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costing

aisha kapoor (90 Points)

13 February 2018

why are allocated or absorbed fixed overhead not relevant for decision making?

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5 Replies

Sagar Khandelwal (392 Points)
Replied 13 February 2018

Being fixed, they will be incurred in all scenarios, whether you go for Option A, Option B or do nothing. Being irrelevant, they will not have any impact on your decision.

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aisha kapoor (90 Points)
Replied 13 February 2018

and what do we particularly mean by "absorbed or allocated" over here?

Himanshu chopra (59 Points)
Replied 13 February 2018

Fixed overheads are allocated to a particular job/ department, but they will continue to occur if we close down that department.

Sagar Khandelwal (392 Points)
Replied 13 February 2018

See, when you charge a particular Fixed OH to any activity on a reasonable basis (like Machine hrs, Labour hrs) that is called Absorption.
(eg. Total wages absorbed to Product 1 and Product 2 based on machine hrs for each product)

When you charge any Fixed OH to any activity based on your knowledge that it relates to that activity, it's called Allocation.
(eg. Factory Rent for factory of Product 1)

The crux here is that the Fixed OH will always be there - no Matter how you allocate / absorb it to a process. If this OH cannot be avoided, then it becomes irrelevant for both Options.
(eg. Factory Rent will always be there whether you make Product 1, 2 or none.
Permanent labour's wages will always be there whether you make 1 or 2 or none)