What Is Absorption Costing?
How all manufacturing costs are assigned to units, with a worked example.
Home › Accounting Glossary › Absorption Costing
| Also called | Full costing |
|---|---|
| Compare with | Marginal costing |
| Used for | Valuing inventory in financial statements |
Absorption costing in plain English
Under absorption costing, every unit carries a share of the factory’s fixed costs. That means some fixed overhead sits in unsold inventory on the balance sheet instead of being charged to profit straight away.
Worked example
A factory makes 10,000 units. Costs per unit: materials 10, labour 6, variable overhead 4. Fixed overhead is 80,000, so fixed overhead per unit is 80,000 ÷ 10,000 = 8.
| Cost per unit | Absorption | Marginal |
|---|---|---|
| Materials | 10 | 10 |
| Labour | 6 | 6 |
| Variable overhead | 4 | 4 |
| Fixed overhead | 8 | 0 |
| Total cost per unit | 28 | 20 |
- Using absorption costing figures for short-term decisions such as accepting a special order. Marginal costing is usually better for that.
- Forgetting that profit can differ between the two methods when inventory changes.
Frequently asked questions
What is the difference between absorption and marginal costing?
Absorption costing includes fixed manufacturing overhead in unit cost. Marginal costing includes only variable costs and treats fixed costs as a cost of the period.
Which method is used for financial statements?
Absorption costing, because accounting standards require inventory to include a share of production overheads.
Why can profit differ between the two methods?
When production and sales differ, fixed overhead is carried in inventory under absorption costing but charged immediately under marginal costing.
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This page is for general learning. Accounting rules vary by country and standard.