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.
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What is Absorption Costing?
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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.
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Advantages of Absorption Costing:
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- 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.
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Disadvantages of Absorption Costing:
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- 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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