Absorption Costing

Instead of defining absorption costing, it will be better to explain it with example. Suppose, Mr. A has the factory of wood works where there are lots of furniture products are manufactured. So, there are lots of material cost, labor cost and overhead expenses.

Now, if we tell our total manufacturing cost is $ 10,000, it is no so useful for anybody. But if we find the unit cost of each wooden table, it will be helpful. For finding each product unit cost, we need to absorb manufacturing cost. A system which tell us the procedure is called absorption costing. In absorb costing system, we uses methods of absorption.

For example, we need to calculate the unit cost of each table, we will add direct material cost and direct labor cost. To add this cost is not difficult. For example, we have bought $5000 wood and we have made 100 tables. It means, material cost of each table is $ 50. $ 2000 direct labor cost, we have paid. These labor manufactured 100 tables. It means, one table direct labor cost is $ 20. Now, most difficult part is to absorb manufacturing variable and fixed overheads. In this, we can include electricity cost of  each table, supervisor's cost of each table etc. So, we need different basis of absorption.

Following are main methods of absorption of overheads into unit produced.

1. Direct Material Cost Method 
2. Direct Labour Cost Method 
3. Prime Cost Method 
4. Direct Labour Hour Method 
5.Machine Hour Rate Method 
6. Rate Per Unit of Production Method 
7. Sales Price Method 

If you want to read the detail of all these methods, you should read at here

If we have calculated overhead cost of each table is $ 10 from above method, we have the total cost of manufacturing each table is

$ 50+$20+$10 = $80

Now, on the basis of this cost, we can fix the price of each table. 







Accounting Education: Absorption Costing
Absorption Costing
Accounting Education