Absorption costing is a means of determining the actual costs associated with producing the final product. There can be a multitude of factors involved to determine the actual cost to produce a single product. Some of the costs involved may include materials, parts, labor as well as other overhead considerations. Absorption costing is generally determined for a single unit but can be used for a single job order run.
What’s Figured Into the Absorption Costing Method?
Virtually all costs and expenses associated with a finished manufactured product are figured into the determining the unit cost. The following is a list of categories that are used to determine the cost of a single unit of a finished product.
- Direct Materials Cost is the actual cost of all materials that are used in the production of a finished product
- Direct Labor Cost is the expense of the actual internal wages associated with the production of a finished product.
- Variable Manufacturing Cost fluctuates with output. Examples may include equipment depreciation, utilities, outside labor, plant or equipment maintenance and material handling.
- Variable Sales Costs are associated with the expense of sales. Salespersons commissions and advertising are examples of variable sales costs.
- Fixed Manufacturing Overhead costs remain the same regardless of manufacturing output. Salaries paid to plant managers, rent on the facilities and insurance are some examples.
- Fixed Selling Costs are expenses that do not fluctuate that are associated with the sale of the final product. Examples may include sales managers and administration salaries.
Determining the Cost of Goods Sold Using Absorption Costing
Once the above categories costs are figured, the next step is to get a total sum of all the absorption cost categories to determine the cost of goods sold. The total units produced are then divided into the total sum of the absorption cost categories. As an a example:
- Direct materials cost $1,000,000
- Direct labor cost per $500,000
- Variable manufacturing cost $250,000
- Variable sales cost $125,000
- Fixed manufacturing overhead $250,000
- Fixed selling costs $125,000
- Total all costs $2,500,000
- Units produced 500,000
Total cost per unit $5.00 (500,000/$2,500,000)
Absorption Costing and the Breakeven Point
The total cost per unit is basically the company’s breakeven point for that particular product. That’s why it’s important the all costs associated with the manufacturing of a particular product are figured into the equation. Once the breakeven point (cost per unit) for a particular product is determined, the selling price must be established. Return on investment (ROI), competition, economic conditions and consumer behavior must be analyzed to determine the appropriate selling price.
Another method for costing finished products is the variable costing method. There can be advantages and disadvantages to using either method. There are also considerations for determining whether or not either method should be used for determining inventory costs as well as cost of sale to figure gross profit. The financial statements could have an adverse affect depending on how costing methods are applied.
James Clausen - Clausen received a Bachelors Degree in Business Administration in Automotive Management and Marketing at Northwood University, graduating ...
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