Advanced Management Accounting and Absorption Costing

Absorption costing assigns a proportion of the fixed cost of production to the units produced. This share is added together with the direct cost of production for each individual product to obtain the total or the full cost of producing a unit of output. The fixed costs are assigned using the overhead absorption rates. Absorption costing goes through three distinct key stages; these are, allocation, apportionment, and absorption. Marginal costing is a technique in which only variable manufacturing costs are considered. The variable costs are used in valuing inventories and determining the cost of goods sold. Additional costs (marginal cost) in the form of labor, material, expenses, and overhead variables incurred in producing an extra unit are considered relevant in marginal costing as fixed costs do not change during production. They are treated as period costs. Thus, they are written off to the profit and loss accounts in the period in which they are incurred.

Just like any other process, absorption costing has a number of strengths. One advantage is that it makes use of the fixed cost of production when computing the cost per unit of output. Therefore, the management is able to view the total cost associated with producing a product. Secondly, the method is consistent with the Generally Accepted Accounting Principles; therefore, the results of absorption costing helps the management prepare the financial reports. Thirdly, absorption costing helps management in the valuation of the stock. Another advantage is that absorption costing does not depend on fluctuation in sales