Page 80 - BA2 Integrated Workbook STUDENT 2018

Chapter 4

Over and under absorption

6.1 Predetermined overhead absorption rates

Overhead absorption rates are usually predetermined, that is, they are calculated in
advance of the period over which they will be used, using budgeted or expected
costs and activity levels.

 Overhead costs are not incurred evenly throughout the period. The actual
overhead rate per hour or per unit will therefore be subject to wide fluctuations.

 If the actual rate was used in product costing, then product costs would also
fluctuate wildly. Such product costs would be very difficult to use for planning
and control purposes.

 Fluctuations in the actual level of production would also cause the same
problem of fluctuating product costs. It would be unrealistic for a company to
change its selling price regularly in line with the changes in production costs.

 Managers have an overhead rate permanently available which they can use in
product costing, price quotations and so on. The actual overhead costs and
activity levels are not known until the end of the period.

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