Absorption costing
Classifying costs
There are 2 ways to classify costs
- Direct vs indirect (overheads)
- Fixed vs variable
Definitions
- Overhead (indirect cost) can’t be directly allocated to a product or service
- Fixed cost doesn’t vary with the amount of product (meals) or services you provide
Example – trying to work out how much a meal costs
Direct Indirect Fixed Variable
A lobster X x
Electricity X x
for cooking
Rent x x
Head chef x x
salary
What gets included in the cost of a product or service?
- Direct costs
- All indirect costs – whether they are fixed or variable
- As long as the costs relate to PRODUCTION
How do we divide up the indirect costs (overheads) between products?
- In the example above, we have to spread out the total cost of electricity, rent and
the head chef’s salary to products (meals served)
- What basis could we do this on?
o Flat rate per meal?
o How many hours the meal takes in the oven (i.e. oven hours)
o How many hours the meal takes to prepare (i.e. labour hours)
- Sometimes different departments use different bases
o E.g. admin department costs like rent might use number of meals and kitchen
department costs like electricity and head chef salary might use oven hours
Example
, Answer
Classifying costs
There are 2 ways to classify costs
- Direct vs indirect (overheads)
- Fixed vs variable
Definitions
- Overhead (indirect cost) can’t be directly allocated to a product or service
- Fixed cost doesn’t vary with the amount of product (meals) or services you provide
Example – trying to work out how much a meal costs
Direct Indirect Fixed Variable
A lobster X x
Electricity X x
for cooking
Rent x x
Head chef x x
salary
What gets included in the cost of a product or service?
- Direct costs
- All indirect costs – whether they are fixed or variable
- As long as the costs relate to PRODUCTION
How do we divide up the indirect costs (overheads) between products?
- In the example above, we have to spread out the total cost of electricity, rent and
the head chef’s salary to products (meals served)
- What basis could we do this on?
o Flat rate per meal?
o How many hours the meal takes in the oven (i.e. oven hours)
o How many hours the meal takes to prepare (i.e. labour hours)
- Sometimes different departments use different bases
o E.g. admin department costs like rent might use number of meals and kitchen
department costs like electricity and head chef salary might use oven hours
Example
, Answer
