• Profile photo of John Moffat says

      In management accounting, inventories are always valued at standard cost.

      With absorption costing, the standard cost includes fixed overheads – and this is the case here. There is nothing to adjust!

  1. avatar 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?

    Thank you for your patience.

    • Profile photo of John Moffat 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. avatar 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?

    A) 200 4400 (400) 3200
    B)(400) 4400 200 3200
    C)200 3200 (400) 4400
    D)(400) 3200 200 4400

    • Profile photo of John Moffat 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. avatar 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?

    Please clarify.


  4. Profile photo of 6shahir 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??

  5. avatar 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

    3. If Absorbed Overhead > Actual Overhead = Over absorption
    if Absorbed Overhead < Actual Overhead = Under Absorption

    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.

      • avatar 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!

  6. avatar 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,

    Absorbed overheads: Estimated overheads on actual output (etc.)
    Budgeted overheads: Estimated overheads on estimated output (etc.)
    Actual overheads: Self explanatory

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

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

    If Absorbed overheads>Actual overheads: Over-absorption occurs (Profits increase)
    If Absorbed overheads< Actual overheads: Under-absorption occurs (Profits decrease)

  7. avatar 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 ^^

  8. avatarTemperance 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?

  9. Profile photo of John 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.

    • Profile photo of John Moffat 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)

    • Profile photo of John Moffat 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)

  10. avatar 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

  11. Profile photo of zahidkhan2015 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???

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