Under and over absorption of overhead
The amount of overhead absorbed in costs is sum total of overhead cost allotted to individual cost units by application of overhead rates under the actual rate method, overhead cost are fully charged to production so that overhead absorbed in equal to overhead incurred.
Pre-determined overhead rate is calculated on the basis of budgeted overheads and this is applied to actual base. The amount absorbed may not be identical with the amount of overheads incurred it is called under absorption and in reverse condition it is called over absorption. This may happen due to error in esteeming expenses, error in estimating the base, major changes in methods of production and seasonal fluctuation of overhead.
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