# Pre-determined Rate vs Actual Rate, and Under/Over Absorption
## Two ways to compute an absorption rate
| Formula | Timing | |
|---|---|---|
| Pre-determined Rate | Budgeted Overheads ÷ Budgeted Base Quantity | Set in advance, used during the period |
| Actual Rate | Actual Overheads ÷ Actual Base Quantity | Computed at year-end |
## Three overhead figures to keep straight
- Budgeted Overheads = Budgeted Overheads ÷ Budgeted Base Quantity (planning figure)
- Absorbed Overheads = Pre-determined Rate × Actual Base Quantity
- Actual Overheads = Actual Overheads ÷ Actual Base Quantity (what really happened)
## Why under/over absorption arises
Because we absorb using a pre-determined rate, the amount absorbed rarely equals the actual.
$$\text{Under / Over Absorption} = \text{Actual Overheads} - \text{Absorbed Overheads}$$
- Actual > Absorbed → UNDER absorption (too little charged to products)
- Absorbed > Actual → OVER absorption (too much charged to products)
## Treatment at year-end
At the year-end, the difference must be corrected in the cost sheet / cost ledger. Treatment depends on the cause:
```
Under / Over Absorption
│
├── Due to NORMAL price-level changes → PRODUCT cost
│ → Apportion to entire year's production using a Supplementary Overhead Rate
│
└── Due to INEFFICIENCY / ABNORMAL reasons → PERIOD cost
→ Transfer to Costing Profit & Loss A/c
```
## Supplementary Absorption Rate (for the normal/product-cost route)
When treated as product cost, the amount is spread across stocks and cost of sales using a supplementary rate.
Steps:
1. Apportion across the whole period's production using a supplementary rate.
2. $$\text{Supplementary Rate} = \frac{\text{Amount of under/over absorption}}{\text{Quantity Produced}}$$
3. $$\text{Quantity Produced} = \text{Qty Sold} + \text{Closing Finished Goods} + (\text{Closing WIP} \times \text{Degree of Completion})$$
4. Transfer the apportioned amount to:
- Quantity Sold → Cost of Sales A/c
- Closing Finished Goods → Finished Goods Control A/c
- Closing WIP → WIP Control A/c
## Journal entry (under-absorption, supplementary rate)
```
Cost of Sales A/c Dr
Finished Goods Control A/c Dr
WIP Control A/c Dr
Costing P&L A/c (period cost) Dr
To Production Overheads A/c
```