What is absorption costing

What is absorption costing

Description/Paper Instructions

Absorption costing

What is absorption costing?

Absorption costing is a method of inventory costing that includes all manufacturing costs (variable and fixed) in the cost of products. This means that fixed manufacturing overhead costs, which are typically expensed as incurred, are deferred in inventory until the products are sold.

Why use absorption costing?

There are several reasons why companies use absorption costing. First, it is required by generally accepted accounting principles (GAAP) for external reporting purposes. Second, absorption costing is a more accurate way to reflect the full cost of producing a product, as it includes all of the manufacturing costs that are incurred. Third, absorption costing can be helpful for making decisions about pricing, product mix, and capacity utilization.

How does absorption costing work?

Absorption costing assigns all manufacturing costs to products using a predetermined overhead rate. The predetermined overhead rate is calculated by dividing the total estimated manufacturing overhead costs by the total estimated units of production.

To illustrate how absorption costing works, let’s consider a company that produces widgets. The company estimates that it will incur $100,000 in manufacturing overhead costs and produce 10,000 widgets during the year. The predetermined overhead rate is therefore $10 per widget ($100,000 / 10,000 widgets).

When the company produces a widget, it assigns $10 of manufacturing overhead costs to the product. These costs are deferred in inventory until the widget is sold. When the widget is sold, the $10 of manufacturing overhead costs are expensed.

Advantages and disadvantages of absorption costing

Absorption costing has both advantages and disadvantages. Some of the advantages of absorption costing include:

It is a more accurate way to reflect the full cost of producing a product.

It can be helpful for making decisions about pricing, product mix, and capacity utilization.

It is required by GAAP for external reporting purposes.

Some of the disadvantages of absorption costing include:

It can distort product costs, especially when there is a significant difference between production levels and sales levels.

It can make it difficult to compare the profitability of different products.

It can make it difficult to identify the costs of unused capacity.

When should absorption costing be used?

Absorption costing should be used when it is important to reflect the full cost of producing a product. This is typically the case for companies that manufacture products with a long production cycle or that have significant fixed manufacturing overhead costs.

Absorption costing should not be used when it is important to compare the profitability of different products. This is because absorption costing can distort product costs, especially when there is a significant difference between production levels and sales levels.

Conclusion

Absorption costing is a method of inventory costing that includes all manufacturing costs (variable and fixed) in the cost of products. This method is required by GAAP for external reporting purposes and can be helpful for making decisions about pricing, product mix, and capacity utilization. However, absorption costing can distort product costs and make it difficult to compare the profitability of different products.

What is absorption costing

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And/or there is a significant use of highly questionable sources. 15 out 20 points:  Credible Scholarly sources are used effectively support claims and are, for the most part, clear and fairly represented.  APA 6th Edition is used with only a few minor errors.  There are minor errors in reference and/or citations. And/or there is some use of questionable sources. 20 points:  Credible scholarly sources are used to give compelling evidence to support claims and are clearly and fairly represented.  APA 6th Edition format is used accurately and consistently. The student uses above the maximum required references in the development of the assignment. 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The paper has slight errors within the paper. This can include small errors or omissions with the cover page, abstract, page number, and headers. There could be also slight formatting issues with the document spacing or the font Additionally the paper might slightly exceed or undershoot the specific number of required written pages for the assignment. 10 points: Student provides a high-caliber, formatted paper. This includes an APA 6th edition cover page, abstract, page number, headers and is double spaced in 12’ Times Roman Font. Additionally, the paper conforms to the specific number of required written pages and neither goes over or under the specified length of the paper.
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