Skip to content

Cost Accounting · Overheads

Under and Over Absorption of Overheads: Causes and Treatment

Updated 10 October 2026 · Fact-checked

Under absorption means overheads absorbed in cost are less than actual overheads incurred; over absorption means they are more. Absorbed overhead = predetermined rate × actual base. Write off the difference to Costing P&L A/c if it is small or due to abnormal causes. Apportion it over WIP, finished goods and cost of sales if it is large and arises from normal causes.

Understand Under and Over Absorption of Overheads

Overheads cannot be traced to a unit directly. So you charge each job or unit at a predetermined overhead rate, fixed before the period starts. The rate is budgeted overhead ÷ budgeted base (machine hours, labour hours, units and so on).

The rate is set in advance, but actual overhead and actual activity are known only later. Because of this, overhead absorbed (rate × actual base) rarely equals overhead incurred. The gap is the under or over absorption.

Under absorption: absorbed < actual. Costs have been charged too little, so profit in the cost accounts is overstated. Over absorption: absorbed > actual. Costs have been charged too much, so cost profit is understated.

There are two causes. First, actual overhead differs from budget (overspending, price rise, unexpected repairs). Second, actual activity differs from budgeted activity (idle capacity, strikes, breakdowns, lower or higher demand). Faulty budgeting, a wrong choice of base, and seasonal fluctuations also lead to it.

The difference is held in an Overhead Control Account (or Overhead Adjustment Account). At the end of the period it is cleared. Normally a small difference, or one due to abnormal causes, is written off to the Costing Profit and Loss Account. If it is large and arises from normal causes, it can be apportioned between WIP, finished goods and cost of sales.

Key rules to remember

Predetermined overhead rate
Budgeted overhead ÷ Budgeted base (hours, units or value)
Fixed before the period. Use budgeted figures for both numerator and denominator.
Overhead absorbed
Predetermined rate × Actual base
Use actual hours or units, not budgeted ones.
Under absorption
Actual overhead − Overhead absorbed (when positive)
Debit balance in Overhead Control Account; cost profit is overstated until written off.
Over absorption
Overhead absorbed − Actual overhead (when positive)
Credit balance in the Overhead Control Account; cost profit is understated.
Treatment of difference
Under absorption: Dr Costing P&L A/c, Cr Overhead Control A/c. Over absorption: Dr Overhead Control A/c, Cr Costing P&L A/c
This is the simple write-off method. Supplementary rate or proration applies where the question asks.
Supplementary rate
Under or over absorbed amount ÷ Actual base carried in WIP, finished goods and cost of sales
Used to correct the charge on units already costed. Apply it to the hours or units in WIP, finished goods and cost of sales, not to total production, unless the question states otherwise.

How to solve Under and Over Absorption of Overheads questions

Use this method for any numerical on under or over absorption.

  1. 1Read the question and list budgeted overhead, budgeted base, actual overhead and actual base.
  2. 2Compute the predetermined rate from the budgeted figures only.
  3. 3Compute overhead absorbed = rate × actual base. If the question gives different activity bases for departments, do each department separately.
  4. 4Compare absorbed with actual overhead. Label the result clearly as under absorbed or over absorbed.
  5. 5Identify the cause if asked: spending difference (actual overhead − budgeted overhead) or volume difference ((budgeted base − actual base) × rate).
  6. 6Pass the accounting entry through the Overhead Control Account, and show the transfer to Costing P&L A/c or proration as instructed.
  7. 7If the question asks for the effect on profit, remember that under absorption reduces profit when written off and over absorption increases it.

Quickest way: Absorbed minus actual, with a sign check

When to use it: Use it for MCQs and for the first line of a written answer when time is short.

  1. Calculate the rate once: budgeted overhead ÷ budgeted base.
  2. Multiply by actual base to get absorbed overhead.
  3. Subtract actual overhead from absorbed. A positive result means over absorbed; a negative result means under absorbed.
  4. For cause split, compute volume difference: (budgeted base − actual base) × rate, and spending difference: actual overhead − budgeted overhead.
  5. Check using signs: under absorption = volume difference + spending difference. A negative spending difference is favourable. For example, 50,000 + (−20,000) = 30,000.

Common mistakes in Under and Over Absorption of Overheads

  • Using actual overhead to compute the rate

    Students forget that the rate is predetermined, so only budgeted figures are used.

    Fix: Always take the rate from budgeted overhead and budgeted base. Actual overhead is used only for comparison.

  • Multiplying the rate by budgeted base to get absorbed overhead

    Both budgeted and actual quantities are given and the student picks the wrong one.

    Fix: Absorbed overhead always uses the actual base: hours worked or units produced.

  • Mixing up under and over absorption

    The direction of the subtraction is not remembered.

    Fix: Ask whether the cost accounts have charged too little or too much. Absorbed less than actual means under absorbed.

  • Wrong side of the Overhead Control Account

    Students memorise entries without linking them to the meaning.

    Fix: Actual overhead is debited, absorbed overhead is credited. A debit balance means under absorption; a credit balance means over absorption.

  • Treating all differences as simply written off

    Students ignore the wording of the question about abnormal causes or large amounts.

    Fix: Follow the instruction. Write off abnormal differences to Costing P&L A/c. For large normal differences, prorate over WIP, finished goods and cost of sales if asked.

  • Using the wrong base for the supplementary rate

    Students use budgeted units or total production instead of the base named in the question.

    Fix: Divide the unabsorbed amount by the hours or units carried in WIP, finished goods and cost of sales, unless the question names a different base.

Worked examples

Example 1

A factory budgeted factory overheads of ₹6,00,000 for 1,20,000 machine hours. In the period, actual overheads were ₹5,80,000 and actual machine hours were 1,10,000. Find the overhead absorbed, the under or over absorption, and its causes.

Show the solution
  1. Predetermined rate = ₹6,00,000 ÷ 1,20,000 = ₹5 per machine hour.
  2. Overhead absorbed = ₹5 × 1,10,000 = ₹5,50,000.
  3. Actual overhead = ₹5,80,000. Absorbed is less than actual, so under absorbed by ₹5,80,000 − ₹5,50,000 = ₹30,000.
  4. Spending difference = actual − budget = ₹5,80,000 − ₹6,00,000 = −₹20,000, which is favourable (lower spending) and reduces the under absorption.
  5. Volume difference = (1,20,000 − 1,10,000) × ₹5 = ₹50,000 unfavourable (lower activity).
  6. Check with signs: volume difference + spending difference = ₹50,000 + (−₹20,000) = ₹30,000 under absorbed.

Answer: Overhead absorbed ₹5,50,000; under absorbed ₹30,000, caused by a ₹50,000 shortfall in activity partly offset by ₹20,000 lower spending.

Example 2

Using the same data as in the first example, show the entries for the overhead and treat the difference in the cost accounts. Also find the supplementary rate if all 1,10,000 machine hours are assumed to be carried in WIP, finished goods and cost of sales.

Show the solution
  1. Actual overhead incurred: Dr Overhead Control A/c ₹5,80,000, Cr Various accounts (wages, stores, etc.) ₹5,80,000.
  2. Overhead absorbed: Dr Work-in-Progress Control A/c ₹5,50,000, Cr Overhead Control A/c ₹5,50,000.
  3. The Overhead Control A/c now has a debit balance of ₹30,000, which is the under absorption.
  4. Transfer by simple write-off: Dr Costing P&L A/c ₹30,000, Cr Overhead Control A/c ₹30,000. This reduces cost profit by ₹30,000.
  5. Supplementary rate = ₹30,000 ÷ 1,10,000 machine hours = ₹0.2727 per hour, about ₹0.27. It is applied to the machine hours carried in WIP, finished goods and cost of sales, because the cost has already passed into them. Here those hours are taken as all 1,10,000 hours.

Answer: Under absorbed ₹30,000 is debited to Costing P&L A/c; the supplementary rate is about ₹0.27 per machine hour if it is instead spread over the hours in WIP, finished goods and cost of sales.

Exam tips

  • Write the rate, the absorbed figure and the difference as three separate lines. This secures step marks even if one value is wrong.
  • State clearly whether the amount is under or over absorbed. A correct figure labelled the wrong way loses marks.
  • In MCQs, check which base the question gives (hours or units) and whether it is actual or budgeted before multiplying.
  • If asked for the reasons, give both cause types: spending and volume. Add examples such as idle time, breakdown and wrong estimates.
  • Show the entry in ledger form with the Overhead Control Account when the question says to pass journal entries.

Practice questions from Overheads

Under 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 and Over Absorption of Overheads: frequently asked questions

What is the difference between under absorption and over absorption of overheads?

Under absorption occurs when overhead absorbed in cost is less than the actual overhead incurred. Over absorption occurs when absorbed overhead exceeds actual overhead. Both arise because the rate is fixed in advance.

How do I calculate over absorbed overhead?

First find the predetermined rate from budgeted overhead and budgeted base. Multiply it by the actual base to get overhead absorbed. If absorbed is more than actual overhead, the excess is the over absorbed amount.

What is the treatment of under absorbed overheads in cost accounts?

A small or abnormal difference is usually written off to the Costing Profit and Loss Account. A large difference from normal causes may be prorated over WIP, finished goods and cost of sales. Follow the instruction in the question.

What are the main reasons for under absorption of overheads?

Actual overhead may be higher than budgeted because of price rises or overspending. Actual activity may be lower than budget because of idle time, breakdowns or poor demand. Errors in estimating the budget or choosing the base also cause it.