Which of the following would not cause either an under or over-absorption of overheads ?

Question

Accepted Answer

The correct option is 2:
The mechanism for absorbing overheads relies on a predetermined overhead absorption rate (POAR), which is calculated by dividing *Budgeted Overheads* by a *Budgeted Activity Level* (such as direct labour hours or units). The resulting rate is then applied to the *Actual Activity Level*. Therefore, the actual cost per hour paid to a direct labourer is a price variance for the direct labour cost itself; it does not change the predetermined overhead rate, the actual overheads incurred, or the activity base (hours/units) used to absorb the overheads. Since this factor only affects a *direct* cost's rate and not the overhead *absorption formula* components, it does not cause under- or over-absorption of overheads.

The incorrect option is 1:
Actual direct labour time permit being greater than budget. Under- or over-absorption of overheads is directly influenced by the actual activity level being different from the budgeted activity level. If the *actual direct labour hours used* (the activity base) are greater than the budgeted hours, the total overheads absorbed will be higher than the amount that would have been absorbed at the budgeted hours, leading to an **over-absorption** of overheads, assuming all other factors remain constant. This volume-related difference is a key cause of absorption variance.

The incorrect option is 3:
Actual overheads incurred being less than budget. Under- or over-absorption is the difference between the overheads *absorbed* into production (using the POAR) and the *actual overheads incurred*. If the actual overheads incurred are less than the budgeted overheads, a favourable spending variance will exist. Critically, this variance will contribute to **over-absorption** if the actual overheads incurred are lower than the absorbed amount, even if the volume/activity is exactly as budgeted.

The incorrect option is 4:
The number of units produced being greater than budget. This represents a difference between the actual activity level and the budgeted activity level, and activity level is the denominator in the POAR calculation. If the number of units produced is greater than budgeted, the company has applied the overhead rate to a larger volume than planned. This increased activity base will result in total absorbed overheads being higher than anticipated, which leads to an **over-absorption** of overheads.