Absorption and Direct Costing

Question 1

How is absorption costing (AC) fundamentally different from direct costing (DC)?

Answer 1

The difference between AC and DC can be fundamentally isolated to the treatment of fixed manufacturing overhead. For AC it is a product cost and with DC it is a period cost.

Question 2

When does absorption costing income equal direct costing income?

Answer 2

When the number of units sold equals the number of units produced, absorption costing and direct costing produce identical incomes. (Note: This assumes that fixed cost per unit remains the same from one period to the next).

Question 3

How does absorption costing (AC) v. direct costing (DC) effect inventory valuation?

Answer 3

Inventory using AC will always be greater than inventory using DC because AC includes fixed product overhead costs.