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.