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Why should we adjust under/ over absorption in the income statement ? Whether it is under/over absorbed we have already fixed a price and have bore the profit/loss. What is the point in adjusting it in income statement at the year end
The profit is the difference between the sales revenue and the actual cost.
Fixed overheads are absorbed based on the actual production and the standard cost – if the actual total fixed overheads are different (as is likely) then we need to make the adjustment.
Have you watched the free lectures on this? The lectures are a complete free course for Paper F2 and cover everything needed to be able to pass the exam well.
I have John. But i cant seem to understand the logic still. If the FOH are different why are we making an adjustment ? Absorption was did based on budgets . Why make an adjustment in actual ? what is the end effect ?
The amount absorbed is the actual number of units produced multiplied by the absorption rate (and the absorption rate was calculated using the budgeted production).
Suppose we budgeted on fixed overheads of $20,000 and budgeted on production of 5,000 units. The absorption rate would be $4 per unit.
Suppose we actually produced 6,000 units. Then we will have absorbed 6,000 x $4 = $24,000.
So even if the fixed overheads were budgeted correctly and actually are $20,000, we will have charged 24,,000 which is 4,000 too much – we will have over-absorbed $4,000 and therefore need to correct for it.
Oh thank you so much John. I was kind of ignoring the fact that we absorbed on the basis of actual activity level. Thanks a lot. Its clear now
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