Uses and Limitations of Absorption Costing

/, Notes, ZIMSEC A Level Accounting/Uses and Limitations of Absorption Costing

Uses and Limitations of Absorption Costing

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

  • According to research by CIMA the leading Management Institute
  • Traditional costing methods such as Absorption costing are still in widely used by manufacturing businesses throughout the world
  • There is are reasons for this

Uses/Advantages of Absorption costing

  • Often used to determine inventory values in accordance with International Financial Reporting Standards
  • It is also used to determine a profitable selling price that covers all costs of making each unit
  • Recognises the fact that each unit produced must cover (“absorb”) its share of fixed overheads
  • Adheres to the matching principle by making sure that revenue is matched to expenditure incurred in making that revenue instead of treating Fixed Overhead Costs as period costs
  • Recognises the fact that fixed overheads are essential for production
  • Is more consistent with external reporting rules and regulations such as company laws and IFRSs
  • Produces a profit amounts that fluctuate less when production is constant but sales fluctuate for example in businesses that have seasonal sales

Disadvantages /Limitations of Absorption Costing

  • It is not very useful as for decision making plans as it emphasises fixed overheads examples of decisions that it cannot help make are make or buy, product mix etc
  • Cost absorption is not really a science as a lot of judgement is involved in that regard absorption of costs is somewhat arbitrary
  • Not useful when it comes to cost control as fixed overheads are included since it would be unfair to blame a manager over costs he/she does not control
  • Profit can be inflated by increasing production which reduces cost per unit

To access more topics go the ZIMSEC Advanced Level Accounting page

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

By |2018-09-18T09:54:43+00:00August 16th, 2018|Cambridge AS A Level Accounting, Notes, ZIMSEC A Level Accounting|Comments Off on Uses and Limitations of Absorption Costing

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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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