Absorption and Allocation

Costing
Prepared By:-
Ashish Goyal
www.find4education.com
www.amcap.in
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 Absorption Costing
• Absorption costing, is a costing technique that
includes all manufacturing costs, in the form of
direct materials, direct labour, and both variable
and fixed manufacturing overheads, while
determining the cost per unit of a product. It is
also referred to as the full- cost technique.

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 Variable Costing
• Only those costs of manufacturing that vary with
output (variable costs) are treated as product
costs
• This would include direct material, direct labor
and variable manufacturing overhead
• Fixed manufacturing overhead is expensed
during the current period
• Variable costing is used for internal planning and
control only

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Overview of Absorption and
Variable(Marginal) Costing
The only cost of driving my car
on a 200 mile trip today is
$12 for gasoline.

Variable
Costing
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Overview of Absorption and
Variable Costing
No! You must consider these costs too!
Cost Per month Per day
Car payment $ 300.00 $ 10.00
Insurance 60.00 2.00

Absorption
Costing
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Overview of Absorption and
Variable (Marginal) Costing
You are wrong. I have the car
payment and the
insurance payment even if
I do not make the trip.

Variable
Costing
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Overview of Absorption and
Variable Costing
Who’s right?
How should we treat the car
payment and the insurance?

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 Overview of Absorption and
Variable Costing
Absorption Variable
Costing Costing

Direct Materials
Product
Product
Direct Labor Costs
Costs
Variable Manufacturing Overhead

Fixed Manufacturing Overhead

Period
Period
Variable Selling and Administrative Expenses Costs
Costs
Fixed Selling and Administrative Expenses

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Note: Manufacturing Cost Flows
Balance Sheet Income
Costs Inventories Statement
Expenses
Material Purchases Raw Materials

Direct Labor
Work in
Variable ti ng Process
s
Manufacturing co
Overhead ti on
rp
bso Cost of
A Finished
Fixed Goods
Manufacturing Goods
Overhead Variable Sold
costing

Selling and Fixed Mfr’g OH

Administrative Period Costs Selling and
Administrative
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 Cost Allocation Overview

• What is “Cost Allocation”?

– Cost Allocation is a Process to Determine the
“Total Cost” of a “Cost Objective”
– Achieved By Distributing or Apportioning
Costs to a Benefiting “Cost Objective”…
– Using Statistical Data or Metrics that Measure
the Usage of a Service or the Relative Benefit
Received

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 Cost Allocation Overview

• What is a “Cost Objective”?

– A “Cost Objective” is a particular award,
contract, grant, project, service, or other
activity of an organization for which cost
data are desired and for which provision
is made to accumulate and measure the
costs

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 Cost Allocation Overview

• What is the “Total Cost” of a Cost

Objective?
– “Total Cost” is composed of the sum of the
allowable direct costs and allocable indirect
costs, less any applicable credits.

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 Total Costs = Direct + Indirect
• Direct Costs • Indirect Costs
Can be identified Incurred for common
specifically with a or joint objectives and
particular final cost cannot be readily
objective (i.e., a identified with a
particular award, particular final cost
service or direct objective
activity)

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 Allocating Indirect Costs
• Allocation Bases: The methodology or
statistical measure by which Indirect
Costs are distributed to other benefiting
services and/or cost objectives
– Examples May Include:
• Number of Active Employees;
• Number of Transactions Processed;
• Square Footage Occupied;
• Salaries and Wages of Units Supervised;
• Direct Assignment

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 Allocating Indirect Costs
• Allocation Bases: The methodology or
statistical measure by which Indirect
Costs are distributed to other benefiting
services and/or cost objectives
– Examples May Include:
• Number of Active Employees;
• Number of Transactions Processed;
• Square Footage Occupied;
• Salaries and Wages of Units Supervised;
• Direct Assignment

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 Cost Allocation Overview
 Simple Example:
 Centrally Located Copier
 “Cost to Operate” includes:
 Lease Payments
 Repairs & Maintenance

 Toner

 Paper

 Supplies, etc.

 “Direct Costs”

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 Cost Allocation Overview
 Copier Example (continued):
 What about electricity used, the space
it occupies, the office manager’s time
paying related bills, ordering paper &
supplies, arranging deliveries and
coordinating servicing, etc.?

 “Indirect Costs”

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 Cost Allocation Overview
 Copier Example (continued):
 Three Divisions Utilize
 Division A – 12 Staff
 Division B – 6 Staff
 Division C – 22 Staff

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 Cost Allocation Overview
 Copier Example (continued):
 How Do We Apportion or Allocate These
“Costs” to the Three Divisions?
 Equal Distribution (i.e., 1/3rd Each)
 “Good”

 Number of Staff Using the Copier

 A – 30%, B – 15%, C – 55%

 “Better”

 User Codes
 Measures Actual Usage of the Copier

 “Best”

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What is a Cost Allocation Plan?
• A Cost Allocation Plan is a set of documents that
relate to a process where Indirect Costs are allocated
using a set of allocation methods to benefiting Cost
Objectives

• The Purposes of a Cost Allocation Plan are as follows:

– They are often the only way to determine the total cost of
operating programs
– They allow an organization to ensure that it is recovering all
allowable costs incurred by the organization
– They can provide valuable management data to an
organization regarding funding levels and time spent on
activities (when time and effort reporting is also employed)

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THANK YOU

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