Absoprtion Costing

BesarB

Hi everyone.

One of the methods of valuing inventory is to use absoprtion costing where all costs are absorped into finished goods and according to most online accounting websites it is in accordance with Gaap and IFRS. But if we absorb the administrative expenses into a finished product then that can't be in line with those two accounting standards. I really can't get my head around the valuation of inventory and its use of full absoprtion costing. I understand its use with finding the full cost of one unit produced but not its involvement in the valuation of inventory for financial statements.

crispy

Hi BesarB,

Remember that with absorption costing that it is only concerned with the factory overheads (such as machine depreciation, factory supervisor wages, rent, power & heat of factory) that are absorbed in order to attempt to establish a full product cost. The other administrative costs, such as office staff salaries etc. are not included and therefore do not form part of the inventory cost.

BesarB

Thank you for your answer Crispy. Have another question and would love your answer to it. If the overhead costs are budgeted and obsorbed into the product cost then how is it used to value the inventory of a finished units, isn't it suppose to be based on actual overheads cost incurred. I am sure there must be an adjustment process along the way before the closing inventory goes on balance sheet.

crispy

Hi,

Under / Over absorption of overheads, see the below link which explains better than I could

http://www.accountingtools.com/questions-and-answers/what-is-under-absorption-and-over-absorption-of-overhead.html

BesarB

Thank you again.