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Good day, Sir Moffat.
I have a question regarding under and over absorption of overheads:
A business absorbs its fixed production overhead on the basis of direct labour hours. The budgeted direct labour hours for week 24 were 4,200. During that week 4,050 direct labour hours were worked and the production overhead incurred were $16,700. The overhead was under-absorbed by $1310.
The budgeted fixed overhead for the week (to the nearest $10) was $______.
Answer: $15,960
Solution: $16,700 – $1,310 = $15,390OAR = 15,390/ 4,050 = $3.80 per hour
Budgeted fixed overhead = 4,200 x $3.80 = $15,960My question is, why did we divide 15,390 with 4050 instead of 4,200, since 4,200 is the budgeted labour hours worked? If you could explain the entire solution in detail, I would be most thankful 🙂
Thank you in advance, Sir Moffat! God bless 🙂
The amount absorbed/charged in the profit statement is always the actual hours worked multiplied by the absorption rate.
We know what the overheads absorbed are (15,390), and since this is the actual hours x the absorption rate, the absorption rate is 15,390 / 4,050.
My free lectures on absorption and marginal costing will help you.
hi
It is clear but how do I differentiate when to divide on actual activity and when not? I am asking because I did something similar test and don’t understand why we in one case divide on actual activity and another one on budgeted activity?
thanks in advance
The absorption rate is calculated on the budgeted activity. The amount absorbed is the actual activity charged at the standard absorption rate.
If you are referring to questions in your BPP Revision Kit, then tell me which question(s) and I will explain.
I am using the Kaplan version.
for example, see this one..
“The following data relate to Lola Ltd for Period 9.
Budget Actual
overheads $148,750 $146,200
Machine hours 8,500 7,928Overheads were under/over* absorbed by
*delete as appropriate ”my answer:
OAR = Overheads / Machine hours = 148,750 / 8500 = 17,5 per machine hour
Then this figure I multiplied by the actual MACHINE HOURS…
Overhead absorbed – >17.5 X 7928 = 138,740
Actual overhead -> 146,200
Under-absorbed -> 7460 (146,200-138,740)Here I am divided with budgeted activity, not with actual activity. But in the above case, it is the opposite and it confuses me.
I do not have Kaplan books (only the BPP Revision Kit). However on what you have typed, your answer is correct – there is an under-absorption of $7,460.
If the Kaplan answer is different then it would seem that they have made a mistake.
(And I don’t understand what you have written about it being the opposite.)
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