Absorption Costing
Absorption costing refers to an accounting method that assigns both direct and indirect costs to inventory items produced by a business. This approach is also known as full cost absorption or just absorption, and it's commonly used in manufacturing industries to allocate overhead expenses to products. By including all production costs in the final product price, absorption costing helps businesses determine the true profitability of their operations and make better decisions about pricing, production levels, and resource allocation. This method is based on the principle that all costs incurred during the production process should be accounted for, regardless of whether they can be directly traced to individual products or not. It contrasts with variable costing, which only includes direct materials and labor costs in product costs, leaving overhead expenses as period costs. Absorption costing is required for external financial reporting under generally accepted accounting principles (GAAP) but may not always reflect the most accurate picture of a company's profitability.