Absorption costing:Statement of Profit or Loss

• Profit is the overriding aim of most businesses and for this reason management accountants do also prepare income statements (also known as statement of profit or loss)
• Although similar in spirit to the Income Statement prepared by Financial Accountants it is a little different as will be shown below
• The statement is usually prepared on a monthly basis and its objective is to show whether profit is higher or lower than expected
• If there is a difference, as is usually the case, the reasons for the differences are ascertained
• Absorption costing values each unit of inventory at the cost incurred to produce the unit
• Under absorption costing overheads are included in the cost of each unit which means the cost of sales, opening and closing inventory all include a portion of overheads for the period
• To reiterate each unit is assigned its share of fixed overheads for the period
• In accounting term we say each unit absorbs its share of fixed overheads for the period

The format of an Absorption Costing Statement of Profit or Loss

• Valuation of inventory -opening and closing inventory are valued atfull production cost under absorption costing
• Under/over-absorbed overhead -over-absorption of overheads is necessary in absorption costing statements
• Absorption costing statements are split into production costs in the cost of sales and non-production costs after gross profit
• A worked example for Absorption costing can be found here

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