Absorption was originally set out to measure how much of the company's overheads are being covered by the profits generated from Aftersales, but this second version does not provide you with a truly accurate reflection. This is because the Semi-Fixed Expenses of the Sales Department are omitted from the equation.
The example demonstrates that 79.49% of the overheads are covered by Aftersales, but where are the Semi-Fixed Expenses of the Sales Department?
Example:
A) Direct Profit from Aftersales = R1,154,223 B) Company Overheads = R1,452,238 C) Overheads Absorption = R79.49% (A ÷ B X 100) D) Value of under Absorption = R298,015 (B - A)
Discussion:
Some people say that they should be included and some say that they should be excluded. Neither one is right nor wrong, but it does make a big difference to the Absorption percentage. It is all a matter of what you want to measure.
If your financial reports show this version of Absorption then you know that you still have to earn sufficient profit from the Sales department to cover the Semi-Fixed Expenses. Be sure that you know which version you are using or you could be faced with a sizeable shortfall.