Under and Over Absorption of Overhead

 

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.

 

Dr.Sucheta Dalvi 

Asst. Prof. T J College, Khadki

under SPPU, Pune 

 

 

 

                         

 

 

x