Under
Absorption and Over Absorption of Overhead
Over
absorption of overhead – when the actual overhead
incurred are less than the overhead
absorbed it is known as over absorption of overhead
Under
absorption of overhead- when the actual overhead incurred
are more than the overhead absorbed
it is known as under absorption
ICMA London defines
overhead under or over absorption as “The difference between the amount of
overhead absorbed and the amount of overhead incurred”
Reasons
of under and over absorption of overhead
1.
When
overhead incurred is more or less than the estimated overhead
2. When actual hours
are more or less than the budgeted hours
3. When actual output
is more or less than the budgeted output
4. Non- recurring
nature of expenses may be incurred during that year
5. Fluctuation in the volume of production due to the trade cycle
6. Mistakes in
determination of overhead rate due to faulty estimation of overhead expenses
7. Seasonal
fluctuations in the level of production
8. underutilization of
the available capacity
9. Changes in the
techniques and methods of production
Accounting
treatment of under and over absorption of overhead
1.
Use
of supplementary rate
2. Write off to costing
profit and loss account
3. Carry forward to the
next year’s account
1. Use of supplementary rate - The amount of over absorbed overhead is
adjusted to finished goods, work in progress, factory cost of sales by
supplementary rates.
These
supplementary rates are of two types
a) Positive
supplementary rate
b) Negative
supplementary rate
The amount of under
absorption is adjusted by adding it to the job with the help of positive
supplementary rates. If there is over absorption the same is to be deducted
through a negative supplementary rate. A positive rate is applied when there is
an under absorption and the negative rate is applied when there is an over
absorption.
Supplementary
rate = amount of under or over
absorption
Base
Applied
This
supplementary rate is applied when the amount of under or over absorption
overhead is abnormally high. If the difference is small then it can be ignored.
2.
Write off to costing profit and loss
account
If
the under or over absorption is not due to seasonal fluctuations of not
deliberate or the amount is small then it can be written off to costing profit
and loss account at the end of the year.
3.
Carry forward to the next year’s account
In
this method, the balance of under or over absorption overhead is transferred to
an overhead reserve or suspense account and it is carried forward to the next
year’s account for absorption.
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