Absorption Costing Discussion Paper Homework Assignment Help
Absorption Costing Discussion Paper Homework Assignment Help
paper instructions
Absorption Costing Definition
The method in cost accounting by which the manufacturing cost of a product is computed is termed as absorption costing. This method includes labor cost and material cost along with all the other direct and indirect costs such as rent insurance that are associated with the manufacturing of a product. As per the Generally Accepted Accounting Principles, this method of costing is required for external reporting.
Overview of Absorption Costing
Absorption costing is a managerial accounting method. The absorption costing method is different from other costing methods as it considers fixed overhead costs along with variable costs while computing product cost. This method is also known as the full costing method as it considers all the costs while computing unit costs. The costs which are included in the absorption costing method are direct labor costs, direct material costs, fixed overhead costs, and variable overhead costs. The absorption cost can be calculated by adding direct costs and production overhead costs. The direct costs may include direct labor costs and direct material costs, whereas the production overhead costs may include variable overhead costs and fixed overhead costs.
You can expect under-absorption or over-absorption costs if you are using the absorption costing method. Under absorption of costs implies that the absorption of overheads is less than the actual amount incurred on account of overheads while over-absorption of costs implies that the absorption of overheads is more than the actual overheads. The image below shows the effect of the absorption costing method on an income statement:
Is there any formula to calculate absorption costing? Yes, the formula to calculate absorption costing is as shown below:
Absorption Costing Formula Graphic
Example
Let us take an example here. Company XYZ produces a board game In the month of April, they manufactured 12,000 units out of which 10,000 were sold in April and remaining 2,000 are added to inventory at the end of the month. The direct labor and material cost is $5 for each unit. The fixed overhead costs is $20,000 for each month for the production facility. The additional cost of $1.67 is assigned to each unit for fixed overhead costs ($20,000/12,000).
The absorption costing is then calculated by adding the labor and material cost with the fixed overhead cost. The absorption cost for each board game is calculated as below: Absorption Costing Examples
The total cost of goods sold will be calculated by multiplying the number of goods sold and the total absorption cost incurred on each board game. The calculation for the total cost of goods sold is as follows: Total Cost of Goods
Total cost of goods sold=Absorption cost×Number of goods sold\text{Total cost of goods sold}=\text{Absorption cost}\times \text{Number of goods sold}Total cost of goods sold=Absorption cost×Number of goods sold = $ 6.67×10,000=\text{ }\!\!\$\!\!\text~{6}\text{.67}\times\text{10,000}= $ 6.67×10,000 =$66,700=\$66,700=$66,700
Now, let us understand the types of costing systems. There are six types of costing systems which are used to compute the manufacturing cost of a product.
Costing Systems
First, is the historical costing system. In this type of costing system, the historical cost is considered. The historical cost is that cost at which an asset is acquired originally. This method is used to evaluate the accumulated cost, which are the costs that are already incurred.
The second type of costing system is direct costing. In this type of costing system, only the direct costs or the varying costs are charged to the product. The direct costs may include direct labor cost, direct material cost and all the expenses that vary if the number of products varies.
The third type of costing system is marginal costing. The marginal costing method is the method under which fixed and variable costs are classified separately and variable costs are imposed on cost units. The variable cost varies with an increase or decrease in the number of units produced, whereas the fixed cost is allocated based on the total production for a specified period. This method is used by the management for decision-making purposes.
The fourth method is the standard costing method, under which the cost is predetermined by considering all the factors of production. This method is useful when the manager wants to control the difference in the actual costs incurred and the standard costs. This method helps in calculating deviation and hence the control measures can be decided.
The fifth type of costing system is the absorption costing method. In it, all the manufacturing costs are considered while calculating the cost of a unit produced. The manufacturing cost can be classified as fixed cost and variable cost. This method is generally used for financial reporting.
The sixth type of costing is the uniform costing system where identical costing principles and procedures are adopted by various companies of similar industries to keep uniformity so that a comparison can be made whenever required.
Advantages of Absorption Costing
Let us understand the reasons for which the absorption costing method is used and preferred for external reporting. The absorption costing method is useful as it considers the fixed cost while determining the cost of units produced. If the fixed overhead charges are not taken into consideration, then there are chances that the fixed cost will not be fully covered or can remain under-absorbed. In the absorption costing method, the fixed manufacturing cost is shown as expenses only when goods are sold. This method proves to be beneficial at the time of external reporting, as it reflects profits more accurately when compared to the profits calculated based on the variable costing method. This method ensures that accrual and matching concepts of accounting is followed, as the cost is matched with the revenues for an accounting period.
The absorption costing method is significant because it helps in assessing the efficient or inefficient utilization of production resources. Other costing methods, like the variable costing method, do not help in assessing the effectiveness of capital utilization. The use of the absorption costing system in an organization puts responsibility on the departmental managers as the costs are specifically allocated to various cost centers.
Limitations of Absorption Costing
The absorption costing has limitations too. The absorption costing method is not suitable for managerial decisions. The managers need to make decisions on product-mix selection, buying decisions, performance evaluation, selection of production process to achieve optimum utilization of resources and capacity of manufacturing machinery. This method is not helpful in these decisions as the cost of a product is based on both fixed and variable costs. However, the method of absorption costing considers the fixed costs only. In the absorption costing method, it is difficult to accurately apportion fixed overhead costs to specific product lines and this could lead to an inaccurate assessment of product costs.
Practice question
Now try it for yourself and apply the learnings to the practice question below.Company C has incurred the following costs:
Manufacturing costs:
Direct materials
$19 per unit
Direct labor
$22 per unit
Variable manufacturing overhead
$28 per unit
Fixed manufacturing overhead
$10,800
Selling and administrative costs:
Variable selling and administrative costs
$49 per unit
Fixed selling and administrative costs
$62,718 per unit
If the company produced 900 units, what is the unit product cost under variable costing and absorption costing? (Round your intermediate calculations and final answers to 2 decimal places).Choose an answerAThe unit product cost under variable costing and absorption costing is $81.00 and $69.00 per unit respectively.BThe unit product cost under variable costing and absorption costing is $118.00 and $69.00 per unit respectively.CThe unit product cost under variable costing and absorption costing is $69.00 and $81.00 per unit respectively.DThe unit product cost under variable costing and absorption costing is $69.00 and $69.00 per unit respectively.
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