It is relatively easy to ascertain the prime cost as they are closely identified with the final product. However it is more difficult to relate the indirect costs – the overheads to the product. Absorption costing is an attempt to achieve this so that overhead can be charged to products.
There are three stages in the absorption costing process- allocation, apportionment and absorption.
Allocation is the process of locating overheads which can be identified with a particular cost centre in that cost centre. Overhead items which cannot be identified with a cost centre but are incurred for the benefit of the entire business must be shared out or apportioned across a number of cost centres. If there are overheads located in non-production or service cost centres they must be re-apportioned to production cost centres. Finally, when all the production overheads are located in production cost centres the final stage of absorbing or recovering the overheads and charging them to a product, job or process.
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