Why Under or over absorbtion of overhead happens?

Under-/over-absorbed overhead occurs when overheads incurred do not equal overheads absorbed.

Rate of overhead absorption is based on estimates (of both numerator and denominator) and it is pretty likely that either one or both of the estimates will not agree with what actually occurs. Actual overheads incurred will probably be either higher than or lower than overheads absorbed into the cost of production, and so it is almost unavoidable that at the end of the accounting year there will have been an over absorption or under absorption of the overhead actually incurred.

• Over absorption denotes that the overheads charged to the cost of sales are larger than the overheads actually incurred.

• Under absorption denotes that insufficient overheads have been included in the cost of sales.

The causes for under-/over-absorbed overhead The overhead absorption rate is predetermined from budget estimates of overhead cost and activity level.

Under or over recovery of overhead will happen in the following situations.

• Actual overhead costs and actual activity level differ from those budgeted.

• Actual overhead costs are different from budgeted overheads.

• The actual activity level is different from the budgeted activity level.
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