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Unit 9: Absorption of Overheads

(b) To costing profit & loss account, the amount may be written off. Notes
(c) To the production, a supplementary rate may be worked out & applied.

Over and Under Absorption

Overheads are apportioned or allotted to cost units on an estimated basis. But it is quite natural
that the overhead so estimated may be different from the amount of overhead actually incurred.
Hence the question of under or over absorption of overhead arises when there is a difference
between the amount of overhead absorbed and the amount of overhead incurred.

Meaning of Under-absorption of Overheads

Under-absorption of overheads means that the amount of overheads absorbed in the production
is less than the amount of actual overheads-Incurred. For example if the overheads absorbed on
a predetermined basis are ` 1, 00,000 and the actual overheads incurred are ` 1, 20,000, there is
under-absorption to the extent of ` 20, 000.
It represents under stating the costs as the overheads incurred are not fully recovered in the cost
of jobs or processes, etc. Under-absorption is also termed as ‘under recovery’,

Meaning of Over-absorption of Overheads

Over-absorption of overheads means the excess of overheads absorbed over the actual amount
of overheads incurred. In other words when the amount absorbed is more than the expenditure
incurred due to expenses being less than the estimates it would mean over-absorption of
overheads. Usually over-absorption inflates the cost. Over- absorption is also formed as ‘over
recovery’.
For example the overheads recovered are ` 3, 00,000 and the actual production overheads are
` 2, 75,000 then there will be over-absorption of ` 25, 000. (` 3, 00,000 – ` 2, 75,000).

Reasons of Under/Over-absorption of Overheads

The under or over-absorption of overheads may arise due to any one or more of the following
reasons:

(i) Wrong estimation of overhead expenses: The actual overhead expenses may be substantially
less or more than the estimated amount.
(ii) Wrong estimation of work done: The amount of work done may greatly exceed or may be
substantially less than the estimated work. For example if actual work is 8,000 working
hours against estimated working hours of 10,000, then the expenses charged to job will be
20% less.
(iii) Error in using method of absorption: Sometimes the method of absorption may not be
suitable. If the percentage of direct material method is used, fluctuation in prices of material
may lead to under or over-absorption of overheads.
(iv) Seasonal fluctuation in overhead: Due to seasonal nature of work, overhead may fluctuate
from one period to another period.

(v) Under or over utilization of capacity: There may be under or over-absorption of overhead
due to under or over utilization of productive capacity.
(vi) Wrong estimation of output: When the actual output substantially differs from the
anticipated output, it leads to under or over-absorption of overheads.

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