Absorption costing

Absorption costing

One method of determining the total cost of a given product or service is that of adding the costs of overheads to the direct costs by a process of allocation, apportionment and absorption. Since overheads (or indirect costs) can be allocated as whole items to production departments, it is possible to arrive at a notional amount that must be added to the cost of each product in order to cover the production overheads.

In absorption costing, each product manufactured is made (at least in theory) to cover all of its costs. This is achieved by adding a notional amount to the total unit cost of each product.