over and under absorption of production overhead

Question

Over And Under Absorption of Production Overhead Costs

This may be analyzed beneath

a) Activity

This is level of the business or cost center. Expenditure on several items of production overhead costs will vary directly along with activity whereas others will be fixed irrespective of the changes in activity level. As an example, in a machine orientated, power cost and cost center will vary in proportion to machine hours where salary of the cost center manager will be fixed.

b) Level of expenditure on production overhead

Expenditure level might change from the budgeted level since of a change in the price of a change in the usage or an overhead item of the overhead item

c) Activity absorption and level of production overhead cost

In the table underneath the variable overhead absorbed per machine hour is constant as Shs.3 irrespective of the activity level. So the fixed overhead cost per machine hour depends on the activity level used as the base. If 100 machine hours are utilized, Shs.5 per machine hour should be charged in order to absorb the fixed overhead cost of Shs.500. and if 300 machine hours are utilized, Shs.1.67 per machine hour is an enough charge in order to absorb the net fixed overhead cost.

Diagram of Machining cost center

Activity level  Machine hrs	Total fixed  Overhead costs	Total variable  Overhead costs	Total overhead  cost	Average  Machine	Overhead  Hour	C ost per
Shs.	Shs.	Shs.	Shs.	Shs.	Shs.	Shs.
100	500	300	800	5.00	3.00	8.00
150	500	450	950	3.33	3.00	6.33
200	500	600	1100	2.50	3.00	5.50
250	500	750	1250	2.00	3.00	5.00
300	500	900	1400	1.67	3.00	4.67

Production overheads will be absorbed via jobs or products at the previously determined rater per machine hour.

If the real number of machine hours utilized differs from the number utilized in the computation of the overhead absorption rate, an over or beneath absorption will happen.

Note that this problem does not happen along with variable overheads as the incidence of the cost such like power cost varies along with changes in activity.