Absorption costing treats fixed overhead as an expense in the period it is incurred

12/3/2015Assignment Print View5.Award:0 out of 2.00 pointsMC Qu. 121 Swisher, Incorporated reports the following...Swisher, Incorporated reports the following annual cost data for its single product:Normal production level30,000 unitsDirect materials$6.40 per unitDirect labor$3.93 per unitVariable overhead$5.80 per unitFixed overhead$150,000 in totalThis product is normally sold for $48 per unit. If Swisher increases its production to 50,000units, while sales remain at the current 30,000 unit level, by how much would the company'sincome increase or decrease under variable costing?$60,000 decrease.$90,000 decrease.There is no change in gross margin.$90,000 increase.$60,000 increase.There would be no change because fixed costs are expensed in the period in which they areincurred, regardless of the number of units sold.

Everything You Need To Know About Absorption Costing

Posted In | Gridlex Academy | Finance | Accounting

What is Absorption Costing?

In accounting, absorption costing (or full costing) is a way of assigning manufacturing overhead to an inventory item or cost object. The method treats manufacturing overhead as a period expense and includes it in the calculation of the inventory's cost. This is the cost that appears on the company's financial statements. The calculation assigns all manufacturing overhead costs, both fixed and variable, to products. The goal is to have the costs match the revenue generated by the sale of those products. The method is generally used in situations where external reporting is required, such as in financial statements.

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Example of Absorption Costing

A company produces a product that requires two direct materials and one direct labor hour to produce. The company's overhead consists of $5 in fixed overhead and $2 in variable overhead. The company's absorption rate is $5 per direct labor hour. The company produces 100 units of the product. The cost of each direct material is $10 and the direct labor cost is $20 per hour. The cost of each unit of the product is $35 under absorption costs. This includes $10 for direct materials, $20 for direct labor, and $5 for overhead (1 direct labor hour x $5 absorption rate).

What is the Difference between Variable Costing and Absorption Costing?

The two costing methods used in managerial accounting are variable costing and absorption costing. Variable costing assigns all manufacturing costs to products, while absorption costing assigns a portion of manufacturing costs to products and a portion to period costs. The main difference between the two methods is how they treat fixed manufacturing costs. Under variable costing, fixed manufacturing costs are treated as period costs and are not assigned to products. This means that only variable costs are included in the product cost. Under absorption costing, fixed manufacturing costs are included in the product cost. This means that both variable and fixed costs are included in the product cost.

What are the Advantages of Absorption Costing?

The main advantage of absorption costing is that it provides a complete picture of the actual costs of production, including all fixed and variable costs. This information can be used to make important strategic decisions about pricing, production levels, and other factors that affect the bottom line. Absorption costing can help managers identify areas where costs can be reduced and improve overall efficiency. Another advantage of absorption costing is that financial institutions and investors generally accept it. This makes it easier to obtain financing and raises confidence in the financial statements. Additionally, it can be useful in tax planning. A final advantage is that it is relatively easy to implement and maintain. This is especially true when compared to other costing methods, such as variable costing.

What are the Disadvantages of Absorption Costing?

Some of the disadvantages of absorption costing include the following:

• It can be complex and time-consuming to calculate absorption costing, particularly for large businesses with many products.
• It may not accurately reflect the true cost of production, as some fixed costs may be allocated to products even if they did not contribute to those costs.
• It may lead to sub-optimal decision-making, as managers may be reluctant to reduce the production of certain products even if it would be more profitable to do so.
• It may give a false impression of profitability, as it includes all manufacturing costs regardless of whether they are variable or fixed.

How do you Calculate Absorption Costing?

To calculate absorption costing, you will need to add the cost of direct materials, direct labor, and overhead. Once you have these costs, you will then need to divide them by the number of units produced. This will give you the cost per unit of production. For example, if the cost of direct materials is $100, the cost of direct labor is $200, and the overhead is $300, the total cost would be $600. If you divide this by the number of units produced (say, 10), the cost per unit of production would be $60.

What is the Purpose of Absorption Costing?

The purpose of absorption costing is to allocate all manufacturing costs to products. This includes both fixed and variable costs. The goal is to create a more accurate picture of the true cost of each product, which is important information for pricing and making other strategic decisions. In addition, since all costs are assigned to products under absorption costing, this provides a better basis for evaluating the profitability of individual products and for making decisions about which products to continue manufacturing and which to discontinue.

What are the Features of Absorption Costing?

The features of absorption costing are:

• All manufacturing costs are assigned to products.
• Both fixed and variable manufacturing costs are assigned to products.
• Cost of goods sold includes both fixed and variable manufacturing costs.
• Inventory includes both finished goods and work in progress.
• Manufacturing overhead is allocated to products based on a predetermined overhead rate.
• The cost of goods sold is determined when products are sold, not when they are produced.
• Income is determined when products are sold, not when they are produced.
• Profits can be negative in the short-term if fixed costs exceed revenue.

Is Absorption Costing required by GAAP?

Absorption costing is required for external reporting under generally accepted accounting principles (GAAP). It includes all manufacturing costs in inventory, even those that do not increase the value of the product, such as indirect materials and indirect labor.

What are the Limitations of Absorption Costing?

The main criticism of absorption costing is that it does not provide accurate information for pricing decisions. The main reason for this is that it includes fixed overhead costs in the cost of goods sold, even if those costs have nothing to do with the production of the goods. This means that the true cost of inventory is not accurately represented. Another limitation is that it allocates fixed overhead to products even if they do not use the overhead. This is because the fixed overhead is allocated based on the number of units produced, not on the number of units that actually use the overhead. This can lead to products being overpriced or underpriced. Finally, absorption costing can distort the true cost of inventory. This is because it includes all costs, regardless of whether they are variable or fixed. This means that the total cost of inventory may be higher than it should be, which can lead to incorrect pricing decisions.

What are the Types of Absorption Costing?

The three types of absorption costing are job order costing, activity-based costing, and process costing.

Is Absorption Costing Unethical?

There is no definitive answer to this question as opinions will vary. Some people may view absorption costing as unethical because it can artificially inflate the cost of goods sold and lead to decision-makers making sub-optimal choices. Others may view it as a legitimate and necessary accounting tool. Ultimately, the ethicality of absorption costing is a matter of opinion.

Why do Companies use Absorption Costing for their Internal Reporting?

Absorption costing is often used for internal reporting because it includes all of the fixed and variable costs associated with producing a product. This information can be helpful to managers when making decisions about pricing, production levels, and product mix. Additionally, using absorption costing can make it easier to compare the profitability of different products or product lines.

How are fixed costs treated in absorption costing?

Does absorption costing include fixed costs?

What are period costs under absorption costing?

When using absorption costing fixed manufacturing overhead costs are?