You work as a senior financial controller for Alpha, a company that produces consumer goods for the health care industry. The company uses absorption costing system for both financial reporting purposes and management decisions.

At a most recent management meeting you presented the monthly profit and loss statement to the participants. In the previous month the company increased the volume of production without selling more. This caused a huge over-absorption in the profit and loss statement.

The CEO of the company could not fully understand the issue around under-/overabsorption and turned to you for further explanation.

(a) Explain what we mean by absorption costing. (1 mark)

(b) What is the predetermined overhead absorption rate and how is it calculated? (2 marks)

(c) Explain what we mean by under-/overabsorption? (3 marks)