Cost recording techniques: costing methods, cost centres and absorption
Costing methods
The method follows the way output is produced. Job costing builds a separate cost for each identifiable job (a bespoke kitchen). Batch costing treats each batch as the cost unit (500 identical components). Contract costing applies to long-term, site-based work. Process costing suits continuous, homogeneous output, where costs are averaged over units and normal loss and scrap are handled separately. Service costing uses composite cost units such as passenger-mile or bed-night.
Recording costs to cost centres
Overheads follow three steps: allocation (a whole cost charged to one centre, e.g. a department manager's salary), apportionment (a shared cost split on a fair basis - rent by floor area, depreciation by machine value), and reapportionment of service department costs to production departments. Overhead is then absorbed into cost units using a predetermined overhead absorption rate (OAR) = budgeted overhead ÷ budgeted activity, with activity measured in labour hours, machine hours or a percentage of direct labour cost.
Absorption consequences
Because the OAR is based on budget, overhead absorbed rarely equals overhead incurred. Absorbed greater than incurred is over-absorption (added back to profit); absorbed less than incurred is under-absorption (charged to profit).
Worked example. Budgeted production overhead £120,000; budgeted machine hours 15,000. OAR = £8 per machine hour. Job 44 uses 200 machine hours, so absorbs 200 × £8 = £1,600.
Traps: apportioning a cost that could be allocated directly; dividing by actual activity instead of budgeted activity when setting the rate; omitting one of the three cost elements from a job cost; using labour hours in a machine-intensive department.