what is absorption costing what are the advantages of absorption costing?

imptags : what is absorption costing what are the advantages of absorption costing, What do mean by absorption costing, What is absorption costing with examples, What is absorption costing formula,What is absorption costing and marginal costing,

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A managerial accounting technique known as “absorption costing,” also known as “full costing,” is used to record all expenses related to producing a specific product. This strategy accounts for both direct and indirect costs, including direct materials, direct labour, rent, and insurance.

Absorption costing is required by generally accepted accounting principles (GAAP) for external reporting.

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Understanding Absorption Costing :
Anything that is a direct cost of creating a good is included in absorption costing’s cost base. Fixed overhead costs are included in the product costs under absorption costing as well. Wages paid to workers who physically produce a product, raw materials required in production, and all overhead expenditures (such as all utility bills) incurred during production are a few of the costs related to product manufacturing.

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.

Comparing variable costing and absorption costing :
The way fixed overhead costs are handled in absorption costing and variable costing differs. All units produced throughout the time are charged with the fixed overhead expenses according to absorption costing. On the other side, variable costing aggregates all fixed overhead costs and shows the cost as a single line item distinct from cost of goods sold  (COGS) or still available for sale.

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Unlike absorption costing, variable costing determines the per-unit cost of fixed overheads. When calculating net income on the income statement using variable costing, fixed overhead costs will result in a single lump-sum expense line item. Two categories of fixed overhead costs will come from absorption costing: those attributable to the cost of products sold and those attributable to inventory.

The benefits and drawbacks of absorption costing
At the end of the quarter, assets like inventory are still listed on the balance sheet of the firm. The expenses for the items remained in ending inventory will not be shown on the income statement for the current period since absorption costing allocates fixed overhead costs to both cost of goods sold  and inventory. More fixed expenses related to terminating inventory are reflected by absorption costing.

Because the costs associated with ending inventory are tied to the complete cost of the item still in stock, absorption costing assures more accurate accounting for ending inventory. Additionally, additional costs are recorded in things that aren’t sold, which lowers the real costs listed in the current period on the income statement. In comparison to calculations using variable costing, this leads to a greater net income  estimate.

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Absorption costing is less advantageous than variable costing when management is deciding on internal incremental  pricing since it includes fixed overhead expenditures in the cost of its products. This is so because variable costing only accounts for the additional expenses incurred in producing a product’s subsequent incremental  unit.

Additionally, the application of absorption costing results in a circumstance when merely producing more products than are sold at the end of the period will raise net income . The unit fixed cost will drop as more products are produced since fixed costs are shared among all units produced. Because the fixed-cost element of the cost of products sold will decline as output grows, net income  will grow naturally.

Absorption Costing Example
Let’s say ABC Company manufactures widgets. It produces 10,000 widgets in January, of which 8,000 are sold by the end of the month, leaving 2,000 unsold. $5 worth of directly attributable labour and materials are used to make each widget. In addition, the production plant has monthly fixed overhead expenses of $20,000 to pay. For fixed overhead expenses, ABC will charge an additional $2 for each widget using the absorption costing approach ($20,000 total 10,000 widgets produced in the month).

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$5 for labour and supplies plus $2 for fixed overhead costs equals the $7 absorption cost per unit. The total cost of goods sold is $56,000 ($7 total cost per unit x 8,000 widgets sold), which reflects the 8,000 widgets that were sold. Widgets totaling $14,000 will be in the ending inventory (2,000 widgets remaining at a cost of $7 per unit).

what is absorption costing what are the advantages of absorption costing?

imptags : what is absorption costing what are the advantages of absorption costing, What do mean by absorption costing, What is absorption costing with examples, What is absorption costing formula,What is absorption costing and marginal costing,

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About souravpandey

Hi i'm sourav pandey a mechanical engineer and motorcycle enthusiast.

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