However, this "artificial" profit is not sustainable, as it is based on a cost calculation error rather than genuine revenue generation. If the inventory is eventually sold, the excessive overhead previously absorbed will have been released to the income statement all at once, causing future periods to show abnormally low costs and potentially masking future inefficiencies.
Detecting Over Absorption In Manufacturing: Key Signs and Identification Strategies
Strategies for Identification and Correction Accounting systems are designed with mechanisms to detect and rectify the variance caused by over absorption. Additionally, adopting more modern costing methodologies, such as Activity-Based Costing (ABC), can mitigate the risk.
ABC assigns overhead based on the actual activities that drive costs, providing a more accurate and dynamic cost allocation that is less susceptible to volume fluctuations. This phenomenon typically arises within traditional cost accounting systems, particularly those utilizing standard costing methods, where predetermined overhead rates are established based on estimated activity levels.
Detecting Over Absorption In Manufacturing: Key Signs and Identification Strategies
At the end of a financial period, a calculation is performed to determine the exact overhead variance. If the applied overhead exceeds the actual overhead, the difference is termed an over absorption variance.
More About Over absorption
Looking at Over absorption from another angle can help expand the discussion and give readers a second clear paragraph under the same section.
More perspective on Over absorption can make the topic easier to follow by connecting earlier points with a few simple takeaways.
