Understanding Underabsorbed Overhead: Definition and Implications
Definition & Meaning
Underabsorbed overhead refers to a situation where a company's total overhead costs have not been fully allocated to the products sold or services provided. Overhead costs include all expenses that are not directly tied to the production of goods or services, such as utilities, rent, and administrative salaries. When overhead is underabsorbed, it can lead to an inaccurate representation of the cost of goods sold, potentially affecting financial reporting and decision-making.
Legal Use & context
This term is primarily used in accounting and finance, particularly in the context of business operations and financial reporting. It is relevant in various legal areas, including corporate law and tax law, where accurate financial statements are crucial. Companies may need to address underabsorbed overhead when preparing financial reports or during audits. Users can manage related forms and documents through platforms like US Legal Forms, which offer templates drafted by legal professionals.
Real-world examples
Here are a couple of examples of abatement:
For instance, a manufacturing company incurs $100,000 in overhead costs but only allocates $80,000 to its products. This results in $20,000 of underabsorbed overhead, which could misrepresent the actual cost of production and affect pricing strategies.
(hypothetical example) A service-based business incurs $50,000 in overhead costs but only charges $40,000 to its clients, leading to a $10,000 underabsorbed overhead situation.