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Dear Sir,
Once again I am asking for your help please.
A company uses absorption costing with a predetermined hourly fixed overhead absorption rate. Last year, the following situations arose:
1.Actual overhead expenditure was less than the budgeted expenditure.
2.Actual hours worked were less than the budgeted hours used to set the predetermined overhead absorption rate.Which of the following statements is correct?
1.Both situations would cause the overheads to be under absorbed
2.Both situations would cause the overheads to be over absorbed
3.Situation (1) would cause the overheads to be under absorbed and situation (2) would cause the overheads to be over absorbed
4.Situation (1) would cause the overheads to be over absorbed and situation (2) would cause the overheads to be under absorbedAnswer is option 4
I understood the first situation and how it causes over absorption but I am having a hard time understanding the second situation where the result is under absorption.If you could please explain using some simple figures, I would be so so grateful.
Thanking you in advance
Suppose overheads are $100,000 and budgeted production was 20,000.
Then overheads are absorbed at 100,000/20,000 = $5 per unit.Suppose actual production is only 15,000 units. Then the overheads absorbed will be 15,000 x $5 = $75,000. But overheads should be still $100,000. So they have been under-absorbed.
For more examples you should watch the free lecture on absorption costing.
Thank you for bringing this question up Mel and sorry for commenting here.
Dear Sir, as per my understanding in situation 1 it means that budgeted expenditure being more than actual overhead expenditure will be considered over absorbed right? and does this rule apply everywhere? i seem to confuse myself with how to identify this. i have gone through the lectures too.
Mel was only asking about situation 2.
However, in situation 1 it is correct that if actual expenditure is less that budgeted, then (on its own) it would result in the overhead being over-absorbed.
The amount absorbed uses the absorption rate which is calculated using budgeted figures.
Thank you Sir for your help.
I will rewatch the lectures. 🙂
And Ruksar, I know how confusing all this can be. One minute I seem to understand all the variances, the other I am completely lost.
Good luck and thanks again Mr Moffat for the great help.
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