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What is meant by Absorption Costing.

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What is meant by Absorption Costing.
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Tejas Gaikwad
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What is meant by Absorption Costing. - August 7th, 2013

Absorption Costing

What is meant by Absorption Costing.
As the name suggests, absorption costing is the method of costing in which the entire cost of manufacturing a product or providing a service is absorbed in it. In contrast to the variable costing (Activity based costing) method, it includes both fixed and variable costs for absorption in addition to the direct costs. As all the costs incurred are absorbed, this method is also sometimes referred to as Full absorption costing or Total absorption costing (TAC).

One of the main reasons for absorbing overheads into the cost of is for inventory valuation purposes. Absorption costing is permissible under GAAP.

Traditional TAC was developed in the age of manufacturing and mostly used to arrive at the full manufacturing cost of producing goods; an alternative method of arriving at full cost known as activity-based costing (ABC) is often thought to be more appropriate for services. Absorption costing is a means of incorporating a fair share of indirect cost or overheads into the cost of a unit of product or service provided.

Absorption costing – A costing method that includes all manufacturing costs—direct materials, direct labour, and both variable and fixed manufacturing overhead—in unit product costs. According to the ICMA London "Absorption costing is a principle whereby fixed as well as variable costs are allocated to cost unit the term may be applied where production costs only or costs of all function are so allocated".


Variable costing is generally used for the managerial decision making whereas as per the Generally Accepted Accounting Principles (GAAP), an organization is bound to use the absorption costing method for financial reporting purposes.


Example

No. of units produced = 100

Direct Variable cost per unit = Rs. 2

Variable Overhead cost per unit = Rs. 1

Fixed Overhead cost = Rs. 200

Under Absorption Costing,

Total Cost per unit = 2 + 1 + (200/100)= Rs. 5

Under Variable Costing,

Total Cost per unit = 2 + 1 = Rs. 3
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Re: What is meant by Absorption Costing. - April 18th, 2016

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Originally Posted by tejas.gaikwad.1044 View Post
Absorption Costing

What is meant by Absorption Costing.
As the name suggests, absorption costing is the method of costing in which the entire cost of manufacturing a product or providing a service is absorbed in it. In contrast to the variable costing (Activity based costing) method, it includes both fixed and variable costs for absorption in addition to the direct costs. As all the costs incurred are absorbed, this method is also sometimes referred to as Full absorption costing or Total absorption costing (TAC).

One of the main reasons for absorbing overheads into the cost of is for inventory valuation purposes. Absorption costing is permissible under GAAP.

Traditional TAC was developed in the age of manufacturing and mostly used to arrive at the full manufacturing cost of producing goods; an alternative method of arriving at full cost known as activity-based costing (ABC) is often thought to be more appropriate for services. Absorption costing is a means of incorporating a fair share of indirect cost or overheads into the cost of a unit of product or service provided.

Absorption costing – A costing method that includes all manufacturing costs—direct materials, direct labour, and both variable and fixed manufacturing overhead—in unit product costs. According to the ICMA London "Absorption costing is a principle whereby fixed as well as variable costs are allocated to cost unit the term may be applied where production costs only or costs of all function are so allocated".


Variable costing is generally used for the managerial decision making whereas as per the Generally Accepted Accounting Principles (GAAP), an organization is bound to use the absorption costing method for financial reporting purposes.


Example

No. of units produced = 100

Direct Variable cost per unit = Rs. 2

Variable Overhead cost per unit = Rs. 1

Fixed Overhead cost = Rs. 200

Under Absorption Costing,

Total Cost per unit = 2 + 1 + (200/100)= Rs. 5

Under Variable Costing,

Total Cost per unit = 2 + 1 = Rs. 3
Hey friend, as we all know that absorption costing is a technique of determining the price of a product or business by considering indirect expenditures as well as primary costs. For more detailed information, please download my presentation.
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