Cost and Management Accounting · Overheads - Absorption Costing Method

Under-Absorption and Over-Absorption of Overheads: Calculation and Treatment

Updated 4 October 2026 · Fact-checked

Under-absorption means overheads absorbed into production are less than actual overheads incurred. Over-absorption means absorbed overheads exceed actual. Compute: absorbed = predetermined rate × actual base; difference = actual − absorbed. Positive is under-absorbed, negative is over-absorbed. Then write it off to Costing P&L, or spread over cost of sales, WIP and finished stock.

Understand Under-Absorption and Over-Absorption of Overheads

Overheads cannot be known exactly when a job is costed. So you fix a predetermined overhead rate at the start of the period: budgeted overheads ÷ budgeted base (machine hours, labour hours, units and so on). You charge every job or unit at this rate.

At the end of the period you know the actual overheads and the actual base. The overhead charged to production is the absorbed overhead (rate × actual base). It will rarely equal the actual overhead incurred.

If absorbed is less than actual, you have under-absorption. Cost has been understated. If absorbed is more than actual, you have over-absorption. Cost has been overstated.

The usual causes are: wrong estimate of budgeted overheads, wrong estimate of the budgeted base (activity level different from plan), seasonal or unexpected changes in expenses, idle capacity, inefficiency, and errors in apportionment or in the choice of absorption base.

The difference is not left hanging. If the difference is small, or arises from abnormal causes (idle capacity, inefficiency and the like), write it off to the Costing Profit and Loss Account. If it is significant and due to normal or general causes, apportion it over cost of sales, work-in-progress and finished goods using a supplementary rate.

Key rules to remember

Predetermined overhead rate: Budgeted overheads ÷ Budgeted base (hours, units, etc.); Fixed before the period starts. Use the same base for budget and actual.
Absorbed overhead: Predetermined rate × Actual base; Use actual hours or units, not budgeted ones.
Under- or over-absorption: Actual overheads − Absorbed overheads; Positive = under-absorbed. Negative = over-absorbed.
Supplementary rate: Under- or over-absorbed amount ÷ Actual base of cost of sales, WIP and finished stock; Used when the difference is spread over stock and cost of sales.

How to solve Under-Absorption and Over-Absorption of Overheads questions

Follow the same order for any question on this topic.

1Identify the base given (machine hours, labour hours, units, % of prime cost) and note which figures are budgeted and which are actual.
2Compute the predetermined rate from budgeted overheads and budgeted base.
3Compute absorbed overheads: rate × actual base. For a percentage base, apply the percentage to actual prime cost or wages.
4Find actual overheads incurred. Add up all items if given separately and exclude items that are not overheads.
5Subtract: actual − absorbed. State clearly whether it is under- or over-absorption.
6Give the reasons, if asked, linking to the given data (activity lower than budget, expenses higher than budget).
7Show the accounting treatment: write off to Costing P&L, or apportion over cost of sales, WIP and finished goods, as the question requires.

Quickest way: Rate, absorb, compare

When to use it: For MCQs and for the first part of any written question.

MCQ: compute the rate, multiply by actual base, compare with actual overheads. If absorbed is lower, pick under-absorbed.
Under- or over-absorption = actual overheads − absorbed overheads, where absorbed overheads = rate × actual base. Do not use (actual base − budgeted base) × rate for this. That term is only the change in absorbed overhead from the budgeted overhead, so it is not the under- or over-absorption figure.
Written answers: show the rate working, absorbed amount, actual amount and the difference in four separate lines to earn step marks.
Write the word 'under-absorbed' or 'over-absorbed' next to the figure, and add one line of treatment.

Common mistakes in Under-Absorption and Over-Absorption of Overheads

Using budgeted hours or units to compute absorbed overheads.
The rate was computed from budgeted figures, so students keep using them.
Fix: Rate uses budget. Absorption uses actual base. Underline 'actual' in the question.
Reversing the sign and calling an under-absorption an over-absorption.
Students subtract absorbed from actual in one question and the opposite in another.
Fix: Always compute actual − absorbed. Positive means under-absorbed because actual cost was not fully recovered.
Including non-overhead items such as direct wages or interest in actual overheads.
The data lists many expenses together.
Fix: Include only the overhead items the question treats as part of the pool. Check each one.
Treating under-absorption as a gain or over-absorption as a loss in the Costing P&L.
Students confuse the effect on profit with the label.
Fix: Under-absorbed overhead is a debit (reduces profit). Over-absorbed overhead is a credit (increases profit).
Giving only a number and no reasons or treatment when the question asks for them.
Students stop once the computation is done.
Fix: Read the last line of the question. Add reasons and treatment in one or two lines each.

Worked examples

Example 1

A company budgets factory overheads of ₹6,00,000 and 1,20,000 machine hours for the year. Actual overheads are ₹6,30,000 and actual machine hours are 1,16,000. Compute the under- or over-absorbed overheads.

Show the solution

Predetermined rate = ₹6,00,000 ÷ 1,20,000 = ₹5 per machine hour.
Absorbed overheads = ₹5 × 1,16,000 = ₹5,80,000.
Actual overheads = ₹6,30,000.
Difference = ₹6,30,000 − ₹5,80,000 = ₹50,000. Actual exceeds absorbed, so it is under-absorbed.

Answer: Overheads under-absorbed by ₹50,000. This is debited to the Costing Profit and Loss Account.

Example 2

Budgeted overheads are ₹2,40,000 and budgeted direct labour cost is ₹3,00,000. Actual overheads are ₹2,50,000 and actual direct labour cost is ₹3,30,000. Of the actual direct labour cost of ₹3,30,000, cost of sales, WIP and finished stock carry ₹2,00,000, ₹30,000 and ₹1,00,000 respectively. Find the difference and show its distribution using a supplementary rate.

Show the solution

Rate = ₹2,40,000 ÷ ₹3,00,000 = 80% of direct labour cost.
Absorbed = 80% × ₹3,30,000 = ₹2,64,000.
Difference = ₹2,50,000 − ₹2,64,000 = −₹14,000, so over-absorbed by ₹14,000.
Supplementary rate = ₹14,000 ÷ ₹3,30,000 = 4.24% of direct labour cost (approx).
Cost of sales: ₹2,00,000 × 4.24% ≈ ₹8,485.
WIP: ₹30,000 × 4.24% ≈ ₹1,273.
Finished stock: ₹1,00,000 × 4.24% ≈ ₹4,242. Total ≈ ₹14,000 after rounding.

Answer: Overheads over-absorbed by ₹14,000. If spread, reduce cost of sales by about ₹8,485, WIP by about ₹1,273 and finished stock by about ₹4,242.

Exam tips

Read which figures are budgeted and which are actual before you start. Mark them on the question paper.
Show the rate, absorbed amount, actual amount and difference as separate lines. Examiners give marks for each.
If the question asks for the treatment, name both options: write off to Costing P&L, or spread over cost of sales, WIP and finished goods.
For reasons, tie them to the numbers given, such as lower activity than budget or higher expenses than budget.
Many MCQs ask only the direction. Check the sign before choosing.

Practice questions from Overheads - Absorption Costing Method

Under-Absorption and Over-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.

Under-Absorption and Over-Absorption of Overheads: frequently asked questions

How do you calculate over-absorbed overhead?

Compute the predetermined rate from budgeted overheads and budgeted base. Multiply by the actual base to get absorbed overheads. If absorbed is more than actual overheads, the excess is over-absorbed overhead.

What is the treatment of under-absorbed overheads?

If the amount is small or due to abnormal causes, transfer it to the Costing Profit and Loss Account. If it is due to normal causes and is significant, it may be spread over cost of sales, WIP and finished goods using a supplementary rate.

What are the reasons for under-absorption of overheads?

Common reasons are actual activity lower than budget, actual expenses higher than budget, wrong estimates of overheads or base, idle capacity, and errors in apportionment. Seasonal fluctuations and unforeseen events also cause it.

Does under-absorption increase or decrease profit?

It decreases profit in the costing records, because cost recovered through products was less than the cost incurred. The shortfall is charged to the Costing Profit and Loss Account.