Definition of Fixed Overhead Absorbed
Fixed overhead absorbed refers to a manufacturer’s fixed indirect manufacturing/production costs. Since these costs are indirect, they must be assigned or allocated to the products manufactured. This is required because U.S. accounting principles and income tax regulations require manufacturers to follow full absorption costing. This means that the cost of manufactured goods must include the costs of the direct materials, direct labor, variable manufacturing overhead, and fixed manufacturing overhead. Accountants will state that the goods produced must absorb the fixed manufacturing overhead costs.
It is common that the fixed manufacturing overhead costs are absorbed by the goods produced (or are assigned/allocated to the goods produced) through predetermined overhead rates based on the number of machine hours.
Example of Fixed Overhead Absorbed
Assume that TOPCO has budgeted next year’s fixed manufacturing overhead costs to be $2,000,000 (consisting of depreciation on its equipment, salaries of the managers involved in the manufacturing operations, utilities, etc.). TOPCO also anticipates there will be 100,000 machine hours (MHs) involved in the production of goods. Therefore, the company will be assigning to the goods produced (and the goods will be absorbing) the fixed manufacturing overhead costs at the rate of $20 per MH.
If the actual production volume is less than the planned volume (and the costs are as planned) the fixed manufacturing overhead will be underabsorbed. When the actual volume exceeds the planned volume (and the costs are as planned) the fixed manufacturing overhead will be overabsorbed.
