Over or under absorption of overheads meaning:
Overhead expenses are usually applied to production on the basis of predetermined rates. The pre-determined rate may present estimated or actual cost. The actual overhead cost incurred and overhead applied to the production will seldom be the same. But due to certain reasons the difference between two may arise.
If the amount applied exceeds, the actual overhead, it is said to be an over absorption of overheads.
If the amount applied is short fall of the actual overhead in production it is said to be the under absorption of overheads.
The over or under absorption of overheads may be termed as overhead variance.
Reason of over or under-absorption of overheads:
The under or over-absorption of overhead arises due to following reasons:
- Errors in estimating overheads.
- Overhead may change due to change in method of production.
- The seasonal fluctuation in overhead cost in some industries.
- Under utilization of available capacity, unexpected change in the volume of out put.
- Valuation of work in progress in wrong process.