Chapter 9 - The Analysis of Cost

Abstract

This chapter explores a fundamental issue in management accounting: what is meant by cost? The total cost of a product or service is made up of its direct cost plus a share of indirect costs or overheads. The process of assigning overhead costs to products or ser vices is known as overhead absorption. Overhead absorption has traditionally used direct labor hours or machine hours as an absorption basis. More recent developments in overhead absorption techniques attempt to identify what drives overhead costs in order to determine more appropriate bases for the attribution of overhead costs to individual products and services. Another time-based absorption rate that is widely used is a machine hour rate. This works in exactly the same way as a direct labor hour rate, except that the absorption is based on the number of machine hours taken to produce each item.