In overhead absorption, which sequence is correct?

In overhead absorption, which sequence is correct?

• A. Calculate how much overhead has been absorbed by actual activity, Calculate OAR, Compare overhead cost with absorbed overhead
• B. Calculate OAR, Calculate absorbed, Compare overhead cost with absorbed overhead
• C. Compare overhead cost with absorbed overhead, Calculate OAR, Calculate absorbed
• D. Calculate absorbed, Compare overhead cost with absorbed overhead, Calculate OAR

Answer: (B)

The main idea is understanding the proper order of steps to absorb overhead. First you establish the overhead absorption rate (OAR) by using estimated overhead and an allocation base. Once you know the OAR, you apply it to the actual level of activity to find how much overhead is absorbed during the period. Only after you have this absorbed overhead do you compare it with the actual overhead cost incurred. This comparison shows whether overhead was over- or under-absorbed. For example, if estimated overhead is 120,000 and estimated activity is 10,000 units, the OAR is 12 per unit. With actual activity of 9,500 units, absorbed overhead is 114,000. You then compare this absorbed figure to the actual overhead cost to determine the variance. The other sequences jump ahead without having a defined rate or the absorbed amount, which isn’t logically consistent because you need the OAR first and the absorbed amount second before making the comparison.

The main idea is understanding the proper order of steps to absorb overhead. First you establish the overhead absorption rate (OAR) by using estimated overhead and an allocation base. Once you know the OAR, you apply it to the actual level of activity to find how much overhead is absorbed during the period. Only after you have this absorbed overhead do you compare it with the actual overhead cost incurred. This comparison shows whether overhead was over- or under-absorbed.

For example, if estimated overhead is 120,000 and estimated activity is 10,000 units, the OAR is 12 per unit. With actual activity of 9,500 units, absorbed overhead is 114,000. You then compare this absorbed figure to the actual overhead cost to determine the variance. The other sequences jump ahead without having a defined rate or the absorbed amount, which isn’t logically consistent because you need the OAR first and the absorbed amount second before making the comparison.