What is absorption costing?

Definition of Absorption Costing

Absorption costing (or full absorption costing) indicates that all of the manufacturing costs have been assigned to (or absorbed by) the units produced. In other words, the cost of a finished product will include the costs of:

  • direct materials
  • direct labor
  • variable manufacturing overhead
  • fixed manufacturing overhead

Absorption costing is required for external financial reporting and for income tax reporting.

Another method of costing (known a direct costing or variable costing) does not assign the fixed manufacturing overhead costs to products.

Standard Costing: Fixed Manufacturing Overhead Variances

Standard Costing: Variable Manufacturing Overhead Variances