Absorption Costing

The process described in this section by that net overheads are absorbed into production naturally enough is identified as absorption costing.  The absorption of net overheads into product costs has implications for performance measurement, and stock valuation and cost control and students should be aware about the process described is subject to criticism via some accountants and managers.

The criticism arises from the fact such overheads contain items, identified as fixed costs - that do not change when the activity level changes and that would now have to be paid whether there was no activity, as an example of rates - and items, identified as variable costs, that vary more or less directly along with activity, as an example of power consumption. To overcome some of the problems, an alternative way of costing has been developed, identified as marginal costing, that, though by using the process of absorption, eliminates fixed costs from the absorption process.