• Accounting ,
• 31 Aug

Absorption Costing is helpful in calculating the value of inventory on the Balance Sheet and determing the selling price of products. We also call this Full Costing. There are two big differences between this and Variable Costing. One is that we add in fixed costs to derive the total cost per unit. The other is that Variable costing is much more helpful in analysis and decision making.

We recognize our expenses when the inventory is sold through the cost of goods sold (cogs). This aligns with the matching principle in Accounting.

Absorption Costing

where

Direct Material

Direct Labor

Variable Manufacturing Overhead

Fixed Manufacturing Overhead

Quantity

Direct Material

Typically you can get this from the income statement. These are all of the materials that we consume in producing the product. These should be easy to identify and often found on the Bill of Materials. Some examples of indirect materials are general cleaning supplies, lubrication and general maintenance materials.

Direct Labor

This is labor that we can directly connect to producing the product. This can include assembly line staff, machine operators, etc. Do not include period costs such as administration, maintenance, and other services that do not change in relation to production levels.

Variable Manufacturing Overhead

These are overhead or indirect costs that change when manufacturing quantities change. This is an important part of costing and pricing. These costs can include indirect materials, shipping, handling, and utilities. The difference between general manufacturing overhead and variable manufacturing overhead is that the changes need to correlate to changes in production. Therefore we leave out costs that do not change when you make more or less units. This can include administrative and other SG&A costs that are often very small in relation to total fixed costs values.

Fixed Manufacturing Overhead

Fixed costs that do not directly relate to changes in production. This is line items such as rent, insurance, property taxes, accounting fees, and depreciation on a factory. Note that a  fixed cost in one company may not be a fixed cost in a different company.

Quantity

The number of units produced.

Other Considerations

You may want to break down each cost by unit and then add them up rather than adding them all up and then dividing by total units.