Absorption Costing

Absorption costing is a costing method in which all costs of manufacturing a particular item/ product including both fixed and variable are made part of the product cost of the said item/ product. In other words, the cost incurred to produce a single unit of a specific product will include costs of:

• Direct material
• Direct labor
• Variable manufacturing overhead
• Fixed manufacturing overhead

Under the said costing method, the costs mentioned below are considered as period costs and are not made part of a product:

• Fixed selling and administrative costs
• Variable selling and administrative costs

Example of Absorption Costing

Company ABC manufactures and sells a single product. The costs of manufacturing a single unit of a product is as follows:

Variable Costs Per Unit

• Cost of direct labor = $10
• Cost of direct material = $20
• Variable manufacturing overheads = $12
• Variable administrative and selling costs = $5

Fixed Costs

• Fixed manufacturing overheads = $150,000
• Fixed administrative and selling costs = $110,000

Over the year, ABC Company manufactured 60,000 units of the product.

Under the absorption costing method, the product cost of a single unit is as follows:

Product cost = $10 + $20 + $12 + ($150,000/ 60,000) = $44.5