Page 255 - DMGT403_ACCOUNTING_FOR_MANAGERS

Accounting for Managers

Notes Introduction

It is one of the premier tools of management not only to take decisions but also to fix an
appropriate price and to assess the level of profitability of the products/services. This is a only
costing tool demarcates the fixed cost from the variable cost of the product/service in order to
guide the firm to know the minimal point of sales to equate the cost of production. It is a tool of
analysis highlighting the relationship in between the cost, volume of sales and profitability of
the firm.

12.1 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 fixed 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.

Notes 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 profit.
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 Profit xxxxx

Fixed Production O/H absorbed xxxx
Contd...

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