A costing method that allocates all manufacturing costs — both fixed and variable — to each product unit, also known as full costing.
Absorption costing assigns direct materials, direct labor, variable manufacturing overhead, and fixed manufacturing overhead to every unit produced. This contrasts with marginal costing, which only assigns variable costs. Under absorption costing, fixed overheads are 'absorbed' into inventory cost and expensed only when goods are sold. It is mandatory under Indian Accounting Standards (Ind AS 2), IFRS (IAS 2), and for income tax reporting. The method provides a more complete picture of true product cost but can distort profitability analysis when production volumes fluctuate significantly.
A factory produces 10,000 widgets. Direct material: ₹30/unit, direct labor: ₹20/unit, variable overhead: ₹10/unit, total fixed overhead: ₹2,00,000. Under absorption costing: ₹30 + ₹20 + ₹10 + (₹2,00,000 ÷ 10,000) = ₹80/unit.
glossaryTermPage.reasons.accuracy
glossaryTermPage.reasons.compliance
glossaryTermPage.reasons.decisions
glossaryTermPage.reasons.efficiency
Absorption costing includes fixed overheads in product cost; marginal costing treats them as period expenses. Absorption shows higher inventory values and potentially higher profits when production exceeds sales. Marginal costing is better for short-term decision-making.
Accounting standards (Ind AS 2, IAS 2, US GAAP) require it because it matches all production costs with revenue when goods are sold, following the matching principle. It prevents understating inventory and overstating expenses.
A costing method that assigns only variable costs to products and treats all fixed costs as period expenses charged to the profit & loss account.
A branch of accounting that records, classifies, analyzes, and allocates costs to products, services, or activities to help management make informed business decisions.
The ongoing costs incurred by a business in its day-to-day operations, including rent, salaries, utilities, marketing, and administrative expenses.
The direct costs attributable to the production or purchase of goods sold by a company during a specific period.
glossaryTermPage.cta.subtitle