Computation of overhead absorption rates should be based on:

The correct answer is Normal Capacity.

Key Points Overhead Costing:

• The computation of overhead absorption rates can be based on normal capacity.
• Normal capacity refers to the level of production or activity that a business expects to achieve on a regular basis.
• It is based on the assumption that the business will operate at a consistent level over a period of time.
• Therefore, normal capacity is a reasonable basis for estimating the overhead costs that will be incurred in the production of goods or services.
• When computing overhead absorption rates based on normal capacity, the overhead costs are divided by the expected level of activity or production to determine the overhead rate per unit of activity.
• This rate is then used to allocate overhead costs to the products or services produced during the period.

Additional Information Idle Capacity- Idle capacity refers to the unused or underutilized capacity of a business to produce goods or services. The computation of overhead absorption rates based on idle capacity is generally not recommended because it can result in over-absorption of overhead costs.

Maximum capacity- It is generally not recommended because it can result in under-absorption of overhead costs. Maximum capacity refers to the highest level of production or activity that a business can achieve in a given period, assuming all resources are fully utilized.

Practical capacity-  The level of practical capacity may change over time, as a business acquires new resources or implements process improvements. If the overhead absorption rates are based solely on practical capacity, they may not accurately reflect changes in the business's capabilities.

Hence, the correct answer is Normal capacity.