Meaning and treatnment of under and over absorbed overheads

1. Overhead Rates…
Dr. Shruti Ganpule

2. Overheads are absorbed on the basis of
absorption rates
These rates are required for fixation of cost
of job, process or products
Rate = Amount of overheads absorbed /
quantity or value of base
The base may be units of products, direct
labour cost, labour hours, machine hours or
direct material cost.

3. Objectives
of
Overhead
rates
To facilitate absorption of cost units on a
logical basis.
To estimate overhead cost in advance of
production
To even out the fluctuations in the
overhead rates.
To facilitate quick computation of cost on
completion of production
To calculate cost of WIP easily.

4. Types of
OH rates
Actual Rate
Pre-
determined
rate
Blanket rate
Multiple rate

5. Actual Rate…
• Formula….
• Actual o/h rate = Actual overheads incurred during the period
Actual quantity produced during the period
• This rate can be calculated only after the accounting period is over.
• It causes delay in determination of cost.
• The actual volume of activity is affected by seasonal and cyclic factors.
• Actual rates do not provide any basis for cost control.

6. Pre Determined Rate….
• Formula…
• Predetermined rate = Budgeted overheads for the period
Budgeted Base for the period
• It facilitates computation of costs in advance.
• Quotations can be given in advance.
• It helps to prepare bills promptly.
• It is more helpful if budgetary control system is
followed.

7. Blanket Rate…
• This is the single and general overhead rate applicable to the whole
factory.
• Blanket or flat rate = Overhead cost for the entire factory
Total Quantity of the base selected.
• It is applicable when only one product is manufactured in a factory on
a large scale.
• It is also feasible where work performed by each department is
almost similar.

8. Multiple Overhead Rates…
• Overhead Rate = Overhead costs of each department
• Corresponding Base
• These are applicable where production lines are varied.
• These are also applicable where different types of machinery is used.
• If the conditions of the factory are not uniform.

9. Under / Over Absorption of Overheads
• This situation arises when pre determined rates of overhead
absorption are used.
• Under absorption:
• When the amount of overheads absorbed is less than the amount of
overhead incurred.
• In this case cost is understated as actual cost overheads recovered are
not fully recovered in in the cost of jobs, processes, etc.

10. Over Absorption of Overheads
• This situation arises when pre determined rates of overhead
absorption are used.
• over absorption:
• When the amount of overheads absorbed is more than the amount
of overhead incurred.
• In this case cost is overstated as actual cost of overheads recovered is
more as compared to actual overheads.

11. Reasons of over absorption & under absorption
• Faulty estimation of overhead costs
• Overheads incurred are either more or less than overheads absorbed.
• Faulty estimation of quantity of output.
• Seasonal fluctuation in the amount of overhead in certain industries.
• Unforeseen changes in the production capacity.
• Unexpected changes in the method of production affecting changes in the
amount of overhead.
• Non utilization of full capacity.

12. Difference between under and over absorption
Under absorption
• the amount of overheads
absorbed is less than the
amount of overhead incurred.
• Cost is understated
• There is positive supplementary
rate
• Under absorbed overheads are
to be added.
Over absorption
• the amount of overheads
absorbed is more than the
amount of overhead incurred.
• Cost is overstated.
• There is negative supplementary
rate
• Over absorbed overheads are to
be deducted.

13. Accounting treatment of disposal of under or over
absorption
• Supplementary Rate method:
• It is used when amount of under or over absorbed overheads is quite large.
• Under or over absorbed overheads are due to normal reasons.
• Supplementary Rate = Amount of under / over absorbed overheads
Actual Base
• In case of under absorption:
• The cost of sales, stock of finished goods and WIP are increased by applying
positive supplementary rate.
• In case of over absorption:
• The cost of sales, stock of finished goods and WIP are decreased by applying
negative supplementary rate.

14. Writing Off to Costing Profit & Loss a/c
• This method is usually used when…
• It is used when amount of under or over absorbed overheads is not large.
• Under or over absorbed overheads are due to abnormal reasons.
• The amount of under absorbed overheads is transferred to debit of
costing profit and loss account.
• The amount of over absorbed overheads is transferred to credit of
costing profit and loss account.

15. Carry over to next accounting Period Method..
• It is used when the period of normal business cycle is more than one
year and overhead rates are determined on a long term basis.
• In case of new projects, more output in the next period than that in
the initial period is expected.
• The amount of under absorbed overheads is transferred to debit of
overhead reserve or suspense account.
• The amount of over absorbed overheads is transferred to credit of
overhead reserve or suspense account.