Characteristics of Absorption Costing

Characteristics of Absorption Costing

Characteristics of Absorption costing have been briefly explained below. In absorption cost both direct cost and Factor overheads are taken into account for determining the product cost.

1.    Direct & Indirect Cost

Absorption Costing takes into account both direct & indirect cost. Direct costs vary with level of activity i.e. Production, where indirect cost does not change with level of activity (production). Absorption costing method is also referred as full cost method, because it consider all cost associated with a product.

2.    Direct Costs are Allocated

In absorption costing direct cost are directly allocated to the product (Direct material & Direct Labour). For example for a product A (1000 units), direct material cost is 10,000 and Direct labour cost is 15,000, then direct cost is 25,000 and unit Direct cost is $ 25,000/1000 = $ 25.

3.    Indirect Costs are absorbed

In absorption costing, indirect costs are absorbed. In first place costs are accumulated as overheads cost, and then overheads are charged to different products by using an absorption rate. Absorption rate is used because indirect cost cannot be directly traced & allocated to a product.

4.    Suitable Absorption Rate

In Absorption costing Indirect cost or overhead are absorbed by using a suitable or fair absorption rate. A rate may be based on machine hour, labour hour, or unit produced. For example total overhead is $ 40,000 and machine hour used (expected to use) are 10,000, then absorption rate is $ 4 per machine hour i.e. (40,000/10,000). If a product consumed 5,000 hour, then this product will be charged $ 20,000 for overhead i.e. (5000 hr x $ 4 per hour).

5.    Administration Expense are not absorbed

In absorption costing only the production related expenditure are absorbed. Administration expenditure is not part of production and therefore reported separately in the financial statement. Administrative cost shown as administrative or operating expenditure in the financial statements.