# The Management Accountant’s Profit Statement – Absorption Costing part b

1. says

Hi Sir, I am confused on the 2 examples for over/under absorption.
In example 1 when calculating the adjustment for Fixed Overheads, you compared the amount absorbed \$22000 and budget total \$20000 to arrive at the over-absorbed amount of %2000
In example 2, when calculating the adjustment for Fixed Overheads,, the amount absorbed \$312000 is compared to the actual total for April which is \$315500 to obtain \$3500

However, if I were to do example 2 with respect to example 1, I would be comparing the amount absorbed, \$312000 with the budgeted total of \$320000 to obtain the answer of \$8000.

So my question is, what is the difference between example 1 and example 2 at this step and why do I use \$315500 instead of \$320000?

• says

We compare the actual overheads with the amount absorbed.
In example one the amount absorbed is \$22,000. We are not told the actual overheads and therefore we have no choice but to assume that they are the same as the budgeted amount of \$20,000 (in practice, obviously the actual overheads could be different, but the question asks for budget profit statements. We would therefore be budgeting on them remaining at \$20,000 because by definition they would not be expected to change because of the level of production).

In example 2, the amount absorbed is \$312,000 and we are specifically told that the actual overheads are \$315,500. If we had been preparing a budgeted statement, then we would obviously not at that stage no what the actual overheads would be and in that case we would have (as in example 1) had no choice but to have assumed for budget purposes that they stayed at \$320,000

2. says

can u help me out with this question?

production: month 1= 3900 units
sales: month 1= 3800 units
opening inventory month 1= 400 units

production month 2= 4400 units
sales month 2= 4200 units

profits/losses have been calculated for each month using absorption/marginal costing principles. which of the following combinations of profits and losses for the two months is consistent with the above data?

ABSORPTION COSTING PROFIT/LOSS ABSORPTION COSTING PROFIT/LOSS
MONTH 1 MONTH 2 MONTH 1 MONTH 2
A) 200 4400 (400) 3200
B)(400) 4400 200 3200
C)200 3200 (400) 4400
D)(400) 3200 200 4400

• says

In future please ask questions in the Ask the Tutor forum rather than as a comment on a lecture.

This question does not ask you to calculate the exact profits – that is not possible here. What is want to know is which combination of profits is possible.

In month 1 production is more than sales, so inventory will increase, so absorption will give the higher profit. That should now give you the way of solving it

3. says

Hi John

As I was watching video lecture, you mentioned about the rule we should remember for Absorption Costing; Sales – adjustment for over/under absorption fixed overhead then we would be able to find out the correct Gross Profit, isn’t it we need to calculate the sales to standard profit before the adj. for over/under absorption fixed o/head then the Gross Profit?

Thanks

• says

Hi John,

Ooops…I just realised that you are correct because you have mentioned sales x standard profit per unit. Ignore me.

Jefzen2610

4. says

Hi Jon,

Just out of curiosity, this online tutorial is free, therefore how do you make your money from this, are you the sole owner of this online tutorial?

• says

It is not just this tutorial – we have free lectures on all topics for all papers. We do not do it to make money. It is the advertising revenue that helps cover the costs of running the website.

5. says

Sir, predetermined OAR=Budgeted overheads/Budgeted activity levels
Fixed Production OAR=Budgeted fixed production overheads/budgeted production
What is the difference between these two, Are they same??

6. says

Hello Mr Moffat,

Please will i be right if write and use the following formulas for easy remembrance during the exam?

1. Overhead Absorption Rate (OAR) = Budgeted Overheads divided by Budgeted Activity level (ie no of hours, no of units, etc)

2. Absorbed Overheads= OAR X Actual Activity Level

4. Under absorption overstates profits so it is deducted from the profits in the income statement

5. Over absorption understates profits so it is added to the profits in the income statement.

Knowing this, will I be able to answer any questions under this topic or is there a part i have missed out or is there a way the question can be asked that i wouldnt be able to use any of the above approaches?

Is this right please? This will help make me more comfortable and confident with this topic.

• says

Yes – everything that you have written is correct.

(But don’t take the formula to the exam with you or you will be banned!!)

• says

Thank you very much for your confirmation. Makes me more relaxed and confident. I will not take the formula to the exam with me because I do not want to get banned.

Next Chapter

Thank you once again!

7. says

Sir, you are a prince among men. I had a lot of trouble understanding absorption costing, but now the concept is crystal clear to me. Do correct me, but based on my comprehension,

By etc. I mean any other level of activity eg. labor hours worked, machine hours and so on

Absorbed overheads= Budgeted OAR x Actual output (etc.)
[The reason for doing so is to check whether we have overcharged or undercharged in our estimates with respect to the actual overheads].

• says

And all credits goes to you sir! By the way sir, I scored 94 on my FA1 Test (Recording Financial Transactions) but only a measly 78 on my MA 1 Test (Management Accounting). I will try to work harder sir. Thank you for being the savior to ALL CAT and ACCA students around the globe. You’re a superhero!

• says

That is great – many congratulations

8. says

@John Moffat

sir, when doing process costing, if there is no value given for normal loss, is there a method for calculating this value and if yes, how do we calculate it??

i just know that the value should already be given in the question ^^

• says

If no value is given then you assume that there is no sale value and so the value is zero.

(Please ask this sort of question in the F2 Asl the ACCA tutor forum – not under a lecture on something different)

• says

thank you sir..

yeah.. ok

9. Temperance says

@John Moffat

H Sir, I’m just trying to understand the concept of under and over absorption.

Is it that an under absorption occurs when the amount absorbed is less than the actual overhead incurred?

And an over absorption occurs when the amount absorbed is greater than the actual overheads occurred?

10. says

Sir can I ask for your help please. I have a problem regarding the difference in eg1 and eg2:

Why do you say in eg1 “adjustment for fixed overheads = amount absorbed – BUDGET total” [at 05:30 in the lecture], and yet in eg2 it is the “amount absorbed – ACTUAL total” [at 27:05 in the lecture]? Surely as we used the budgeted amount of 20000 in eg1 then the budgeted amount of 320000 should be used in eg2? Have I missed something?

Many thanks.

• says

Firstly, we always calculate the absorption rate using budget figures – so in example 1 the absorption rate is \$2 per unit, and in example 2 the absorption rate is \$4 per hour. I guess that you are happy with that.

With absorption costing, every unit or hour is effectively charged (absorbed) at this absorption rate which is why we may have over or under absorption (because the amount absorbed is different than the amount it should be).

The difference between the two examples is that in example 1 we are asked to prepare budget profit statements – so we are comparing the amount absorbed with what the total budget fixed overheads should be; but in example 2 we are not asked to prepare a budget statement, we are told what the actual overheads are and so we are comparing the amount absorbed with the actual total fixed overheads.

(You will see when we come to variance analysis in a later chapter that we can split the over/under absorption between the difference between absorbed and budget figure, and the difference between actual total and budget total – but don’t worry about that yet )

Hope that helps.

(PS I have a feeling that you asked this before and that I did not answer. If so, then sorry – I was away last week and it was difficult for me to check things)

11. says

Hello Moffat,could you please explain why we add the over absorption yet deduct the under absorption from the standard Gross profit? i am confused a bit!

• says

Over absorption means that the fixed overheads have been over absorbed – i.e. that we have charged more fixed overheads than we should have.
To correct it means that the fixed overhead cost should be lower, which means that the profit should be higher.
(vice versa when we have under-absorbed (or under-charged) we have not charged a big enough expense, so more expense means that the correct profit should be lower)

• says

Thank you very much Moffat. Got it straight and clear…

12. says

Mr John, i don’t understand how you got 2000 for the fixed cost under the heading selling costs and as it is under-absorbed, why did you reduced it from the gross profit ? i thought it was 1000 and must be added to the gross profit

• says

The question says that the fixed selling cost is 2,000.

Selling costs are never over or under absorbed, because it is only production costs that are absorbed into the unit cost.

13. says

these r the toughest chapters for me in f2 absorption/marginal costing,,,,,,hw can i b gud in these chapters,,im going to attempt CBE in the next few days,,,any tips 2 b gud at these chapters n for passing f2 plzzzzzz???

• says

Although it is important that you understand what is happening, you only really need to know a couple of rules to be able to answer most of the exam questions on this.
Have a look at the F2 Revision Notes and lectures on here and it might help.

Otherwise there is no alternative but to keep practicing questions!!