1. Introduction and Objectives
Because predetermined rates are based on estimates, the total overhead cost applied to products during the year will rarely match the actual overhead expenses incurred. This mismatch creates under- or over-absorbed overhead balances.
 
2. Evaluation Mechanics
At the end of the period, cost accountants perform a reconciliation audit:
Overhead Absorbed = Actual Base Volume Achieved × Predetermined OAR
  • Under-Absorbed Overhead: Occurs when Actual Overhead Incurred > Overhead Absorbed. This means production was undercharged for support costs.
  • Over-Absorbed Overhead: Occurs when Overhead Absorbed > Actual Overhead Incurred. This means production was overcharged.

3. Ledger Disposition and Closing Entries
  • Immaterial Differences: Debited or credited directly to the Cost of Goods Sold (COGS) account on the current period’s income statement.
  • Material Differences: Prorated across remaining inventory accounts (WIP, Finished Goods, and COGS) based on the ending balance of each account. This ensures that inventory carrying valuations remain compliant with historical cost conventions under GAAP and IFRS.

 
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