Author: Aaron Ehasz
As opposed to variable costing, absorption costing aims to fully attribute the indirect fixed costs of manufacture across all products.
Providing production is on or above the break even sales point of the business, and the production is sold, not just piled into unsold inventory, then this method of cost allocation would ensure that all the manufacturing costs are recovered – a concept more commonly known as overhead recovery.
Absorption costing is not without it’s inherent problems. For example, what if production is not above breakeven? That means for every product produced, insufficient manufacturing overhead would be attributed to the products, and therefore the overheads would not be fully recovered
Also, if cost allocations were changed to accommodate this fact, it may be that the new cost of production is too expensive to turn a profit, or make the products unsaleable due to uncompetitive pricing.
If the business is operating above break even, then the over recovery of manufacturing overheads may mean that the product is costed and subsequently priced in a way that it cannot take advantage of “marketing opportunities”, which would further boost sales and profits
It is for these reasons that a good system of costing feedback and control needs to be established to ensure the effective and timely pricing decisions required to run a profitable business
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