What Is Absorbed Cost?
Absorbed cost, also known as absorption cost, is a managerial accounting method that accounts for the variable and fixed overhead costs of producing a particular product. Knowing the full cost of producing each unit enables manufacturers to price their products. That is why absorption costing is also referred to as full costing or the full absorption method.
Absorbed Cost Explained
Absorption costing absorbs all the manufacturing costs per unit produced. By including overhead, in addition to materials and factory labor costs, it helps companies determine the overall cost of producing a single brand, line or product — and which of these are the most profitable. Absorbed costs are expenses like energy costs, equipment rental costs, insurance, and property taxes.
Absorbed Costs vs. Variable Costing
Absorbed cost gives a much more comprehensive and accurate view of how much it costs to produce your inventory, in comparison to the variable cost method, which does not allocate any of the fixed manufacturing overhead. It breaks down fixed overhead into two categories: costs attributable to cost of goods sold and those attributable to inventory.
Absorbed cost calculations produce a higher net income figure than variable cost calculations because more expenses are accounted for in unsold products which reduces actual expenses reported. Also, net income increases as more items are produced, because fixed costs are spread across all units manufactured.
While absorbed costs are needed to prepare financial statements for financial reporting, variable costing is more useful for making internal incremental pricing decisions, because it only includes the extra costs of producing the next incremental unit of a product.