Under-absorption of overheads occurs when absorbed overheads < actual overheads

Steps:

• Calculate predetermined overhead rate: budgeted overheads ÷ budgeted activity level.
• Compute absorbed overheads: predetermined rate × actual activity level.
• Compare absorbed overheads to actual overheads incurred.
• Under-absorption results if actual activity is low (reducing absorption) and actual overheads are high (increasing the gap).

Why C is correct:

• Actual activity less than budgeted reduces absorbed overheads below budgeted level; actual overheads more than budgeted increases incurred costs, ensuring absorbed < actual per absorption costing formula.

Why the others are wrong:

• A: Both low, so absorbed may approximate or exceed low actual, causing over-absorption or balance.
• B: High activity boosts absorption above budgeted; low overheads make absorbed > actual, causing over-absorption.
• D: Both high, so absorption rises with activity while overheads increase, often balancing or causing over-absorption.

Final answer: C