Absorption Costing
Full Costing

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Inventory valuation / costing including all manufacturing costs. Explanation of Absorption Costing.

The Absorption Costing method (also: Full Costing) is an inventory valuation and costing model that includes all manufacturing costs:

Direct materials. Those materials that become an integral part of a finished product, and which can be easily traced back into the finished product.
Direct labor. Those factory labor costs that can be easily traced back to individual units of product. Also known as touch labor.
Both variable and fixed manufacturing overhead.

in the cost of a unit of product. As a result, under absorption costing, fixed overhead is a product cost until the products are sold.

Absorption costing is also known as the full cost method.

Should Fixed Manufacturing Costs be Included in Inventories?

Advocates of Absorption Costing say that it should, because all of the production costs are needed to create the products. Thus, they have "future economic benefits."

Advocates of Variable Costing argue that for a fixed manufacturing-cost to be an asset, it has to meet a future cost avoidance criterion. Much in the same way as prepaid insurance. In the case of fixed manufacturing costs, they do not meet this criterion because they are incurred each time the production line opens. Thus, they should be regarded as expenses in that period, and only the variances in expenses should be inventoried.

Problems with absorption costing also include potential manipulations by plant managers, such as increasing production regardless of sales levels. In this way costs can be deferred to the next year, and a higher current profit can be shown for the sake of bonuses and promotions.

Consequences of using Absorption Costing for Profit calculation

The difference is important for calculating profit when the beginning inventory level and the ending inventory level are different:

If beginning & ending inventory levels are equal: absorption costing profit = variable costing profit;
If inventory levels are run down over the period: variable costing profit will be higher than absorption costing profit;
If inventory levels are increased over the period: absorption costing profit will be higher than variable costing profit.

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Recent User Comments

    			 
             Deepak Jain - India
  	       
  		     Absorption Cost Frequency
  	  		 "How often (what frequency) should we calculate absorption cost?"
  			   
    	  		 0

    			 
  			   Janet - USA
  	       
  		     Absorption of Fixed Costs
  	  		 "How does production affect the absorption of fixed costs?"
  			   
    	  		 4

    			 
  			   Nokuthula - Swaziland
  	       
  		     Absorption costing
  	  		 "Are marketing overheads also direct labour cost. meaning should I include them in doing the calculation?"
  			   
    	  		 1

    			 
  			   angela - UK
  	       
  		     Absorption costing
  	  		 "Aren't Absorption costing and Full costing different?"
  			   
    	  		 1

    			 
  			   Prabhash - India
  	       
  		     Absorption costing
  	  		 "It is a tool which converts fixed production overheads, which are period based expenses, into product cost on per unit basis. As a result of which, one is able to determine the product cost and hence the price. 

After the period has ended, under or over applied overheads are found out & following treatments are made: 
1. Apportioned to cost of goods sold, Finished Goods &  Work in progress.
2. Carried forward to next accouting period.
3. Adjusted with cost of goods sold only."
  			   
    	  		 13

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                      └► Stefano (Switzerland)
                      
                    Absorption of Fixed Costs
                    "The more your produce, the more your fixed costs are 'diluted', and therefore minimized at a 'per unit' level.

Absorption Costing is a very dangerous accounting system, as it can drive to increase production to an unnecessary level, to reduce cost per unit... But bringing to inventory increase!

The more you produce, the more 'absorption profit' you generate. But if you do not sell what you produced, it is just a virtual profit."

                     
                      └► Pakistan (Nasir)
                      
                    Include Marketing Overhead in Full Costing?
                    "No, the reason is that marketing overheads are indirect costs or non production overheads so you won't include this in doing the calculation of absorption costing. In absorption or full costing method you should only include production costs."

                     
                      └► CHEN Patrick (China)
                      
                    Absorption Costing = Full Costing
                    "Absorption Costing equals Full Costing."

                     
                      └► Richard D. Cushing (USA)
                      
                    Absorption Costing and Price
                    ""Absorption costing" or any other costing method cannot "determine... the price."  The market always determines "the price."  The only thing manufacturing cost can determine is whether or not an organization can manufacture an item at a cost low enough that, when sold at a price the market accepts, the price will cover truly variable costs plus operating expenses plus profit.  If the result is "yes," then the item will continue to be manufactured by the organization in question.  If the answer is "no," then the item will cease to be manufactured by the organization."

Absorption Costing Full Costing