Operations management

Table of Contents

1. Topic pack - Operations management - introduction
2. Operations Management (OM) - Introduction
3. 5.1 Production methods notes
4. 5.1 Production methods - questions
5. 5.2 Costs and revenues - notes
   1. Costs and revenues
   2. Types of costs
   3. Costs and revenue - shape of cost curves
   4. Costs - fixed and variable - examples
   5. Revenue
   6. Mattel 1Q Profit Falls On Higher Expenses
   7. Costs and decisions
   8. Contribution to fixed costs
   9. Contribution analysis for multi-product firms
   10. Special orders
   11. Cost centres and profit centres
   12. Why have cost and profit centres?
   13. Apportioning costs to profit and cost centres
   14. Full Costing
   15. Absorption costing
6. 5.2 Costs and revenues - questions
7. 5.3 Break-even analysis - notes
8. 5.3 Break-even analysis - questions
9. 5.3 Break-even analysis - simulations and activities
10. 5.4 Quality assurance - notes
11. 5.4 Quality assurance - questions and activities
12. 5.5 Location - notes
13. Innovation - notes (HL only)
14. 5.6 Innovation - questions
15. 5.7 Production planning - notes
16. 5.7 Production planning - questions
17. 5.8 Project management - notes (HL only)
18. 5.8 Project management - questions (HL only)
19. Print View

Absorption costing

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.

Example 1

The following data is available for Gray Ltd relating to their three cost centres.

The overheads incurred are as follows:

It would seem appropriate to use the following bases for the apportionment of these overheads:

Have a go at apportioning the overheads for Gray Ltd and then follow the link below to see how you got on.

Example 1 - apportionment of overheads

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.