Full Absorption costing

The full absorption costing is a managerial accounting cost method of expensing all costs associated with manufacturing a particular product. This costing method uses the total direct costs and overhead costs associated with manufacturing a product as the cost base. The full absorption costing method is required by generally accepted accounting principles (GAAP) for external reporting. It is also known as full cost method. It is also helpful in the calculation of taxes and sales reports.

Under the full absorption costing method, the variable manufacturing costs, being raw materials and labor, are only one part of the cost. The variable and fixed overhead are considered to be part of the overall cost of the product or service being offered. It includes direct cost in producing a good as the cost base. Absorption costing is usually contrasted with variable costing or direct costing. Under this costing, the fixed manufacturing overhead costs are not allocated or assigned to (not absorbed by) the products manufactured. Variable costing is useful for management’s decision-making. Fixed manufacturing overhead costs provide future benefits. The absorption costing method is useful and required for external financial reporting and for income tax reporting.

Absorption costing can be helpful when a company wants to know whether a retail price accurately reflects the costs involved in the production of a good. It is critical with companies who lack financial reserves, and cannot afford to take a loss or to sell products without accounting for overhead.

One disadvantage of the absorption costing method is that managers can increase production levels without taking into account total sales (whether there is enough demand for all the goods they are producing). With higher production levels in the organization, the current year's expenses can be deferred to next year, thus lowering the current year's costs.

Questions

• What is full absorption costing?
• Why is full absorption costing contrasted to variable manufacturing costs?
• How is it helpful to a firm?