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Compare and contrast absorption costing - Assignment Example

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Lucey (2002, p.1) defines costing as “the establishment of budgets, standard costs and actual costs of operations, processes, activities or products; and the analysis of variances, profitability, or the social use of funds.” From this definition it is apparent that costing…
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Compare and contrast absorption costing
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Compare and contrast absorption costing

Download file to see previous pages... Absorption costing and Marginal costing are two such costing methods. They differ to quite an extent, however whether one method is better than the other depends largely on the situations in which they are applied and the underlying objectives of the businesses in which they are applied.
Before looking at these two concepts in detail, it is appropriate to discuss the components that make up the ultimate cost of a good or service. The cost of something can be broadly broken up into fixed costs and variable costs.  Fixed costs are those costs that are incurred irrespective of the level of production. So for example, in a garment factory business, fixed costs would include the rent on the factory. This rent would largely be the same, irrespective of the volume of garments produced in that factory. On the other hand, the variable costs would include the costs of the materials used (‘direct material’), the daily wages of the staff producing the garments (‘direct labour’) and even perhaps the electricity charges on the machines used (‘direct variable overheads’). These costs increase directly with the volume of production. More garments being produced would mean more fabric being used, more people being employed or the same people being employed for longer and machines using more electricity by being worked for longer or at higher capacities.
This method is also called the full costing method. As the terminology implies, under this method, the full cost of the good or service is used in arriving at the cost per unit. ‘Full costs’ mean that both the variable costs and the fixed costs are included in the calculation of cost per unit. That is, this method does not differentiate between them-all the manufacturing costs are included.
In the garment factory example mentioned above, this would mean that in addition to ...Download file to see next pagesRead More
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