Page 221 - DCOM302_MANAGEMENT_ACCOUNTING

Management Accounting

Notes 11.1 Absorption Costing

Absorption costing technique is also known by other names as “Full costing” or “Traditional

costing”. According to this technique, all costs are recognised or identified with the products

manufactured. Both fixed and variable costs of each product manufactured are taken into account
to ascertain the total cost.

According to author, the absorption costing tells as to how much fixed cost is absorbed besides
the variable cost by each product manufactured. According to this technique, while the variable
costs are directly charged to each unit of the goods produced, the fi xed costs are distributed to
each category of product manufactured by the same firm. In absorption costing, “Fixed cost” will

also be taken into account in ascertaining the profit on sale.
This technique is called traditional costing, as this system of costing emerged from the beginning
of the factory stage. In this technique, “fixed cost” refers to the closing stock of material held by

the firm. These are charged against the sales later, as a part of the goods sold.
The traditional technique popularly known as total cost or absorption costing technique does not

make any difference between fixed and variable cost in the calculation of profi t.

Note Absorption costing can be calculated by the following ways:
` `
Sales Revenue xxxxx
Less: Absorption Cost of Sales

Opening Stock (Valued @ absorption cost) xxxx
Add: Production Cost (Valued @ absorption cost) xxxx
Total Production Cost xxxx
Less: Closing Stock (Valued @ absorption cost) (xxx)

Absorption Cost of Production xxxx
Add: Selling, Admin & Distribution Cost xxxx
Absorption Cost of Sales (xxxx)
Un-Adjusted Profi t xxxxx
Fixed Production O/H absorbed xxxx

Fixed Production O/H incurred (xxxx)
(Under)/Over Absorption xxxxx
Adjusted Profi t xxxxx

Limitations of Absorption Costing

The following are the limitations of absorption costing:

1. In absorption costing, a portion of fixed cost is carried over to the subsequent accounting
period as part of closing stock which is an unsound practice because costs pertaining to
a period should not be allowed to be vitiated by the inclusion of costs pertaining to the
previous period and vice-versa.

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