Part a )

A pre-determined overhead absorption rate is calculated in advance based on budgeted figures for both overhead cost and the activity level.

Part b)

If a company recovers overhead using a predetermined overhead absorption rate there is likely to be an under or over absorption of overhead at the end of an accounting period.  This is because the predetermined overhead absorption rate is based on estimates (budgeted overhead and budgeted activity level).  The actual overhead and actual activity level are unlikely to occur exactly as planned in the budget.

Simple illustration:

Budgeted overhead in the cost centre amounted to €10,000 and the budgeted direct labour hours amounted to 5,000 hours.  Actual overhead amounted to €11,000 when 5,100 direct labour hours were actually used.

The predetermined overhead absorption rate would be calculated as follows:

Under/Over Absorption:

        Actual overhead                              €11,000

        Absorbed overhead (5,100 x €2)    €10,200

        Under absorbed                              €     800

Both the actual overhead and actual activity level were higher than estimated.