Cost accounting is a specialized branch of accounting that focuses on classifying, recording, and allocating costs for various purposes, including decision-making, control, and financial reporting. Three key concepts in cost accounting are allocation, apportionment, and absorption of overheads.
Key Facts
- Allocation is the process of assigning direct costs to specific cost objects or products.
- Overhead costs can be allocated based on various factors such as direct labor hours, machine hours, floor area, number of employees, sales revenue, material cost, or number of units produced.
- The choice of allocation basis depends on the nature of the cost and the objective of the allocation.
Apportionment:
- Apportionment is the process of dividing overhead costs among different cost objects or departments based on a basis of apportionment.
- It is used when overhead costs cannot be directly traced to a single cost object.
- Overhead costs can be apportioned based on factors such as direct labor hours, machine hours, floor area, number of employees, sales revenue, material cost, or number of units produced.
- The choice of apportionment basis depends on the nature of the cost and the objective of the allocation.
Absorption:
- Absorption is the process of including all overhead costs in the cost of a product or service.
- Overhead costs are absorbed into the cost of each product or service based on a predetermined overhead absorption rate.
- The absorption rate is calculated by dividing total overhead costs by the total number of units produced.
- Absorption costing provides a more accurate picture of the true cost of a product or service, including all direct and indirect costs.
Allocation of Overheads
Allocation refers to the process of assigning direct costs to specific cost objects or products. Direct costs are those that can be easily and accurately traced to a particular cost object. Allocation is typically done based on a logical or equitable basis, such as direct labor hours, machine hours, floor area, or number of units produced.
Examples of Allocation Bases
- Direct labor hours: This is a common allocation basis for manufacturing overhead costs, as it reflects the amount of time spent by direct labor workers on a particular product or cost object.
- Machine hours: This allocation basis is used for overhead costs related to the use of machinery or equipment. It reflects the amount of time that a machine or equipment is used to produce a particular product or cost object.
- Floor area: This allocation basis is used for overhead costs related to the use of space, such as rent, utilities, and maintenance. It reflects the amount of space that a particular product or cost object occupies.
Apportionment of Overheads
Apportionment is the process of dividing overhead costs among different cost objects or departments based on a basis of apportionment. Overhead costs are indirect costs that cannot be directly traced to a single cost object. Apportionment is used to assign a portion of these indirect costs to each cost object or department so that the total cost of each cost object or department can be determined.
Examples of Apportionment Bases
- Direct labor hours: This is a common apportionment basis for administrative and selling overhead costs, as it reflects the amount of time spent by administrative and selling personnel on a particular product or cost object.
- Machine hours: This apportionment basis is used for overhead costs related to the use of machinery or equipment, such as depreciation and repairs.
- Floor area: This apportionment basis is used for overhead costs related to the use of space, such as rent and utilities.
Absorption of Overheads
Absorption is the process of including all overhead costs in the cost of a product or service. This means that the total cost of a product or service includes both direct costs and indirect costs. Absorption is typically done using a predetermined overhead absorption rate, which is calculated by dividing total overhead costs by the total number of units produced.
Example of Absorption
Assume that a company has $100,000 of overhead costs and produces 10,000 units of product. The overhead absorption rate would be $10 per unit ($100,000 / 10,000 units). This means that each unit of product would be assigned $10 of overhead costs.
Conclusion
Allocation, apportionment, and absorption of overheads are important concepts in cost accounting. These processes help to ensure that all costs are properly assigned to cost objects or products, so that the total cost of each cost object or product can be accurately determined. This information is essential for decision-making, control, and financial reporting.
References
- https://courseware.cutm.ac.in/wp-content/uploads/2020/06/Cost-Allocation.pdf
- https://intactone.com/allocation-apportionment-and-absorption-of-overheads/
- https://www.investopedia.com/terms/a/absorptioncosting.asp
FAQs
What is allocation of overheads?
Allocation of overheads refers to the process of assigning direct costs to specific cost objects or products. Direct costs are those that can be easily and accurately traced to a particular cost object. Allocation is typically done based on a logical or equitable basis, such as direct labor hours, machine hours, floor area, or number of units produced.
What is apportionment of overheads?
Apportionment of overheads refers to the process of dividing overhead costs among different cost objects or departments based on a basis of apportionment. Overhead costs are indirect costs that cannot be directly traced to a single cost object. Apportionment is used to assign a portion of these indirect costs to each cost object or department so that the total cost of each cost object or department can be determined.
What is absorption of overheads?
Absorption of overheads refers to the process of including all overhead costs in the cost of a product or service. This means that the total cost of a product or service includes both direct costs and indirect costs. Absorption is typically done using a predetermined overhead absorption rate, which is calculated by dividing total overhead costs by the total number of units produced.
What are some examples of allocation bases?
Some examples of allocation bases include:
- Direct labor hours
- Machine hours
- Floor area
- Number of employees
- Sales revenue
- Material cost
- Number of units produced
What are some examples of apportionment bases?
Some examples of apportionment bases include:
- Direct labor hours
- Machine hours
- Floor area
- Number of employees
- Sales revenue
- Material cost
- Number of units produced
What is the purpose of allocation, apportionment, and absorption of overheads?
The purpose of allocation, apportionment, and absorption of overheads is to ensure that all costs are properly assigned to cost objects or products, so that the total cost of each cost object or product can be accurately determined. This information is essential for decision-making, control, and financial reporting.
How does allocation differ from apportionment?
Allocation is the process of assigning direct costs to specific cost objects or products, while apportionment is the process of dividing overhead costs among different cost objects or departments. Allocation is typically done based on a direct relationship between the cost and the cost object, while apportionment is done based on an indirect relationship between the cost and the cost object.
How does absorption differ from allocation and apportionment?
Absorption is the process of including all overhead costs in the cost of a product or service, while allocation and apportionment are processes for assigning costs to cost objects or departments. Absorption is typically done using a predetermined overhead absorption rate, while allocation and apportionment are done based on specific allocation or apportionment bases.