Cambrige AS and A Level Accounting Notes (9706)/ ZIMSECĀ  Advanced Accounting Level Notes: Absorption Costing: Introduction

  • As already said in the introduction to costing for overheads
  • Businesses need to know the cost of production for each unit of production
  • There are many reasons why a business would need to know this:
    1. To calculate a selling price that recoups all costs of production
    2. To ascertain the value of inventory
    3. So the business may be able to create a quotation for a customer etc
  • One traditional method used to ascertain the cost of per unit of production is absorption costing
  • Before we explain what Absorption Costing is it is important to note one thing:
  • The cost per unit has to and is often be calculated in advance i.e during the period
  • The formula for finding cost per unit is:
  • \text{Cost Per Unit=}\dfrac{\text{Total Production Cost}}{\text{Total Units Produced}}
  • However since this cost per unit is calculated in advance the business would not have the Total Units Produced figure
  • The business will have to estimate/forecast this figure based on expectations, experience and other variables
  • The formula would thus be:
  • \text{Cost Per Unit=}\dfrac{\text{Total Production Cost}}{\text{Budgeted Total Units}}
  • Things may become a little more complicated when more than one product is made by the organisation
  • In most cases these product may involve slightly different production process
  • What would be the cost per unit for each product then?
  • Obviously the simple formula shown above would be inadequate at best and even misleading
  • This is where absorption costing comes in
  • Absorption costing-is a method of costing a product in which all fixed and variable costs are apportioned to cost centres where they are accounted for using absorption rates
Cost type$/unit
Direct materialsxxx
Direct Labour costxxx
Direct expenses (e.g. royalty per unit)


Prime Cost/unitxxx
Overhead portion/unitxxx
Total Cost/Unit


  • Under absorption costing first the variable costs be unit are determined and added to get the total variable cost per each unit produced
  • This is easy to do since most variable costs are usually direct costs that can be easily traced to each product
  • Overheads are a different matter
  • Each unit of production has to “absorb” a portion of the fixed costs attributable to it
  • This allows these costs to be recovered for example when the unit is sold
  • The main aim of absorption costing is to make sure that each unit of production absorbs costs a fair portion of overheads that is indicative of the time and effort that went into the production of that unit
  • Absorption costing involves the following stages:
    1. The allocation and apportionment of overheads to the different cost centres
    2. The reapportionment of service (non-production) cost centre overheads to the production cost centres
    3. The absorption of overheads into the products
  • These steps will be clearly illustrated using examples and further explanations follow the links below to access more notes

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