Absorption costing is an accounting method used in inventory evaluation or costing. It includes all the manufacturing costs such as direct materials, direct labor, variable and fixed manufacturing overhead. Under absorption costing a fixed overhead is only a product cost when it is sold. It is also known as the full cost method. Even though it is a accounting method that is required to calculate
. manufacturing costs, there are consequences for using this method for profit calculation. Simply put, absorption costing means that all the manufacturing costs are absorbed by the items being produced. It is often contrasted with variable costing or direct costing where the manufacturing overheads are not absorbed by the products manufactured. Absorption costing is also used when performing financial reports and income tax reports. The fundamental reasoning behind absorption costing is that it causes a product to be measured and reported base on the complete cost.
