Absorption Costing: Introduction

Absorption Costing: Introduction

Cambrige AS and A Level Accounting Notes (9706)/ ZIMSECĀ  Advanced Accounting Level Notes: Absorption Costing: Introduction

  • As already said in the introduction to costing for overheads
  • Businesses need to know the cost of production for each unit of production
  • There are many reasons why a business would need to know this:
    1. To calculate a selling price that recoups all costs of production
    2. To ascertain the value of inventory
    3. So the business may be able to create a quotation for a customer etc
  • One traditional method used to ascertain the cost of per unit of production is absorption costing
  • Before we explain what Absorption Costing is it is important to note one thing:
  • The cost per unit has to and is often be calculated in advance i.e during the period
  • The formula for finding cost per unit is:
  • \text{Cost Per Unit=}\dfrac{\text{Total Production Cost}}{\text{Total Units Produced}}
  • However since this cost per unit is calculated in advance the business would not have the Total Units Produced figure
  • The business will have to estimate/forecast this figure based on expectations, experience and other variables
  • The formula would thus be:
  • \text{Cost Per Unit=}\dfrac{\text{Total Production Cost}}{\text{Budgeted Total Units}}
  • Things may become a little more complicated when more than one product is made by the organisation
  • In most cases these product may involve slightly different production process
  • What would be the cost per unit for each product then?
  • Obviously the simple formula shown above would be inadequate at best and even misleading
  • This is where absorption costing comes in
  • Absorption costing-is a method of costing a product in which all fixed and variable costs are apportioned to cost centres where they are accounted for using absorption rates
Cost type$/unit
Direct materialsxxx
Direct Labour costxxx
Direct expenses (e.g. royalty per unit)

xxx

Prime Cost/unitxxx
Overhead portion/unitxxx
Total Cost/Unit

xxxx

  • Under absorption costing first the variable costs be unit are determined and added to get the total variable cost per each unit produced
  • This is easy to do since most variable costs are usually direct costs that can be easily traced to each product
  • Overheads are a different matter
  • Each unit of production has to “absorb” a portion of the fixed costs attributable to it
  • This allows these costs to be recovered for example when the unit is sold
  • The main aim of absorption costing is to make sure that each unit of production absorbs costs a fair portion of overheads that is indicative of the time and effort that went into the production of that unit
  • Absorption costing involves the following stages:
    1. The allocation and apportionment of overheads to the different cost centres
    2. The reapportionment of service (non-production) cost centre overheads to the production cost centres
    3. The absorption of overheads into the products
  • These steps will be clearly illustrated using examples and further explanations follow the links below to access more notes

To access more topics go the ZIMSEC Advanced Level Accounting page

To access more topics go to the Cambridge AS/A level page

By |2018-08-07T07:49:01+00:00August 6th, 2018|Cambridge AS A Level Accounting, Notes, ZIMSEC A Level Accounting|Comments Off on Absorption Costing: Introduction

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He holds an Honours in Accountancy degree from the University of Zimbabwe. He is passionate about technology and its practical application in today's world.
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