Absorption costing sometimes called “full costing,” is a managerial accounting method for capturing all costs associated with manufacturing a particular product.
The direct and indirect costs, such as direct materials, direct labor, rent, and insurance, are accounted for by using this method.
• Absorption costing is required by generally accepted accounting principles (GAAP) for external reporting.
• Absorption costing differs from variable costing because it allocates fixed overhead costs to each unit of a product produced in the period.
• Absorption costing allocates fixed overhead costs to a product whether or not it was sold in the period.
• This type of costing method means that more cost is included in the ending inventory, which is carried over into the next period as an asset on the balance sheet.
• Because more expenses are included in ending inventory, expenses on the income statement are lower when using absorption costing.
Understanding Absorption Costing :
Absorption costing includes anything that is a direct cost in producing a good in its cost base. Absorption costing also includes fixed overhead charges as part of the product costs. Some of the costs associated with manufacturing a product include wages for employees physically working on the product, the raw materials used in producing the product, and all of the overhead costs (such as all utility costs) used in production. In contrast to the variable costing method, every expense is allocated to manufactured products, whether or not they are sold by the end of the period.
Absorption Costing vs. Variable Costing :
The differences between absorption costing and variable costing lie in how fixed overhead costs are treated. Absorption costing allocates fixed overhead costs across all units produced for the period. Variable costing, on the other hand, lumps all fixed overhead costs together and reports the expense as one line item separate from the cost of goods sold (COGS) or still available for sale.
Variable costing does not determine a per-unit cost of fixed overheads, while absorption costing does. Variable costing will yield one lump-sum expense line item for fixed overhead costs when calculating net income on the income statement. Absorption costing will result in two categories of fixed overhead costs: those attributable to the cost of goods sold, and those attributable to inventory.
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