Absorption Costing

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Definition: Absorption Costing

As the name suggests, absorption costing is the method of costing in which the entire cost of manufacturing a product or providing a service is absorbed in it. In contrast to the variable costing (Activity based costing) method, it includes both fixed and variable costs for absorption in addition to the direct costs. As all the costs incurred are absorbed, this method is also sometimes referred to as Full absorption costing or Total absorption costing (TAC).

Variable costing is generally used for the managerial decision making whereas as per the Generally Accepted Accounting Principles (GAAP), an organization is bound to use the absorption costing method for financial reporting purposes.


No. of units produced =  100

Direct Variable cost per unit = Rs. 2

Variable Overhead cost per unit = Rs. 1

Fixed Overhead cost = Rs. 200

Under Absorption Costing,

Total Cost per unit = 2 + 1 + (200/100)= Rs. 5

Under Variable Costing,

Total Cost per unit = 2 + 1 = Rs. 3

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