Definition
Absorption costing, also known as full costing refers to a system in which all the fixed manufacturing overheads are allocated to products. The alternative system which assigns only variable manufacturing costs to products then fixed costs added separately is termed marginal costing.
Variable costing vs. Absorption costing
Before discussing the arguments for absorption costing, an illustration of both methods would provide a better comparative insight of major differences using the examples below:-
The following information is available for periods 1-6 for a company that produced a single product
($)
Unit selling price10
Unit variable cost 6
Fixed costs for each period 300
Normal activity = 150 units per period, production & sales are as follows:-
P1 P2 P3 P4 P5 P6
Units sold150120180150 140160
Units produced150150150150170 140
There were no opening stocks for P1, actual manufacturing fixed overhead incurred was $300 and non-manufacturing overheads are $100 per period.
The variable and absorption cost statements for periods 1-6 are shown in Exhibits 1 and 2.
Exhibit 1
Variable costing statements:
P1P2P3P4P5P6
($)($)($)($)($)($)
Opening stock--180 --180
Production cost900 900 900 900 1020 840
Closing stock-(180)--(180)(60)
Cost of sales900 720 1080 900 840 960
Fixed costs300 300 300 300 300 300
Total costs1200 1020 1380 1200 1140 1260
Sales1500 1200 1800 1500 1400 1600
Gross profit300 180 420 300 260 340
Less non-manufacturing costs100 100 100 100 100 100
Net profit200 80 320 200 160 240
Exhibit 2
Absorption costing statements:
P1P2P3P4P5P6
($)($)($)($)($)($)
Opening stock--240 --240
Production cost1200 1200 1200 1200 1360 1120
Closing stock-(240)--(240)(80)
Cost of sales1200 960 1440 1200 1120 1280
Adjustment (over/under recovery)
of overheads(40)20
Total costs1200 960 1440 1200 1080 1300
Sales1500 1200 1800 1500 1400 1600
Gross profit300 240 360 300 320 300
Less non-manufacturing costs100 100 100 100 100 100
Net profit200 140 260 200...
Variable vs. Absorption
While some may view this paper as being slightly to technical, it is informative and can definitely be used as a resource for research along with other material.
Good Job.
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