CAT / FIA FMA Syllabus C. Cost Accounting Techniques - Under and over absorption of overheads - Notes ^{22 / 23}

If we absorb MORE overheads than we should have, this is known as over absorption

If we absorb LESS overheads than we should have, this is known as under absorption

Overheads absorbed = OAR x actual level of activity

1. Over-absorption (over-recovery) = Overheads absorbed is MORE than Actually Incurred

2. Under-absorption (under-recovery) = Overheads absorbed is LESS than Actually incurred

Solution

1. Step 1: Calculate OAR

   OAR = Budgeted fixed overheads / Budgeted machine hours
   OAR = $120,000 / 30,000 hours = $4 per hour

2. Step 2: Calculate the Overheads absorbed
    
   = Actual machine hours worked x OAR
   = 31,000 x $4 per hour = $124,000

3. Step 3: Is it over or under-absorbed?

   Overheads absorbed - Actual fixed overhead incurred
   $124,000 - $125,000 = $1,000 under absorption 

   (because we absorbed $1,000 LESS than was actually incurred)