## Cost Allocation, Apportionment, and Absorption
### Why Classify Overheads into Fixed and Variable?
1. Cost Control: Fixed costs are generally non-controllable in the short run; variable costs can be controlled by motivating employees — separation enables targeted action.
2. Marginal Costing: Marginal cost technique requires separation of FC and VC to calculate contribution.
3. Flexible Budgeting: A flexible budget shows different expenditure levels at different activity levels — only possible with F/V separation.
4. Decision Making: Export pricing, shutdown decisions, and make-or-buy decisions require knowledge of which costs are fixed and which are variable.
5. Separate Absorption Rates: Fixed and variable OHs are absorbed at different rates for more accurate product costing.
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### Cost Classification
The process of categorising costs by behaviour, function, or element (covered in the previous lesson).
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### Cost Allocation
> The process of charging the full cost of a specific overhead to the single cost centre that incurred it.
- Applicable when only one department is the beneficiary of the cost.
- No sharing involved — the entire amount goes to that department.
- Example: If production, admin, and sales departments each have a separate electricity meter, each department's bill is directly allocated to that department.
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### Cost Apportionment
> The process of sharing a common cost proportionately across two or more cost centres on a suitable basis.
- Applicable when multiple departments share the benefit of a single cost.
- Requires selecting an equitable basis for sharing.
- Example: If only one electricity meter serves all departments, the total bill is apportioned among departments based on number of light points (or floor area, or machine hours).
#### Allocation vs Apportionment — Key Distinction
| Dimension | Allocation | Apportionment |
|---|---|---|
| Number of beneficiaries | One department only | Two or more departments |
| Cost traceability | Directly traceable to one dept | Common cost, cannot be traced to one dept |
| Example | Separate electricity bill per dept | Single electricity bill shared across depts |
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### Overhead Absorption
> The process of charging overhead cost to one unit of output (product or job).
Methods of overhead absorption:
| Method | Formula |
|---|---|
| % of Direct Material Cost | (Total Production OH / Budgeted Direct Material Cost) × 100 |
| % of Direct Labour Cost | (Total Production OH / Direct Labour Cost) × 100 |
| % of Prime Cost | (Total Production OH / Prime Cost) × 100 |
| Labour Hour Rate | Total Production OH / Direct Labour Hours |
| Machine Hour Rate | Total Production OH / Machine Hours |
| Rate per Unit of Output | Total OH / Number of Units |