Absorption Costing and Unit Product Cost

What are absorption costing and unit product cost?

Costing by absorption and variable costing are costing methods that address the treatment of fixed costs when performing product valuation. In this article, we will look at the concepts of absorption costing and unit product cost.

Cost per absorption

Costing by absorption or total provides that the determination of the cost of production of goods, services or activities consists solely of direct or operational costs and indirect costs of production processes, cost centers or areas of responsibility. According to this theory, production costs – direct and indirect – affect the profits of the period depending solely on the quantity of goods or products produced and sold, or services rendered and invoiced during the period.

The absorption approach considers the cost of the product, the cost of material, labor cost and indirect factory costs; both fixed and variable. Fixed costs are costs that remain constant at any level of production or sale. Variable costs are considered those costs that vary in the same proportion as the level of production or sale. Inventory is evaluated based on manufacturing costs (fixed and variable) and then converted into expenses in the form of manufacturing cost of items sold at the time of sale.

Variable cost

The theory of direct costing, variable or marginal considers that the cost of production of goods or services should only bear the direct costs caused in the production of the goods or services, and additionally considers that the cost of sales of the good or service must incorporate all direct costs of distribution, marketing, market and / or fully identified sales, in order to determine the total direct cost of the economic good, which allows the analyst to obtain a more reasonable profit margin per product or service than that calculated under the theory of cost by absorption. Under normal business development conditions, that is, that the volume of production is greater than the number of units sold and the unit balances at the end of the accounting period are also greater than the initial balances, this economic theory results in lower profits, since the indirect production costs caused in the period affect the results of the period in full, regardless of the number of units produced and sold or services rendered and billed, as is presented in the theory of costing by absorption.

This is a costing method that considers only variable manufacturing costs (material, labor and indirect) as the costs of the inventoried product. It also separates costs from result status into variables and fixed. Direct material cost, direct labor cost, and a portion of indirect manufacturing costs are generally considered as variable production costs as indirect material. electricity, fuels and lubricants. Fixed costs can include indirect labor, plant rental, and depreciation on a straight-line assumption. Variable costing considers fixed production overhead as a cost of the period to be immediately charged to the income statement, rather than being a cost of the product that is retained as inventory and is charged to results later as part of the cost of the goods sold at the absorbing cost.

Comparing absorption costing and unit product cost.

Advantages of variable cost methods

• It facilitates the preparation of the cash budget, because normally variable costs involve disbursements.
• Failure to include fixed indirect costs in the cost of the product and displaying this value in isolation allows for better control of fixed costs, as they can be compared from one period to another independent of production.
• Variable cost profits depend on sales, while the total costing system shows more profits just by producing. It makes sense that profits are correlated with sales and not production.
• The presentation of results under the variable costing system makes it easier for management to control costs and make decisions, based on the criterion of the contribution margin or marginal analysis. Such decisions could be:
  • Set sales prices to special orders.
  • Produce or buy.
  • Analyze the profitability of products or product lines.
  • Make use of marginal analysis to decide on new capital versions.

Disadvantages of variable cost methods

Separating costs into variables and fixed costs is a difficult task. If not done carefully, it generates errors in the valuation of inventories and, therefore, in the determination of profit.