Over/under absorption - help please

gingervicki

Hi any help on this would be appreciated....

What are the implications of switching from direct labour hours to machine hours, or vice versa?

Is one better than the other?

Is over better than under absorption?

I seem to be really doubting myself on this one and just don't seem to be able to make it sink in

thanks
:confused1::confused1::confused1:

SandyHood

I think you'll find very many threads on this topic

What are the implications of switching from direct labour hours to machine hours, or vice versa?

Is one better than the other?

The choice of direct labour hours or machine hours is ultimately arbitrary, but in general you will find the larger number of hours (mainly because it enables us to produce a lower absorption (recovery) rate).
I would answer an exam question on the following lines:

1. If there are more machine hours than labour hours then the department is capital (or machine) intensive so we should use machine hours to recover overheads.
2. If there are more direct labour hours than machine hours the department is labour intensive and a direct labour rate is a more appropriate basis.

So in answer to your second question, the rate that is better is only better if it is more appropriate, but machine hours are not always better than labour hours.

Is over better than under absorption?

It is just reality that each accounting period will have an under or absorbed overhead. Over means that more overhead was recovered than actually incurred. But though this effectively adds to our profit, if we made a mistake when we set the overhead rates and this led to us setting our prices rather higher than we might have done, then we could have set a price which led to lower sales and it cost us lost profits.

Instead a low under or a low over absorption indicates that the budget was pretty close and was useful.

gingervicki

thanks very much

you made it much clearer , thanks

Vicki