Absorption Costing

Over/under absorption only applies to fixed production overheads. In the standard cost card, we absorb based on the expected overheads and the expected production. In the example in the Lecture Notes (and usually in practice) we take the expected average overheads per month divided by the expected average production per month to arrive at the fixed overheads per unit. Obviously, whether we are looking at actual results or we are preparing monthly budgets, the production is likely to vary from month to month. In the example in the notes we are preparing monthly budgets and because the budgeted production is higher or lower than average, the amount absorbed will be higher or lower, even though the total fixed overheads (by definition) should stay constant. Therefore we need to adjust for the over or under absorption to arrive at the correct budgeted profit.

Right, right,right.. So the principle under absorption costing is the same, i.e fixed production OHs no matter will remain Fixed and will not vary? Am i right ?????

Almost, but be careful. Fixed production overheads do not change with the level of production. (They can change for other reasons - for example, the rent of the factory is a fixed cost, but the person we rent from might increase the rent.) In the exam you assume the total does not change, unless specifically told different. But the important thing is that it will not change simply because production level changes.

Alright. Thankyou!

You are welcome :-)