Absorption Costing
A costing method that assigns all manufacturing costs to products, including fixed overheads, required for external financial reporting under GAAP.
Absorption Costing
A costing method that allocates all manufacturing costs to products, including direct materials, direct labor, variable manufacturing overhead, and fixed manufacturing overhead.
For example, a furniture manufacturer using absorption costing would include not only the wood, fabric, and direct labor in each chair’s cost, but also a portion of factory rent, equipment depreciation, and supervisor salaries, even though these fixed costs don’t change with production volume.
Absorption costing, required for external financial reporting under GAAP, treats fixed manufacturing overhead as a product cost that becomes part of inventory valuation. This approach ensures that all manufacturing costs are eventually matched with revenue when products are sold, but can mask the impact of volume changes on profitability compared to variable costing methods.