# Under and Over Absorption of Overheads
When overheads are charged to products using a pre-determined (budgeted) overhead rate, the amount recovered through production is rarely equal to the actual overheads incurred. The gap between OH recovered and actual OH creates either under-absorption or over-absorption.
## Formula
- OH Recovered = Budgeted OH Rate × Actual Units (or actual base)
- Under-absorption = Actual OH > OH Recovered (shortfall not charged to production)
- Over-absorption = Actual OH < OH Recovered (excess charged to production)
## Treatment of Under/Over-Absorbed Overheads
Three alternative treatments are available:
### 1. Adjust against Costing Profit & Loss (decrease/increase profit)
The entire under/over absorbed amount is written off to the Costing P&L of the current period.
### 2. Use a Supplementary Rate (find out reasons)
The overheads are re-distributed to cost units depending on whether the under-absorption arose from normal or abnormal reasons:
| Reason | Cause | Treatment |
|---|---|---|
| Normal | Increase in prices, normal variations | Transfer to Cost of Sales, Finished Goods stock and WIP stock using a Supplementary Rate |
| Abnormal | Strikes, floods, fires, idle capacity | Transfer entirely to Costing P&L |
Supplementary Rate formula:
$$\text{Supplementary Rate} = \frac{\text{Total Overheads Under-absorbed}}{\text{Units Sold} + \text{FG Stock} + \text{Equivalent units in WIP}}$$
### 3. Carry Forward to Next Year
The amount is carried forward by way of a deferred charge / credit account (used when the variance is expected to be offset in subsequent periods, e.g. seasonal businesses).