Group Case Project: Absorption Costing vs. Variable Costing
Cameron R. Bates
Absorption costing is a costing system in which the direct labor, direct materials, and fixed and variable manufacturing overhead costs are traced to every finished product. Thus, in the absorption costing system, all costs are product costs regardless of their classification of variable or fixed. Because of its characteristic of no cost discrimination, absorption costing is also known as full costing or as full absorption method (¨Absorption¨ 1). The absorption costing is the only method approved by the generally accepted ...view middle of the document...
1 shows. The costs of manufacturing will not equal the cost of goods sold because some costs associated with manufacturing will not be expensed in the income statement. Instead, they will remain as assets in an inventory account (1).
Types of Absorption Costing
There are three types of absorption costing: Job-order, process costing, and ABC costing and they are all approved by the GAAP (“Absorption”). In the job order costing, the manufacturing costs are assigned to the product in batches or lots. This method is often used in industries such as printing, furniture manufacturing, and bicycle manufacturing (1). The second type of absorption costing is the process costing. In this method, the costs are systematically assigned to the product. There are no discrete batches to assign cost. Examples of industries that can use this method are oil distilling and soda manufacturing (1). The third type of absorption cost is known as ABC costing. This method is more sophisticated than absorption costing. It consists of matching the costs with activities. An example of a company where this method can be used is in a multi-product firm, where there are different volumes.
The job order costing is a method in which the cost of manufacturing are allocated to the products. The job order costing can be used when a firm produces several different products in each period. An example of this would be, consider a computer manufacturing company. This company wants to determine how much it costs to manufacture 100 computers. The first stage in the production of these 100 computers is the introduction of direct materials such as computer cases, motherboards, CD drives, and usb ports. By using the job order costing, the manufacturing cost is allocated to the 100 computers ordered. Assuming that the assigned number or lot is the lot #4321, the allocated costs of the direct materials are assigned to lot #4321. Also, the time spent on the assembly will be recorded on this lot. Thus, the labor cost will be allocated at the hourly wage rate to the job. Moreover, the overhead costs such as the cost of the plant, cost of machines and utilities will be allocated to the product. The overhead costs are allocated by using an overhead allocation rate which is the estimated overhead cost over the estimated activity base. The job-order costing allows managers to know the profit earned from every job and to determine the average cost per unit produced. Also, it allows companies to their employees’ performance in terms of efficiency, productivity, and cost control (Ingram 1). Examples of companies that use the job-order system are Boeing, Lockheed Martin, and Deloitte and Touche.
The second type of absorption costing is the process costing. The process costing is used when there is a large volume of similar products and the direct labor, direct materials, and overhead costs are consumed equally by each unit of product (“Accounting”). Examples of companies that use...