Chapter

Cost Allocation vs Cost Apportionment vs Cost Absorption

Cost Allocation

When items of cost are identifiable directly with some products or departments such costs are charged to
such cost centres. This process is known as cost allocation. Wages paid to workers of service department can
be allocated to the particular department. Indirect materials used by a particular department can also be
allocated to the department.

Cost allocation calls for two basic factors –

i. Concerned department/product should have caused the cost to be incurred, and
ii. exact amount of cost should be computable.

Cost Apportionment
When items of cost cannot directly charge to or accurately identifiable with any cost centres, they are
prorated or distributed amongst the cost centres on some predetermined basis. This method is known as
cost apportionment. Thus, we see that item of indirect costs residual to the process of cost allocation are
covered by cost apportionment.

Rent and business rates, for example, are sometimes paid by individual cost centres, and floor space is also
used as a basis for apportionment to share costs between relevant cost centres

The basis ultimately adopted should ensure an equitable share of common expenses for the cost centres and
the basis once adopted should be reviewed at periodic intervals to improve upon the accuracy of
apportionment.

Cost Absorption
Ultimately the indirect costs or overhead as they are commonly known, will have to be distributed over the
final products so that the charge is complete. This process is known as cost absorption, meaning thereby that
the costs absorbed by the production during the period. Usually any of the following methods are adopted
for cost absorption –
i. Direct Material Cost Percentage
ii. Direct Labour Cost Percentage
iii. Prime Cost Percentage
iv. Direct Labour Hour Rate Method
v. Machine Hour Rate, etc.

The basis should be selected after careful maximum accuracy of Cost Distribution to various production
units. The basis should be reviewed periodically and corrective action whatever needed should be taken for
improving upon the accuracy of the absorption.

Prepared by: Raman Luthra

Chartered Accountant
 BASIS COST ALLOCATION COST APPORTIONMENT

Meaning Allocation of cost, implies the entire Apportionment of cost refers to distribution of various
distribution of the overhead item to the overhead items, in proportion, to the department on a
departments on a logical basis. logical basis.

Represents It represents that part of cost attribution, It represents that part of cost attribution, which shares
which charges a particular cost to a cost cost among multiple cost units, in the proportion of
unit. expected benefit received.

Distribution Directly assigned to the department. Proportionately assigned to different departments.

Application When the overhead belongs to a specific When the overhead belongs to different departments.
department.

Multiple Choice Question

1. [Question]The process of distribution of overheads allotted to a particular department or cost center over
the units produced is called ?

a) Allocation
b) Apportionment
c) Absorption
d) Departmentalization
e) Division

Answer: c.

2. [Question]Allotment of whole item of cost to a cost centre or cost unit is known as?

a) Allocation
b) Apportionment
c) Absorption
d) Departmentalization
e) Division

Answer: a.

Prepared by: Raman Luthra

Chartered Accountant
3. [Question]Most suitable basis for apportioning insurance of machine would be?

a) Floor Area
b) Value of Machines
c) No. of Workers
d) No. of Machines
e) Production capacity

Answer: b.

Prepared by: Raman Luthra

Chartered Accountant