In one sentenceA predetermined rate for charging manufacturing overhead to products, calculated by dividing estimated overhead by an estimated activity level such as labor or machine hours.
Simply put
You don't wait until year-end to know a product's cost. You estimate overhead and the number of hours from the start, giving you a rate per hour, and you charge each production order according to its hours.
At the end of the period the absorbed amount usually differs from the actual, producing an over-absorption or under-absorption difference that is dealt with in the accounts.
Worked example
A furniture factory estimated its annual overhead at 50,000 SAR and 2,500 machine hours. An order took 30 machine hours.
Absorption rate = 50,000 ÷ 2,50020 SAR per machine hour
Charged to the order = 30 × 20600 SAR
Overhead charged to the order600 SAR
Formula: Estimated overhead ÷ Estimated activity level
Don't confuse it with
Fixed overhead volume varianceIt arises when actual production differs from the volume on which the absorption rate was based.