How to Treat the Under-absorbed Overhead in the Cost Accounts

Under-absorbed overhead means, budgeted overhead are less than actual overheads. We calculate actual overhead with recording of each overhead and we calculate budgeted overhead on the basis of machine hours expected and machine hour rate.

If overheads are under-absorbed, at that time, it is necessary to find the causes of this under absorption and then according to the reason, we treat under-absorbed overheads in cost accounts.

With following example, we try to make you understand about “how to treat the under-absorbed overhead in the cost accounts?”

Problem

In a factory, overheads of a particular department are recovered on the basis of Rs. 5 per machine hour. The total expenses incurred and the actual machine hours for the department for the month of august were Rs. 80,000 and 10,000 hours respectively. Of the amount of Rs. 80,000, Rs. 15000 became payable due to an award of the labor court and Rs. 5000 was in respect of expenses of the previous year booked in the current month (August). Actual production was Rs. 40,000 units, of which 30,000 units were sold. On analyzing the reasons, it was found that 60% of the under absorbed overhead was due to defective planning and the rest was attributed to normal cost increase. How would you treat the under-absorbed overhead in the cost accounts?

Solution

Total Actual expenses = Rs. 80,000

Less award of labor court – Rs. 15000

Less previous year expenses – Rs. 5000

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Balance actual expense = Rs. 60000

Less budget overhead

5 X 10000 = - Rs. 50,000

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Under- absorbed overhead = Rs. 10,000
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Treatment of under – absorbed overheads

60% of 10000 = Rs. 6000 will be debited to profit and loss account

40% X 10000= 4000 will distributed to finished goods and cost of sale

Total balance under-absorbed Rs. 4000

Unit produced Rs. 40000

Rate of under-absorbed per unit = 40000/4000 = Rs. 0.10 paise per unit

Under absorbed overhead charged on finished goods = Rs. 10000 (Closing stock) X 0.10 per unit = 1000 Rs.

Under absorbed overhead charged on cost of goods sold = Rs. 30000 X 0.10 p = Rs. 3000