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Chapter 7

Under and over absorption

5.1 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.

5.2 Under or over absorption

The problem with using predetermined overhead absorption rates is that the actual
figures for overhead and for the absorption base are likely to be different from the
estimates used in calculating the absorption rate.

At the end of the period, the company must determine if it has absorbed too much or
too little overhead into the products. Two things could have changed during the
period:

 The amount of the overhead could be more or less than was budgeted.

 The quantity of the absorption base (units/labour hours/machine hours) could
have been more or less than budgeted.

It is these differences which cause an under- or over-absorption of production
overheads.

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