Absorption Costing Advantages & Disadvantages

Created by: revisingluke
Created on: 09-10-19 10:58


	Absorption Costing Advantages & Disadvantages
	Advantages Recognises importance of including fixed manufacturing costs in product cost determination Helps conform with accrual & matching concepts which require matching cost & revenue for accounting period Avoids separation of costs into fixed & variable elements: cannot be done easily & accurately Helps make managers more responsible for costs & services provided to their centres Helps calculate Gross & Net Profit separately in IS Discloses inefficient and efficient utilisation of production resources by indicating under- or over-absorption of factory overeheads	Disadvantages Dependent on output level: different unit costs for different output levels. Comparison & cost control difficult Not helpful in managerial decisions where marginal costing used EG Buy / Manufacture, Target Profit & output etc. Many accountants argue fixed manufacturing, administration, selling & distribution overheads do not produce future benefits hence should not be included in cost of product Validity of product costs under this technique depends on correct apportionment of overhead costs Not helpful for preparation of flexible budget: no distinction between fixed & variable costs
	Evaluation Overall, absorption costing is beneficial but only if used in the correct manner (i.e. not used for scenarios where marginal costing would otherwise be used such as managerial decisions). The benefits outweigh the disadvantages of absorption costing as businesses using it can identify inefficiencies where costs are under-absorbed, avoid the inaccurate and difficult separation of costs into fixed and variable elements to quickly calculate the Overhead Absorption Rate for products, and be aided with the calculation of the Income Statement Gross and Net Profit figures.Absorption costing should only be used if the business' output level remains similar year-round and across accounting periods to ensure that comparison and cost control remains accurate and easy. Its validity as a costing method also depends on the expertise and patience of those apportioning the overhead costs between departments and products; rushed or improperly completed work may lead to improper apportionment and thus ineffective comparison and cost control.

Absorption Costing Advantages & Disadvantages

Advantages

Recognises importance of including fixed manufacturing costs in product cost determination
Helps conform with accrual & matching concepts which require matching cost & revenue for accounting period
Avoids separation of costs into fixed & variable elements: cannot be done easily & accurately
Helps make managers more responsible for costs & services provided to their centres
Helps calculate Gross & Net Profit separately in IS
Discloses inefficient and efficient utilisation of production resources by indicating under- or over-absorption of factory overeheads

Disadvantages

Dependent on output level: different unit costs for different output levels. Comparison & cost control difficult
Not helpful in managerial decisions where marginal costing used EG Buy / Manufacture, Target Profit & output etc.
Many accountants argue fixed manufacturing, administration, selling & distribution overheads do not produce future benefits hence should not be included in cost of product
Validity of product costs under this technique depends on correct apportionment of overhead costs
Not helpful for preparation of flexible budget: no distinction between fixed & variable costs

Evaluation

Overall, absorption costing is beneficial but only if used in the correct manner (i.e. not used for scenarios where marginal costing would otherwise be used such as managerial decisions). The benefits outweigh the disadvantages of absorption costing as businesses using it can identify inefficiencies where costs are under-absorbed, avoid the inaccurate and difficult separation of costs into fixed and variable elements to quickly calculate the Overhead Absorption Rate for products, and be aided with the calculation of the Income Statement Gross and Net Profit figures.Absorption costing should only be used if the business' output level remains similar year-round and across accounting periods to ensure that comparison and cost control remains accurate and easy. Its validity as a costing method also depends on the expertise and patience of those apportioning the overhead costs between departments and products; rushed or improperly completed work may lead to improper apportionment and thus ineffective comparison and cost control.

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Absorption Costing Advantages & Disadvantages