Number of employees

The OAR is fixed before the year starts, from budgets:

OAR = budgeted production overheads of the department
      ÷ budgeted activity of that department

Use machine hours for machine-led departments, direct labour hours for hand work, and units only if every unit is identical.

Worked example 1: Tarnbrook Instruments

Tarnbrook makes violins in two production departments. Carving uses computer-controlled cutting machines; Varnishing is hand work. Budget for the year:

Overhead	Total	Basis
Indirect wages: Carving 48,600, Varnishing 33,800	82,400	Allocated
Factory rent	84,000	Floor area: Carving 1,400 m², Varnishing 700 m²
Machinery depreciation	36,000	Machinery cost: Carving 270,000, Varnishing 30,000
Staff welfare	21,000	Employees: Carving 9, Varnishing 12
Electricity for machines	28,800	Machine hours: Carving 20,000, Varnishing 4,000
Total	252,200

Step 1 – allocate and apportion. For rent, Carving’s share is 1,400 ÷ 2,100 × 84,000 = 56,000.

	Carving	Varnishing
Indirect wages (allocated)	48,600	33,800
Factory rent	56,000	28,000
Machinery depreciation	32,400	3,600
Staff welfare	9,000	12,000
Electricity	24,000	4,800
Department total	170,000	82,200

Check: 170,000 + 82,200 = 252,200, the budget total.

Step 2 – OARs. Varnishing budgets 13,700 direct labour hours.

Carving:    170,000 ÷ 20,000 machine hours      = 8.50 per machine hour
Varnishing:  82,200 ÷ 13,700 direct labour hours = 6.00 per direct labour hour

Step 3 – total cost of one violin. Materials cost 142.50. Labour is 9 hours at 18 an hour (3 hours in Carving, 6 in Varnishing). The violin needs 5 machine hours in Carving.

Cost of one violin
Direct materials	142.50
Direct labour (9 × 18)	162.00
Carving overhead (5 × 8.50)	42.50
Varnishing overhead (6 × 6.00)	36.00
Total cost	383.00

Under- and over-absorption at Tarnbrook

Overheads absorbed during the year = predetermined OAR × actual activity.

	Carving	Varnishing
Actual activity	21,200 machine hours	13,100 labour hours
Overheads absorbed	21,200 × 8.50 = 180,200	13,100 × 6.00 = 78,600
Actual overheads	176,300	81,050
Outcome	3,900 over-absorbed	2,450 under-absorbed

Net, Tarnbrook over-absorbed 3,900 − 2,450 = 1,450. Product costs carried 1,450 too much overhead, so 1,450 is added back to profit in the statement of profit or loss.

Why? Carving ran 1,200 machine hours above budget, which absorbed 1,200 × 8.50 = 10,200 extra; it also spent 6,300 more than its 170,000 budget, so the net result is 10,200 − 6,300 = 3,900 over. Varnishing worked 600 hours below budget (3,600 less absorbed) and spent 1,150 below budget, leaving 3,600 − 1,150 = 2,450 under.

Activity based costing (ABC)

A single labour-hour or machine-hour rate assumes overheads rise with volume. Many do not: cleaning a line, testing a batch or raising a purchase order costs the same whatever the batch size. ABC traces these overheads through the activities that cause them.

The vocabulary

• A cost pool collects the overheads of one activity, for example all line changeover costs.
• A cost driver is the factor whose quantity makes the cost of that pool rise or fall, for example the number of changeovers.
• Attribution is charging each pool to particular products in proportion to the cost driver each product uses.

Direct costs are still allocated to products. For overheads: driver rate = pool cost ÷ total driver quantity; attribute rate × each product’s driver use; divide each product’s total by its output.

Worked example 2: Hazelford Drinks

Hazelford bottles two cordials. Classic runs in long batches; Botanical is a small-batch range with many flavours. Production overheads total 288,000.

Per case	Classic	Botanical
Cases produced	30,000	6,000
Direct materials	8.60	14.40
Direct labour at 16 an hour	0.3 hours = 4.80	0.5 hours = 8.00

Absorption costing (one factory rate per direct labour hour). Labour hours = 30,000 × 0.3 + 6,000 × 0.5 = 12,000. OAR = 288,000 ÷ 12,000 = 24 per direct labour hour. Classic absorbs 0.3 × 24 = 7.20 a case; Botanical absorbs 0.5 × 24 = 12.00.

ABC.

Cost pool	Cost	Cost driver	Classic	Botanical	Driver rate
Line changeovers	96,000	Production runs	20	60	1,200 per run
Batch testing	54,000	Tests	40	50	600 per test
Supplier ordering	30,000	Purchase orders	30	70	300 per order
Bottling line running	108,000	Line hours	3,000	600	30 per line hour

Attribution:

	Classic	Botanical
Changeovers	20 × 1,200 = 24,000	60 × 1,200 = 72,000
Testing	40 × 600 = 24,000	50 × 600 = 30,000
Ordering	30 × 300 = 9,000	70 × 300 = 21,000
Line running	3,000 × 30 = 90,000	600 × 30 = 18,000
Total attributed	147,000	141,000
Per case	147,000 ÷ 30,000 = 4.90	141,000 ÷ 6,000 = 23.50

Check: 147,000 + 141,000 = 288,000.

Total cost per case	Classic	Botanical
Direct costs	13.40	22.40
Absorption total (+7.20 / +12.00)	20.60	34.40
ABC total (+4.90 / +23.50)	18.30	45.90

Botanical is a sixth of output but causes three-quarters of the changeovers; ABC charges those costs to it rather than spreading them over Classic’s volume.

Setting a selling price

Either total cost can become a price by adding profit:

Mark-up on cost:          price = total cost × (1 + mark-up %)
Margin on selling price:  price = total cost ÷ (1 − margin %)

Tarnbrook’s violin (total cost 383.00). A 35% mark-up gives 383.00 × 1.35 = 517.05. A 20% margin gives 383.00 ÷ 0.80 = 478.75; check: (478.75 − 383.00) ÷ 478.75 = 20%.

Hazelford at a 30% mark-up:

	Classic	Botanical
From absorption cost	20.60 × 1.3 = 26.78	34.40 × 1.3 = 44.72
From ABC cost	18.30 × 1.3 = 23.79	45.90 × 1.3 = 59.67

Priced from absorption cost, each Botanical case sells for 44.72 against an ABC cost of 45.90: a loss of 1.18 a case that the absorption figures hide. Classic is priced 2.99 above its ABC-based price, which could cost Hazelford sales to rivals.

Absorption vs ABC vs marginal costing

Inventory and profit

• Marginal costing values closing inventory at variable production cost. Fixed production overheads are written off in full in the period.
• Absorption costing values inventory at total production cost, so some fixed overhead moves into the next period inside closing inventory.
• ABC also values inventory at total production cost, but the overhead in each unit comes from driver rates, so the figure usually differs from absorption.

Worked example 3: Hazelford’s year

There was no opening inventory. Hazelford sold 28,500 Classic at 27 and 5,200 Botanical at 52, leaving 1,500 Classic and 800 Botanical in closing inventory. Treat materials and labour as variable and the 288,000 of overheads as fixed; actual overheads and activity matched the budget, so nothing was under- or over-absorbed. Selling and administration expenses were 95,000.

	Marginal	Absorption	ABC
Revenue	1,039,900	1,039,900	1,039,900
Production cost	536,400	824,400	824,400
Less closing inventory	(38,020)	(58,420)	(64,170)
Cost of sales	498,380	765,980	760,230
Contribution / gross profit	541,520	273,920	279,670
Fixed production overheads	(288,000)	–	–
Selling and administration	(95,000)	(95,000)	(95,000)
Profit for the year	158,520	178,920	184,670

Reconciliation. The profit gap equals the fixed overhead carried forward in closing inventory:

Absorption: 1,500 × 7.20 + 800 × 12.00 = 20,400   158,520 + 20,400 = 178,920
ABC:        1,500 × 4.90 + 800 × 23.50 = 26,150   158,520 + 26,150 = 184,670

ABC profit is highest because each unsold Botanical case holds 23.50 of overhead. Falling inventory would reverse the order.

Benefits and limitations

Method	Benefits	Limitations
Absorption	Full-cost prices aim to recover all production costs; fixed overhead matched to the inventory it helped make; simple	Apportionment bases are judgement; volume-based rates ignore what causes overheads; under- or over-absorption; building inventory lifts profit
ABC	Costs reflect the activities each product uses, so prices and profitability are more reliable; drivers show which activities to reduce	Costly to set up and maintain; pools and drivers are still judgement; rent and similar costs lack a driver; little benefit if products are alike
Marginal	No apportionment; profit follows sales, not output; contribution suits short-term decisions	Inventory excludes fixed production overhead; marginal-cost prices may not cover fixed costs; semi-variable costs must be split

Common errors

• Calculating overheads absorbed with budgeted hours. The rate comes from the budget; the hours multiplied by it are actual.
• Calling an excess of absorbed over actual “under-absorbed”. Absorbed > actual is over-absorbed and increases profit.
• Charging a machine-hour department’s overhead on labour hours (Tarnbrook’s violin uses 5 machine hours but only 3 labour hours in Carving).
• Dividing an ABC pool by total units rather than total driver quantity.
• Treating a margin as a mark-up: 20% margin on 383.00 is 478.75, not 459.60.

Test yourself with the practice questions, or skim the revision notes.

Official syllabus

OxfordAQA International AS and A-level Accounting (9615) specification, Version 1.2, for International AS exams May/June 2025 onwards and International A-level exams May/June 2026 onwards (OxfordAQA). Section 3.2.2 Absorption and activity based costing.