# Under-absorbed and Over-absorbed Overheads
## Definitions
- Under-absorbed OH: OH absorbed in production < Actual OH incurred → shortfall
- Over-absorbed OH: OH absorbed in production > Actual OH incurred → excess
## Why Under/Over Absorption Occurs
Wrong estimation of:
- Overhead expenditure
- Output levels
- Machine hours or Labour hours
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## Three Treatment Methods
### Method 1: Supplementary Rate (SR)
When to use:
- Amount of under/over absorption is large, AND
- Cause is normal (e.g., increase in labour rates, increase in material prices)
$$\text{SR} = \frac{\text{Amount of under/over absorbed OH}}{\text{Actual Base}}$$
| Situation | SR sign | Effect on cost of sales, FG stock, WIP |
|---|---|---|
| Under-absorption | Positive (+) | Increased |
| Over-absorption | Negative (−) | Reduced |
Rationale: SR retroactively corrects all cost records to reflect true overhead cost.
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### Method 2: Write Off to Costing Profit & Loss Account
When to use:
- Amount is not very high, OR
- Cause is abnormal (e.g., defective planning, strikes)
| Situation | Treatment |
|---|---|
| Under-absorbed OH | Transfer to Debit of Costing P&L |
| Over-absorbed OH | Transfer to Credit of Costing P&L |
Rationale: Abnormal variances should not burden product costs.
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### Method 3: Carry Over to Next Accounting Period
When to use:
- Normal business cycle extends to more than one year
Simply carry this year's under/over absorbed OH forward into the next year's accounting for absorption.
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## Decision Rule Summary
| Condition | Method |
|---|---|
| Large amount + Normal reason | Supplementary Rate |
| Small amount OR Abnormal reason | Write off to Costing P&L |
| Business cycle > 1 year | Carry over |
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## Supplementary Rate Calculation Example
Practical capacity = 2,120 hrs; Actual capacity = 1,800 hrs; Fixed OH = ₹5,30,000.
Idle capacity = 2,120 − 1,800 = 320 hrs
Idle capacity cost (ICC) = 5,30,000 × (320 / 2,120) = ₹80,000
This ₹80,000 can then be spread over actual output using a supplementary rate if the idle capacity arose from unavoidable reasons.