- February 9, 2020 at 11:09 am
Dear sir Hi, please help me with the following.
Sir..under/over absorption is the difference between absorbed foh and actual foh cost and foh are absorbed in actual produtuon on the base of estimated absorption rate. This under/over absorption variance is then adjusted in income statement.
My questions are as follow:
Q. 1 Why over/under absorption whole variance is adjusted in cost of units sold to make it actual cost of sales whereas absorption was made on actual production not on the sales.
According to my point of view, under/over absorption variance should be divided in to two parts. One part will be adjusted in cost of sales and the other part will b adjusted in closing stock which will be carried forward in balance sheet.
Please explain this concept. I’ll be gratefulFebruary 9, 2020 at 10:58 pm
Overheads are always absorbed on fhe basis of budgeted costs and budgeted output. Actual costs and output will not be known until year end yet you might ned to value inventory at the end of each month. Therefore, all over/under absorption is taken to profit and loss so that inventory is left with only its constant, budgeted fixed cost per unit.February 10, 2020 at 12:17 pm
But sir under/over absorption variance is calculated at the end of a period so we could divide it in two parts. One part should be absorbed on units sold and remaining should be in closing invenotry to transfer it on actual/real cost per unit.
Why we don’t do this? In the way u told the inventory value in balance sheet will not be on real cost it would be on budgeted cost/unit sir.
Please explain a little more.
I’ll be grateful
Thank u for ur kind response.February 11, 2020 at 6:43 am
It could be done like that but isn’t. Overheads are absorbed using a fixed absorption rate based on a normal level of activity.
1 This means that all production during the year has the same OH content. It would be odd if production in inventory at the year-end had a different OH content per unit than production made and sold during the year.
2 What if only 1 unit was made during the year instead of the planned 1,000? If that unit was still in inventory should its cost include the whole amount of production overheads? More logical to say it contains the planned 1/1000 of overheads and to write off the other 999/1000 as underabsorbed – effectively wasted because production was so low.
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