Q5. Explain the treatment of over and under absorption of overheads in cost accounts.

Expert Solution

Answer : Overhead expenses are usually applied to production on the basis of pre-determined rates. Production overheads are to be determined in advance as follows for fixing selling price, quote tender price and to formulate budgets etc.

Pre determined overhead rate =

Estimated/Normal overheads for the period

Budgeted Number of units during the period

The actual overhead rate will rarely coincide with the pre-determined overhead rate, due to variation in pre-determined overhead rate and actual overhead rate.

The amount of over-absorption being represented by a credit balance in the account and the amount of under-absorption being a debit balance.

In general view, if the balances are small they should be transferred to the Costing Profit and Loss Account and the cost of individual products should not be increased or reduced as these would be representing normal cost.

However, If the absorbed overheads at predetermined rates are greater than actual overheads, this is known as OVER-ABSORPTION. Conversely, if absorbed overheads are less than the actual overheads, this is known as UNDER-ABSORPTION.

Therefore the supplementary rate is :

Amount of Under or Over Absorption

Actual Absorption base

ekkarill92 answered 2 years ago

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