Absorption costing uses which approach to determine product cost?

Absorption costing uses which approach to determine product cost?

• A. A built up full product cost which adds direct costs and a proportion of production overheads using overhead absorption rates
• B. Only variable costs
• C. Direct costs only
• D. Inventory level

Answer: (A)

Absorption costing determines the cost of a product by accumulating all manufacturing costs into the product cost. This means including direct costs (like materials and direct labour) and a share of production overheads, allocated to the products using an overhead absorption rate. The overhead absorption rate spreads fixed and variable production overheads across units (often based on a base such as machine hours or labour hours), giving a full cost per unit. This approach supports valuing inventory and determining cost of goods sold under standard accounting practice. It’s not just variable costs, not just direct costs, and not determined by inventory level alone.

Absorption costing determines the cost of a product by accumulating all manufacturing costs into the product cost. This means including direct costs (like materials and direct labour) and a share of production overheads, allocated to the products using an overhead absorption rate. The overhead absorption rate spreads fixed and variable production overheads across units (often based on a base such as machine hours or labour hours), giving a full cost per unit. This approach supports valuing inventory and determining cost of goods sold under standard accounting practice. It’s not just variable costs, not just direct costs, and not determined by inventory level alone.