We have already said that fixed costs and overheads, such as heating and lighting, are not easily apportioned to specific profit/cost centres. These costs arise throughout the firm. However, they must still be paid for and absorption costing, like full costing, seeks to apportion these costs between the profit/cost centres.
Where full costing selects just one criterion as a means of allocation, absorption costing attempts to be more 'scientific' in the allocation, apportioning individual overheads using the most logical criterion.
Common methods of apportionment for a profit/cost centre include:
- Floor space
- Number of staff employed
- Value of machinery
- Sales revenue
- Direct labour hours worked
The method chosen should be appropriate to the type of overhead to be apportioned. For example, rent would probably be apportioned to the different cost centres based on the floor space of each cost centre. Whereas, HRM costs may be apportioned according to the number of people employed by each cost centre, since employees are the focus of the HRM department.
The following data is available for Gray Ltd relating to their three cost centres.
|Floor space||50 sq m||30 sq m||20 sq m||100 sq m|
|No of staff employed||15||25||10||50|
The overheads incurred are as follows:
It would seem appropriate to use the following bases for the apportionment of these overheads:
|Heating costs||Floor space|
|Canteen expenses||No. of staff employed|
Have a go at apportioning the overheads for Gray Ltd and then follow the link below to see how you got on.
Evaluation of absorption costing
Absorption costing is more complex than using full costing, but it is fairer in that the allocation of costs mirrors reality more closely, in that the usage of each product is taken into account. As such, the cost per unit of output is likely to be more accurate, and will inform pricing policy if a cost-plus policy is used.
However, the allocation of costs is still arbitrary to some extent and inaccurate. It is likely to be more time-consuming and costly than full costing or contribution costing methods.