Journal entry for over absorption of overhead

Introduction

In cost accounting, we may have an over absorption of overhead when the budgeted overhead does not equal the actual overhead cost or when the budgeted production does not equal the actual production. In this case, we need to make the journal entry for over absorption of overhead in order to make the adjustment to reach the actual fixed overhead cost that actually incurred before we can prepare financial statements.

Under the absorption costing, the fixed overhead cost is allocated to the production based on the predetermined fixed production overhead absorption rate. This overhead absorption rate is determined by using the budgeted fixed overhead and the budgeted production units or activities.

However, the budgeted overhead doesn’t always equal the actual cost of overhead. And it is the same for the budgeted production as the actual production units or activities may be higher or lower than the budgeted one. Hence, it may lead to the over absorption of overhead or the under absorption of overhead at the end of the period when we have a full figure of the actual overhead cost that actually incurred during the period.

In short, we will have an over absorption of overhead if the absorbed overhead is higher than the actual overhead that incurred. On the other hand, we will have an under absorption of overhead instead if the absorbed overhead cost is lower than the actual overhead.

Journal entry for over absorption of overhead

Over absorption of overhead means that the absorbed cost of overhead or the absorbed overhead is higher than the cost of overhead that actually incurred for the period. And an over absorption of overhead usually occurs when the budgeted production is higher than the actual production or when the budgeted overhead is lower than the actual overhead.

In this case, we can make the journal entry for over absorption of overhead by debiting the overhead account and crediting the cost of goods sold account.

Account	Debit	Credit
Overhead	$$$
Cost of goods sold		$$$

In this journal entry, the over absorption amount of overhead is the difference between the actual overhead and the absorbed overhead that is calculated based on the predetermined overhead absorption rate. Specifically, the over absorption of overhead in this case is the remaining amount after we deduct the actual overhead cost from the absorbed overhead. (absorbed overhead – actual overhead cost)

Over absorption of overhead example

For example, we have a $10,000 budgeted fixed overhead and 1,000 budgeted production units. Hence, we use the fixed overhead absorption rate of $10 per unit ($10,000 / 1,000 units) to apply to the production units that we have produced for the period.

And the actual overhead that occurs is $10,000 which is equal to the budgeted overhead. However, due to the increase in production activities, the actual production units that we have produced is 1,200 units which are 200 units more than the budgeted production for the period.

This makes the absorbed overhead cost becomes $12,000 (1,200 units x $10 per unit) which is higher than the $10,000 of actual overhead by $2,000. As a result, we have a $2,000 over absorption of overhead.

In this case, we can make the journal entry for the $2,000 over absorption of overhead by debiting this amount to the overhead account and crediting the same amount to the cost of goods sold account.

Account	Debit	Credit
Overhead	2,000
Cost of goods sold		2,000

Under absorption of overhead

On the other hand, an under absorption of overhead occurs when the absorbed overhead is lower than the actual overhead that incurs during the period. In this case, we need to make the adjustment in the accounting entry by adding more amount to the cost of goods sold to match the actual overhead cost that occurs.

Likewise, we can make the journal entry for under absorption of overhead by debiting the different amount between the absorbed overhead and actual overhead to the cost of goods sold account and crediting this same amount to the overhead account.

Account	Debit	Credit
Cost of goods sold	$$$
Overhead		$$$

In this journal entry, the under absorption amount of overhead is the difference between the absorbed overhead and the actual overhead. However, it is opposite from the over absorption of overhead above as the absorbed overhead in this case is lower than the actual overhead.

Under absorption of overhead example

For example, we have a $50,000 budgeted fixed overhead and 10,000 units of the budgeted production. Hence, we can calculate the fixed overhead absorption rate to be $5 per unit ($50,000 / 10,000 units).

And the actual production units that we have produced for the period is 10,000 units which is the same as budgeted figure. However, due to a sudden increase in the price of the utilities, the actual overhead that incurs during the period is $53,000 which is more than the amount that we have budgeted.

This makes the $50,000 absorbed overhead (10,000 units x $5 per unit) being lower than the $53,000 actual overhead by $3,000. And as a result, we have a $3,000 under absorption of overhead.

In this case, we can make the journal entry for the $3,000 under absorption of overhead by debiting the $3,000 amount to the cost of goods sold account and crediting the same $3,000 to the overhead account as below:

Account	Debit	Credit
Cost of goods sold	3,000
Overhead		3,000

Calculate absorbed overhead

In the absorption costing, the absorbed overhead can be calculated by using the actual production units or activities (e.g. labor hours) to multiply with the overhead absorption rate.

Absorbed overhead = Actual production x Overhead absorption rate

And the overhead absorption rate can be calculated by dividing the budgeted overhead cost by the budgeted production units or activities.

Overhead absorption rate = Budgeted overhead / Budgeted production

As we have seen in the examples above, we can calculate the overhead absorption rate by dividing the budgeted overhead with the budgeted production.

Overhead absorption rate in example 1 = $10,000 / 1,000 units = $10 per unit

Overhead absorption rate in example 2 = $50,000 / 10,000 units = $5 per unit

And then we can use this overhead absorption rate to calculate the absorbed overhead cost and compare it to the actual overhead cost in order to determine whether we have an over absorption of overhead or an under absorption of overhead.

In this case, we can summarize the work in example 1 and example 2 above as below:

Over absorption of overhead example 1
Absorbed overhead	(1,200 units x $10 per unit)	$12,000
Actual overhead	(equal budgeted overhead)	$10,000
Over/ (under) absorption of overhead		$2,000

Under absorption of overhead example 2
Absorbed overhead	(10,000 units x $5 per unit)	$50,000
Actual overhead	(more than budgeted overhead)	$53,000
Over/ (under) absorption of overhead		($3,000)