absorption costing


Absorption Costs Assignment Help:           

Absorption costing is a particular method of costing wherein, the overall cost of a particular product is being calculated which is being manufactured. It includes costs in the name of the direct material, direct labor, fixed and variable overheads. This particular method carries out the calculation of manufacturing of a particular product inclusive of raw material consumed and labor being used in the process of doing manufacturing task. All the products in the inventory include the cost of resources which are being used for the purpose of ensuring that, production is being carried out at a particular point in time.

  1. Absorption costing helps in ascertainment of the actual cost being incurred in the course of production of a single product.
  2. This is being considered helpful for valuation of inventory in a proper and appropriate way by the organization.

This method is also being known as full absorption costing method being used by the organization at a particular point in time. Here, selling and administrative costs are being considered as period costs, therefore; those costs are not being included under the category of calculation of product cost.


Inclusions of Product Cost in Absorption Costing

  1. Direct material: It is the cost of raw material which is being used in the course of ensuring that the products are being produced at a particular point in time.
  2. Direct Labor: It is the cost of labor which is being used for the purpose of manufacturing of the product
  3. Fixed manufacturing overhead: These are the costs which do not change with the volume of production.
  4. Variable manufacturing overhead: It is the kind of cost which changes with the volume of production of the product. It includes electricity, power, fuel etc.


Advantages of Absorption Costing

  1. The inclusion of fixed overhead costs: The first advantage is that it includes fixed overhead costs. It identifies that fixed overhead costs play a similar role in the course of production of a particular product being identified.
  2. External reporting: This helps in the valuation of stocks and ensuring that external reports of the organization are being prepared in a proper and appropriate way.
  3. Helps in the calculation of accurate profits: Absorption cost of the organization has the inclusion of fixed and variable overhead costs. It is not being included in expenses instead; it is being included in the purchase cost of the organization. Therefore, it helps in ensuring that, accurate profits are being estimated by the organization in the area of doing the tasks at a particular point in time.


Disadvantages of Absorption Costing

  1. Fixed costs are period costs: The first disadvantage is regarding the fact that, fixed costs are being considered to be period costs. These costs are not having any kind of future benefit for the organization. Therefore, these costs should not be included in the overall cost of the product of the organization.
  2. Affects decision making: absorption costing is not useful for the organization in the course of decision making being adopted by it.
  3. Impact on long-term profits: The managers of the organization are being in the position to have an enhancement in net profits but long-term profits of the organization are not being enhanced to a certain extent.


Absorption Costs vs. Variable costs

  1. In the case of absorption costing, all manufacturing costs are being included in the cost of production of the organization. On the other hand, in case of variable costing, product cost includes only direct costs which include direct material, direct labor and variable overheads of the organization.
  2. The cost of the product is higher in case of absorption costing in comparison to variable costing.
  3. The value of closing stock is higher in absorption costing. On the other hand, the value of closing stock is lower in case of variable costing.


Example of Absorption Costing 

 

Absorption Costing

Variable Costing

Direct Material

$10

$10

Direct Labor

$8

$8

Variable Manufacturing Overhead

$5

$5

Fixed Manufacturing Overhead

$10

-

Variable marketing and administrative expenses

-

-

Total

$33

$23

 

Marketing and administrative expense are period costs therefore, these are not being included in case of absorption costing and in case of variable costs.

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