What Is Absorption Costing, Its Advantages And Disadvantages

August 13th, 2006 Comments off
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What Is Absorption Costing, Its Advantages And Disadvantages

This article deals with the basic understanding of what is absorption costing and its pros and cons.

What is Absorption Costing?

It is a costing technique where all normal costs whether it is variable or fixed costs are charged to cost units produced.

Unlike marginal costing which take the fixed cost as period cost.

Advantages of Absorption Costing:

  • It recognizes the importance of fixed costs in production;
  • This method is accepted by Inland Revenue as stock is not undervalued;
  • This method is always used to prepare financial accounts;
  • When production remains constant but sales fluctuate absorption costing will show less fluctuation in net profit and
  • Unlike marginal costing where fixed costs are agreed to change into variable cost, it is cost into the stock value hence distorting stock valuation.

Disadvantages of Absorption Costing:

  • As absorption costing emphasized on total cost namely both variable and fixed, it is not so useful for management to use to make decision, planning and control;
  • as the manager’s emphasis is on total cost, the cost volume profit relationship is ignored. The manager needs to use his intuition to make the decision.

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