Absorption costing implies theÂ total production costsÂ getÂ absorbedÂ into the number of units manufactured.To put it differently, the total cost incurred on a finished product inÂ stock encompasses direct material,Â direct wages, and also both variableÂ andÂ fixed production costs. Thus, absorption costing can also be coined as the total costing or the total recovery method. A glimpse through manuals as absorption costing homework answers can give you a better idea.
Its condition in present times:
Absorption costing is sometimes contradicted by marginal costing orÂ variable costing. In the case of variable costing, the fixed/standing production expenses are not apportioned or allocated to (that is, not recovered by) the production. This method of variable costing is sometimes beneficial for managerial decision-makings.
On the contrary, absorption costing system is used in the case of creating and presenting externalÂ financial reportsÂ and for creation of tax files and returns. Thus it is mostly used by the external stakeholders of the business entity.
An insight into the â€˜full-costingâ€™ method
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Absorption costing is often termed as full costing because of every element of costs â€“considering even the fixed overheads â€“are incorporated as part of product cost. Unlike other types of costing systems such as marginal costing,each and every charge is allotted to finished inventories even if they are not actually sold to customers in the financial year.
Distinction between conventional costing and marginal costing system
These are merely two contradictory approaches to measuring the value of stock; they are Variable Costing and Conventional Costing. InÂ case of marginal costing, marginal costs are ascertained by cleaving apart the two components of costs â€“ 1)fixed cost and 2)variable cost.Â Variable cost is solely allocated to the operations, while fixed expenses are not included in its purview and are consequently charged to the profit and loss statement of that year.
On the contrary, Absorption or full costing system is the costing method under which all types and categories of expenses, fixed or variable are charged into the entire units of production. This is primarily used for the purposes of financial reporting, that is external reporting and income-tax purpose reporting.
There are numerous opinions on how variable costing is a better method, whereas some people also prefer using absorption based costing. So, you must be acquainted with the major points of distinctions among marginal costing and traditional full-costing to draw an inference regarding which of the two is to be preferred. This is a basic knowledge that is required before getting absorption costing homework answers related help online.
This traditional method of costing does take into consideration all the fixed charges that reflect and impacts several circumstances in which the entire stock is not sold out, and some amount of closing stock is held in the warehouse.
As assets stay as a part of the companyâ€™s books of accounts as at the closing of the periods, full-costing costing shows more fixed expenses allocable to such products in the ending stock. According to some, this technique of costing would result in a more appropriate and accurate bookkeeping and valuation regarding closing inventories.
Furthermore, higher costs are accounted in, with respect to unsold goods which result in fall of actual costs in books of accounts. Consequently, swelled-up net earnings are computed in contrast to marginal costing computations. With manuals as absorption costing homework answers, you will gain clarity of concepts.
Supposed drawbacks of full-costing
As absorption based costing includes overhead production cost, this is not favored in comparison with marginal costing system while taking up incremental pricing related decisions by the internal managers.
This may be the reason why variable costing would only take into account the excess costs of manufacturing the immediately following incremental unit of production. Apart from this, the utilization of absorption costing yields a distinctive situation in which sheer manufacturing of more goods will pave the way for an increased net income.
As fixed charges are dispersed and scattered among all the units produced, the per unit fixed cost would go down as more and more goods are manufactured. Hence, as and when productions wells, net earnings naturally goes up because the fixed cost section of the total cost of products sold out decreases. The absorption costing homework answers are provided keeping in mind the potential disadvantages of conventional costing system.
Some other important facts to consider
While using absorption costing, if the stock-in-trade goes up then a part of the fixed production cost of the current year will not reflect on the profit and loss statement as a portion of the cost of goods sold. Instead, those charges would be deferred to the Â future accounting periods and are carried forward to the balance sheet as a portion of the closing stock account head. This carry forwarding is called fixed production overheads deferred in closing stock-in-trade. The method associated with this can be clarified with a numerical example.
Suppose during the current year 6,000 units are manufactured but only a part of it, say 5,000 units are actually sold with a residue of Â 1,000 unsold products in the closing stock. Under the absorption based cost system,each and every unit produced is valued on the basis of$5 in fixed overheads.
So each unit goes into the stock at the end of the year and has $5 in terms of fixed production cost included in it or a sum of $5,000 or 1,000 units (1,000 Ã— $5). These fixed production costs of present year accounts are carried forward in the stock to the following periods, in which these unsold units are expected to be taken out from the warehouse and sold off to customers.
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