Absorption Costing 

What is Absorption Costing?

A management cost accounting method of expensing all the costs related with the production of a particular product is known as absorption costing. Absorption costing utilizes the total overhead costs and total direct costs related with producing a product as the cost base. The GAAP need absorption costing for external reporting. Generally accepted accounting principles (GAAP) require the absorption costing for the external reporting.

Absorption Costing

A few of the direct costs related with producing a product include the raw materials used for manufacturing a product, wages for the workers physically producing a product and all the overhead costs like all the utility costs that are used in producing a product or good. Absorption costing comprises anything which is a direct cost in manufacturing a product as the cost base. This is compared with the variable costing, in which the fixed producing costs are not absorbed by the good or product. Many of the advocates use and promote absorption costing since the fixed manufacturing costs would give future benefits.

 Benefits of Absorption Costing:

• It helps to know the importance of the fixed costs in manufacturing or production.
• Absorption costing method is generally utilized to prepare financial accountings or accounts.
• The  Absorption costing system is accepted and used by Inland Revenue since the stock is not undervalued
• When the manufacturing remains stable or same but the sales changes absorption costing would show less change in the net profit.
• Unlike the marginal costing the fixed costs are expected to fluctuate into variable cost which is the cost into the stock value therefore deforming stock valuation.

Drawbacks of Absorption Costing

• When the absorption costing underlined on total cost such as both fixed and variable, it is not very useful for the management to utilize in order to make decision, control and planning.  
• When the manager manager’s emphasis is on the total cost, then the cost volume profit relationship is ignored. The manager has to use his/ her intuition in order make the decision.

Questionnaire:

• What is Absorption Costing? 
• What are the merits and demerits of Absorption Costing?