Absorption of overhead using predetermined rate may cause either under recovery or over recovery of overheads. If the actual overheads work out to be different from the budgeted overheads or if the actual base become different from the budgeted base, this results in either under or over recovery.
Let us suppose actual overheads work out to be $ 10.50 lacs and actual machine hours are 90,000. 90,000 units of product X were produced using 90,000 machine hours.
Oh recovery (9,000 x 10 x 10) 900,000
Actual OH $ 1,050,000
Under recovery $ 150,000
Similarly, if the actual overheads were $ 9.4 lacs and actual machine hours were 95000, recovery position would be as follows.
Oh recovery (95,000 x 10) $ 950,000
Actual OH $ 940,000
Over recovery 10,000
Overhead recovery or under-recovery is absorbed by the product using supplementary rate. Alternatively, over o under-recovery is directly transferred to profit & loss account.
However, over-recovery of overhead causes over-pricing of products which may cause losses to its market share. Under-recovery may cause loss when it becomes difficult to recover it against subsequent production.
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