Absorption Costing

Question 1

Absorption Costing definition

Answer 1

It is a way of finding an appropriate amount of overhead cost per unit so that the total cost of producing a product or job can be calculated.

Question 2

Absorption costing method

Answer 2

1. Allocate/apportion overheads to cost centres.
2. Reapportion service centre overheads to production cost centres.
3. Absorb overheads into production.

Question 3

OAR formula

Answer 3

OAR = Estimate of fixed overheads/ Expected activity level.

Question 4

Reconciling profits under different methods

Answer 4

*If inventory levels increase, absorption costing gives a higher profit.
*If inventory levels decrease, marginal costing gives a higher profit

Question 5

Advantages of absorption costing

Answer 5

*Complies with IAS 2 because an element of fixed overheads are included in inventory values.
*Fixed cost must be covered in the long run and absorption costing takes fixed cost into account unlike marginal costing.
*Recognises that the selling price must cover all cost.

Question 6

Disadvantages of absorption costing

Answer 6

*Unit cost include costs which are not relevant to marginal costing.
*The nature of cost behaviour is obscured.
*The method of absorption is to some extent arbitrary.
*Profits can be manipulated by changing production levels.