Over Under Absorption Overheads

Where overheads are charged to different cost unit on the basis of a predetermined overhead rate, at the end of the accounting period the total overheads charged will be roughly equal to actual overheads incurred during that period. In case the amount of overheads recovered from production is more than the actual overheads, there is said to be “over absorption of overheads”. In a reverse case it is termed as “under-absorption of overheads”. The under-recovery or over-recovery may be on account of any one or more of the following reasons:
    
(i) Wrong estimation of overhead expenses.
    
(ii) Wrong estimation of output or hours to the worked.
    
(iii) Under or over-utilization of production capacity.

Disposal of under or over-absorption of overheads

Any of the following methods may be adopted for disposal of under or over-absorption of overheads, depending upon the circumstances:
    
1. Carrying over of overheads

The amount of under or over-absorbed overheads may be carried over to the next period in the following circumstances:
    
(a) In case of seasonal factory, the balance of overheads for a period (month, quarter or half-year) may be carried forward to the next on the presumption that it will be counter-balanced at the end of the accounting year.
    
(b) In case of business where output is affected by business cycles and overhead rate has been pre-determined for a period of more than one year, the balance of a year may be transferred to next year’s accounts and so on.
    
2. Use of supplementary rate

In case it is observed that the actual and absorbed overheads cannot coincide and the difference is quite large, a supplementary rate may be found out. The cost of each job, order or process may be adjusted by applying this supplementary rate.  The rate may be calculated as follows:


    
3. Transfer to costing profit and loss account

In case the different between actual or absorbed overheads is not very large or the difference is due to abnormal circumstances, such difference should be transferred to the costing profit and loss account at the end of the accounting year.

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