What does over absorption of overheads imply?

Over absorption of overheads occurs when the actual overhead costs incurred are less than the overhead costs allocated to products or services based on a predetermined rate. This situation implies that a company has allocated more overhead costs than necessary, leading to inflated product costs and potentially higher pricing. It can result in improved profit margins in the short term but may indicate inefficiencies or inaccuracies in cost estimation processes. Over time, persistent over absorption could distort financial reporting and decision-making.