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Differences between applied overhead versus actual overhead

Once we have applied the overhead to the product, what do we do if the applied overhead differs from the amount of actual overhead that was incurred?

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Accounting treatment of under or over absorption:

All costs of operating factory other than direct material and direct labor are called manufacturing overhead costs. Overhead costs are assigned to the production by means of predetermined overhead rate.

The basic purpose of overhead absorption is to charge factory overheads to the jobs or products manufactured. When absorption is based on actual overhead rate it is known as actual absorption rate. There are some practical difficulties in the calculation of actual absorption rate.

The rate can be calculated only at the end of accounting year when actual results of production costs are ready. Product cost cannot be calculated even after the end of accounting year. Further there may be some variations due to seasonal nature of some overhead costs, change in the volume of production etc.

Therefore the predetermined overhead rate is calculated. It is based on estimates. The rate is calculated by dividing estimated overhead costs for the year by the ...

Solution Summary

The differences between applied overhead versus actual overhead.