ABSORPTION COSTING

Absorption Costing

Absorption costing

Absorption costing means that all of the manufacturing costs are soaked up by the flats produced. In other words, the cost of a finished unit in inventory will include direct materials, direct labor, and both variable and repaired constructing overhead. As a outcome, absorption costing is furthermore referred to as full costing or the full absorption method.

Absorption costing is often mismatched with variable costing or direct costing. Under variable or direct costing, the repaired constructing overhead costs are not assigned or assigned to (not soaked up by) the goods manufactured. Variable costing is often helpful for management's decision-making. However, absorption costing is required for external financial describing and for income levy reporting. (Staubus, 1971, 22)

Absorption costing, also renowned as full costing refers to a scheme in which all the repaired constructing overheads are allocated to products. The alternative scheme which assigns only variable manufacturing charges to goods then repaired costs supplemented individually is termed marginal costing.

Before considering the contentions for absorption costing, an illustration of both procedures would provide a better relative insight of major dissimilarities utilising the demonstrations below:-

The following data is accessible for periods 1-6 for a business that made a lone product

Unit selling price10

Unit variable cost 6

Fixed charges for each time span 300

Normal activity = 150 flats per time span, production & sales are as follows:-

Units sold150120180150 140160

Units produced150150150150170 140

There were no opening stocks for P1, actual manufacturing fixed overhead incurred was $300 and non-manufacturing overheads are $100 per period.

When a system of variable costing is used , the product cost is $6 per unit, and only includes variable costs since only variable production costs are allocated to the product. Fixed costs of $300 are then added separately to produce a total manufacturing cost of $1200 and are charged in the period in which they incurred. By using the absorption costing method , fixed overheads are allocated to individual products and are included in the production costs. The product cost now consists of variable cost plus a fixed manufacturing cost, making a total of $8 per unit. The production cost for P1 (150 units at $8) is $1200.

As depicted in P2, under the variable costing system, a closing stock of 30 units will be valued at $6. Closing stock of $180 will then be deducted from the production costs, giving a cost of sales figure of $720. The closing stock valuation here does not include any fixed overheads. With the absorption costing, fixed cost is included in the production cost figure; hence note the closing stock of 30 units for P2 is valued at $8.

In P5 & P6, the absorption costing scheme would incur what we call a period cost adjustment. 170 units were produced in P5, so production cost of $1360 includes fixed overheads of $340 (170 units x $2). However, total fixed overheads incurred for the period is only $300, so $40 too much have been charged. An over recovery of fixed overhead is ...