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.
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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.

Collins Dictionary of Business, 3rd ed. © 2002, 2005 C Pass, B Lowes, A Pendleton, L Chadwick, D O’Reilly and M Afferson
References in periodicals archive ?
This did reveal even more interesting details about the reasons for its decline, with five respondents that use absorption costing indicating they had previously used activity-based costing and had changed for the reasons indicated in Table 5.
A case study conducted by Frega, Lemos and Souza (2007) of a brick and ceramic company identified this gain, finding that the company had migrated from absorption costing to direct costing combined with ABC for the purpose of improving its competitiveness.
Using absorption costing, the product costs include only the costs of manufacture, not those of marketing and distribution costs as having been expensed during the accounting period in which the costs are incurred, rather than including them in the cost of items in the ending inventory.
Distinguishing between the variable and fixed parts of company costs is also fundamental to the variable costing method, which is the simplest way of bypassing the shortfalls of absorption costing methods.
TABLE 1 Absorption Costing - Income Statement Sales 100% Less cost of goods sold 74% Gross Margin 26% Less selling and administrative expenses 34% Net operating income -8% Since the variable and fixed costs were combined in the absorption method, further breakdown would have to be made for any understanding of each cost.
By casting budgets in terms of traditional absorption costing and analyzing deviations from static budgeted amounts, many organizations fail to realize the full potential benefit of this process.
A unique feature of the book is the organization format for the presentation of cost allocation and absorption costing methods.
Such a system is characterized by absorption costing. Absorption costing takes its name from the manner in which inventory is valued for reporting on the balance sheet and the cost of goods sold is valued for reporting in the income statement--in other words, the manner in which products "absorb" cost as they are manufactured.
The difference in income between the generally accepted accounting principles (absorption costing) Statement of Income and the variable costing Statement of Income can be directly identified as fixed manufacturing costs and can be traced to the beginning and ending inventories.