Absorption Costing

Absorption costing = The cost rate per unit of productive resource applied to recover fixed costs.

Absorption costs are widely used to attach overhead costs to labor hours worked, or machine hours to recover all fixed costs.

A simple example:
If a firms fixed costs* including rent, utilities, management, office expenses plus indirect supervision, R & D expenses etc are $3,750,000 per annum, and the firm can work 250,000 labor hours per annum in normal time to meet demand at full capacity, the absorption rate of cost recovery = $15.00 per labor hour.

* Fixed costs are those expenses that do not vary directly with production output.

Machine hours, room rates, patient hours, flying hours or any other common economic resource worked or consumed can be used as the basis of the costing rate.

Absorption costing is very useful, however it can lead to difficult decisions at the capacity margin whether not to accept orders at prices below the fixed cost absorption rate.

Real life applications of competitive pricing in real time using marginal costing method are > Last minute booking pricing at successful hotels and airlines.

To calculate costs and prices using Absorption costing, open Costing-Templates 3.0 at the Absorption Costing template.

Software Links

Costing Templates For Excel

Reference Pages

Marginal Costing

Break Even Analysis

Operating Leverage