absorption costing

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Related to absorption costing: marginal costing

Absorption Costing

In accounting, the practice of recording as expenses all costs associated with producing a good. This includes both the costs of the raw materials and the fixed costs, such as employee wages, the cost of machinery, and so forth. External reporting must use absorption costing. It contrasts with variable costing, which does not consider fixed costs.
Absorption costingclick for a larger image
Fig. 2 Absorption costing. Table showing an example.

absorption costing

a system of product COSTING which assigns materials and labour, and OVERHEAD costs to units of product manufactured (as in STANDARD COSTS). Fixed overhead costs are assigned to products by means of an appropriate COST RATE which divides planned overhead costs by planned output. Fig. 2 shows an illustration of absorption costing.

With absorption costing, fixed overhead costs are included in the value of work in progress and finished goods stock. By contrast, with MARGINAL COSTING systems fixed overhead costs are charged as a single block against revenues in the period when they are incurred, and work in progress and finished goods stocks are valued at direct materials and labour cost only.

References in periodicals archive ?
These opportunities arise when production exceeds sales and occurs as a result of the differences between absorption costing and variable costing.
When using GAAP based absorption costing as compared to internally used variable costing, if more was produced than sold, then there was a chance for income manipulation.
Traditional absorption costing systems tend to overstate the costs of high-volume products and understate those of low-volume products.
In absorption costing, manufacturing costs consist of direct costs (variable costs) and indirect manufacturing costs(fixed costs).
Most notably, the absorption costing income statement, which treats direct materials, direct labor, and variable and fixed overhead as product costs and all selling and administrative expenses as period costs, penalized managers' inventory-reduction efforts with a major hit to the bottom line.
In our article in the previous issue, we used absorption costing principles to construct a detailed budget for a fictitious manufacturing company.
In its European subsidiaries, Andreas STIHL employs GPK along with traditional GAAP-type reporting using a full absorption costing system.
The following worked example of budget preparation using absorption costing is of a fictitious manufacturing company that has sales volume as its principal budget factor.
Although they are concerned that firms using absorption costing may produce distorted profitability analyses, perhaps multinationals have a different view of costs compared with smaller companies, since they have a wider range of strategic options.
Absorption costing cannot be used for this analysis, since it includes production overheads--ie, costs that are fixed in the short term.
It usually involves imposing a particular format--always a variation on the absorption costing theme--showing a total cost per unit and hence a profit per unit.