Management Accounting · Absorption and marginal costing

Over and Under Absorption of Overheads: How to Calculate and Treat Them

Updated 11 October 2026 · Fact-checked

Over or under absorption is the difference between overheads absorbed into production and actual overheads incurred. Absorbed = actual activity × predetermined rate. If absorbed is higher than actual, overheads are over absorbed and profit rises. If absorbed is lower, they are under absorbed and profit falls.

Understand Over and Under Absorption of Overheads

In absorption costing, you cannot wait until the year ends to know the true overhead cost of each unit. So you set a predetermined overhead absorption rate before the period starts. You divide budgeted overheads by budgeted activity (for example, machine hours or labour hours).

During the period, you charge each job or unit using that rate and the actual activity. The total charged is the overhead absorbed. It is only an estimate.

At the end of the period, you compare it with the actual overhead incurred. They are almost never equal. Actual spending may differ from budget, and actual activity may differ from budget.

If you absorbed more than you spent, you have over absorbed. Costs were overcharged to products, so you must reduce costs in the income statement. If you absorbed less than you spent, you have under absorbed. Costs were undercharged, so you add the shortfall as an extra expense.

The adjustment goes through an overhead control account or directly in the income statement. It is normally treated as a period adjustment, not added to inventory values.

Key formulas to remember

Predetermined absorption rate: Rate = budgeted overheads ÷ budgeted activity; Set before the period. Activity is usually labour hours, machine hours or units.
Overhead absorbed: Absorbed = actual activity × predetermined rate; Use actual hours or units, not budgeted.
Over/under absorption: Absorbed − actual overhead incurred; Positive = over absorbed. Negative = under absorbed.
Income statement adjustment: Under absorbed: deduct from profit. Over absorbed: add to profit.; Under absorption is an extra cost. Over absorption is a credit.

How to solve Over and Under Absorption of Overheads questions

Use this order for any over or under absorption question. It keeps the budget figures and actual figures apart.

1Find the budgeted overheads and budgeted activity.
2Calculate the rate: budgeted overheads ÷ budgeted activity.
3Find the actual activity for the period.
4Multiply actual activity by the rate to get overhead absorbed.
5Find the actual overhead incurred.
6Subtract: absorbed − actual. A positive answer is over absorbed. A negative answer is under absorbed.
7State the effect on profit: over absorbed increases profit, under absorbed reduces profit.

Quickest way: Absorbed minus actual, then label

When to use it: Use this in Section A objective questions when the rate or the figures are given and time is short.

Write only two numbers: absorbed and actual.
If the rate is not given, calculate it from the budget first.
Subtract actual from absorbed.
If the sign is plus, write over absorbed. If minus, write under absorbed.
Check the answer type: number entry needs the amount only, multiple choice needs the label too.

Common mistakes in Over and Under Absorption of Overheads

Using budgeted activity instead of actual activity to calculate overhead absorbed.
The rate was built from budgeted activity, so students keep using it.
Fix: Budget figures are for the rate only. Absorbed always uses actual activity.
Mixing up over and under absorption.
Students compare in the wrong direction (actual − absorbed).
Fix: Always do absorbed − actual. Plus is over absorbed. Minus is under absorbed.
Getting the profit effect backwards.
Over sounds like a bad thing, so students deduct it.
Fix: Over absorbed means costs were overcharged, so profit is increased. Under absorbed reduces profit.
Using actual overheads to calculate the rate.
Students see the actual figure first in the question.
Fix: The rate is predetermined. Use budgeted overheads ÷ budgeted activity.
Leaving the difference out of the final profit figure.
The adjustment is a separate step after cost of sales.
Fix: Always finish by adjusting profit for the over or under absorption, if the question asks for profit.

Worked examples

Example 1

A company budgets overheads of $240,000 and 40,000 machine hours. Actual overheads were $252,000 and actual machine hours were 41,000. Calculate the over or under absorption.

Show the solution

Rate = $240,000 ÷ 40,000 = $6 per machine hour.
Absorbed = 41,000 × $6 = $246,000.
Actual overhead incurred = $252,000.
Absorbed − actual = $246,000 − $252,000 = −$6,000.

Answer: Overheads are under absorbed by $6,000, so profit is reduced by $6,000.

Example 2

A firm budgets fixed overheads of $90,000 and 18,000 labour hours. Actual overheads were $88,000 and 19,000 labour hours were worked. Reported profit before adjustment is $50,000. Calculate the adjusted profit.

Show the solution

Rate = $90,000 ÷ 18,000 = $5 per labour hour.
Absorbed = 19,000 × $5 = $95,000.
Actual overhead = $88,000.
Absorbed − actual = $95,000 − $88,000 = $7,000 over absorbed.
Over absorption increases profit: $50,000 + $7,000 = $57,000.

Answer: Overheads are over absorbed by $7,000, so adjusted profit is $57,000.

Exam tips

Write the rate first. Most wrong answers start from a wrong rate.
Read whether the question gives actual hours or budgeted hours. Use actual hours for absorbed overhead.
In multiple response questions, check both the label (over or under) and the profit effect.
For number entry, check whether you should enter a positive amount. The label is usually in the question wording.
If the question asks for profit, apply the adjustment to the profit given, not to cost per unit.

Practice questions from Absorption and marginal costing

Over and Under Absorption of Overheads in other exams

The same ground in other exams, if you are preparing for more than one or want another angle on it.

Over and Under Absorption of Overheads: frequently asked questions

How do you calculate over and under absorbed overheads?

Calculate overhead absorbed as actual activity × predetermined rate. Then subtract actual overhead incurred. A positive result is over absorbed and a negative result is under absorbed.

What is the journal entry for under absorbed overheads?

Under absorption is an extra expense. Debit the income statement and credit the overhead control account. For over absorption, the entries are reversed: debit the overhead control account and credit the income statement.

What is the difference between budgeted and actual overhead absorption?

Budgeted figures are used to set the rate before the period starts. Actual activity is used during the period to absorb overhead into products. The difference between absorbed and actual overhead is then reported.

Why do over and under absorption happen?

They happen because the rate is set in advance. Actual overhead spending can differ from budget, and actual activity can differ from budgeted activity. Either difference can cause the totals not to match.