Absorption Costing - Revision history

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User: Absorption costing means that all of the manufacturing costs are absorbed by the units produced. In other words, the cost of a finished unit in inventory will include direct materials, direct labor, and both variable and fixed manufacturing overhead.

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Absorption costing means that all of the manufacturing costs are absorbed by the units produced. In other words, the cost of a finished unit in inventory will include direct materials, direct labor, and both variable and fixed manufacturing overhead. As a result, absorption costing is also referred to as full costing or the full absorption method.

Absorption costing is often contrasted with variable costing or direct costing. Under variable or direct costing, the fixed manufacturing overhead costs are not allocated or assigned to (not absorbed by) the products manufactured. Variable costing is often useful for management's decision-making. However, absorption costing is required for external financial reporting and for income tax reporting.<ref>Definition - What is Absorption Costing?[http://http://www.accountingcoach.com/blog/absorption-costing Accounting Coach]</ref>

[[File: AbsorptionCosting.gif|300px|Absorption Costing]]<br />
source: [http://maaw.info/Chapter2.htm Management and Accounting Web]

'''Absorption Costing Components''' <ref>Absorption Costing Components [http://www.accountingtools.com/absorption-costing Accounting Tools]</ref>

The key costs assigned to products under an absorption costing system are:
*Direct materials. Those materials that are included in a finished product.
*Direct labor. The factory labor costs required to construct a product.
*Variable manufacturing overhead. The costs to operate a manufacturing facility, which vary with production volume. Examples are supplies and electricity for production equipment.
*Fixed manufacturing overhead. The costs to operate a manufacturing facility, which do not vary with production volume. Examples are rent and insurance.
It is possible to use activity-based costing (ABC) to allocate overhead costs for inventory valuation purposes under the absorption costing methodology. However, ABC is a time-consuming and expensive system to implement and maintain, and so is not very cost-effective when all you want to do is allocate inventory to be in accordance with GAAP or IFRS.

One should charge sales and administrative costs to expense in the period incurred; do not assign them to inventory, since these items are not related to goods produced, but rather to the period in which they were incurred.

'''Absorption Costing Steps'''

The steps required to complete a periodic assignment of costs to produced goods is:
*Assign costs to cost pools. This is comprised of a standard set of accounts that are always included in cost pools, and which should rarely be changed.
Calculate usage. Determine the amount of usage of whatever activity measure is used to assign overhead costs, such as machine hours or direct labor hours used.
*Assign costs. Divide the usage measure into the total costs in the cost pools to arrive at the allocation rate per unit of activity, and assign overhead costs to produced goods based on this usage rate.

===References===
<references/>

===Further Reading===

@@ Line 1: / Line 1: @@
-'''Absorption Costing''' means that all of the [[manufacturing]] costs are absorbed by the units produced. In other words, the cost of a finished unit in [[inventory]] will include direct materials, direct labor, and both variable and fixed manufacturing overhead. As a result, absorption costing is also referred to as '''full costing''' or the '''full absorption method'''.
+'''Absorption Costing''' means that all of the manufacturing costs are absorbed by the units produced. In other words, the cost of a finished unit in inventory will include direct materials, direct labor, and both variable and fixed manufacturing overhead. As a result, absorption costing is also referred to as '''full costing''' or the '''full absorption method'''.
-Absorption costing is often contrasted with variable costing or direct costing. Under variable or direct costing, the fixed manufacturing overhead costs are not allocated or assigned to (not absorbed by) the products manufactured. Variable costing is often useful for [[management]]'s decision-making. However, absorption costing is required for external financial reporting and for income tax reporting.<ref>Definition - What is Absorption Costing?[http://http://www.accountingcoach.com/blog/absorption-costing Accounting Coach]</ref>
+Absorption costing is often contrasted with variable costing or direct costing. Under variable or direct costing, the fixed manufacturing overhead costs are not allocated or assigned to (not absorbed by) the products manufactured. Variable costing is often useful for management's decision-making. However, absorption costing is required for external financial reporting and for income tax reporting.<ref>Definition - What is Absorption Costing?[http://http://www.accountingcoach.com/blog/absorption-costing Accounting Coach]</ref>
 [[File: AbsorptionCosting.gif|300px|Absorption Costing]]<br />
@@ Line 10: / Line 10: @@
 The key costs assigned to products under an absorption costing system are:
-*Direct materials. Those materials that are included in a finished [[product]].
+*Direct materials. Those materials that are included in a finished product.
 *Direct labor. The factory labor costs required to construct a product.
 *Variable manufacturing overhead. The costs to operate a manufacturing facility, which vary with production volume. Examples are supplies and electricity for production equipment.
 *Fixed manufacturing overhead. The costs to operate a manufacturing facility, which do not vary with production volume. Examples are rent and insurance.
-It is possible to use [[Activity Based Costing (ABC|activity-based costing (ABC)]] to allocate overhead costs for inventory valuation purposes under the absorption costing methodology. However, ABC is a time-consuming and expensive system to implement and maintain, and so is not very cost-effective when all you want to do is allocate inventory to be in accordance with [[Generally Accepted Accounting Principles (GAAP)|GAAP]] or [[International Financial Reporting Standards (IFRS)|IFRS]].
+It is possible to use [[Activity Based Costing (ABC)|activity-based costing (ABC)]] to allocate overhead costs for inventory valuation purposes under the absorption costing methodology. However, ABC is a time-consuming and expensive system to implement and maintain, and so is not very cost-effective when all you want to do is allocate inventory to be in accordance with [[Generally Accepted Accounting Principles (GAAP)|GAAP]] or [[International Financial Reporting Standards (IFRS)|IFRS]].
 One should charge sales and administrative costs to expense in the period incurred; do not assign them to inventory, since these items are not related to goods produced, but rather to the period in which they were incurred.
@@ Line 28: / Line 28: @@
 ===See Also===
-[[Activity-Based Management (ABM)]]<br />
+*[[Activity-Based Management (ABM)]]
-[[Activity Based Costing (ABC)]]<br />
+*[[Activity Based Costing (ABC)]]
-[[Cost Analysis]]<br />
+*[[Cost Analysis]]
-[[Cost Accounting Standards (CAS)]]<br />
+*[[Cost Accounting Standards (CAS)]]
-[[IT Cost Allocation]]<br />
+*[[IT Cost Allocation]]
-[[IT Cost Optimization]]<br />
+*[[IT Cost Optimization]]
-[[Management Accounting]]<br />
+*[[Management Accounting]]
-[[Accounting]]<br />
+*[[Accounting]]
-[[Accounting Equation]]<br />
+*[[Accounting Equation]]
-[[Accounting Valuation]]<br />
+*[[Accounting Valuation]]
-[[Accounts Receivable Factoring (FACTORING)]]<br />
+*[[Accounts Receivable Factoring (FACTORING)]]
-[[Accounts Receivable Financing]]
+*[[Accounts Receivable Financing]]

@@ Line 1: / Line 1: @@
-Absorption costing means that all of the [[manufacturing]] costs are absorbed by the units produced. In other words, the cost of a finished unit in [[inventory]] will include direct materials, direct labor, and both variable and fixed manufacturing overhead. As a result, absorption costing is also referred to as full costing or the full absorption method.
+'''Absorption Costing''' means that all of the [[manufacturing]] costs are absorbed by the units produced. In other words, the cost of a finished unit in [[inventory]] will include direct materials, direct labor, and both variable and fixed manufacturing overhead. As a result, absorption costing is also referred to as '''full costing''' or the '''full absorption method'''.
 Absorption costing is often contrasted with variable costing or direct costing. Under variable or direct costing, the fixed manufacturing overhead costs are not allocated or assigned to (not absorbed by) the products manufactured. Variable costing is often useful for [[management]]'s decision-making. However, absorption costing is required for external financial reporting and for income tax reporting.<ref>Definition - What is Absorption Costing?[http://http://www.accountingcoach.com/blog/absorption-costing Accounting Coach]</ref>
@@ Line 9: / Line 9: @@
 '''Absorption Costing Components''' <ref>Absorption Costing Components [http://www.accountingtools.com/absorption-costing Accounting Tools]</ref>
-The key costs assigned to products under an absorption costing [[system]] are:
+The key costs assigned to products under an absorption costing system are:
 *Direct materials. Those materials that are included in a finished [[product]].
 *Direct labor. The factory labor costs required to construct a product.
 *Variable manufacturing overhead. The costs to operate a manufacturing facility, which vary with production volume. Examples are supplies and electricity for production equipment.
 *Fixed manufacturing overhead. The costs to operate a manufacturing facility, which do not vary with production volume. Examples are rent and insurance.
-It is possible to use activity-based costing (ABC) to allocate overhead costs for inventory valuation purposes under the absorption costing [[methodology]]. However, ABC is a time-consuming and expensive system to implement and maintain, and so is not very cost-effective when all you want to do is allocate inventory to be in accordance with GAAP or IFRS.
+It is possible to use [[Activity Based Costing (ABC|activity-based costing (ABC)]] to allocate overhead costs for inventory valuation purposes under the absorption costing methodology. However, ABC is a time-consuming and expensive system to implement and maintain, and so is not very cost-effective when all you want to do is allocate inventory to be in accordance with [[Generally Accepted Accounting Principles (GAAP)|GAAP]] or [[International Financial Reporting Standards (IFRS)|IFRS]].
 One should charge sales and administrative costs to expense in the period incurred; do not assign them to inventory, since these items are not related to goods produced, but rather to the period in which they were incurred.
@@ Line 22: / Line 22: @@
 The steps required to complete a periodic assignment of costs to produced goods is:
-*Assign costs to cost pools. This is comprised of a [[standard]] set of accounts that are always included in cost pools, and which should rarely be changed.
+*Assign costs to cost pools. This is comprised of a standard set of accounts that are always included in cost pools, and which should rarely be changed.
 Calculate usage. Determine the amount of usage of whatever activity measure is used to assign overhead costs, such as machine hours or direct labor hours used.
 *Assign costs. Divide the usage measure into the total costs in the cost pools to arrive at the allocation rate per unit of activity, and assign overhead costs to produced goods based on this usage rate.