Absorption costing – Exercise

Absorption Costing (also known as traditional costing or full costing method)

 Under this all costs (fixed and variable) are included for calculation of cost of product. This
calculated cost is known as absorption cost
o Variable costs are charged per unit of product
o Fixed cost are apportioned to each unit on basis of suitable method
 So absorption cost = direct cost + overhead cost (allotted to each unit as per overhead
absorption rates)
 Different methods are available for absorption of overheads
o % of direct material cost
o % of direct labour cost
o % of prime cost
o Rate per labour hour
o Rate per machine hour
o Rate per unit produced
 Income statement prepared under absorption costing is suitable for external reporting

Exercise – Absorption costing

Company manufactures three products namely A, B and C. Information pertaining to these products are
as under

Product A Product B Product C

Total output (units)
Selling price (per unit)
Direct material (per
unit)
Direct labour (per unit)

 Total Overheads are expected = Rs

 Out of which fixed component = Rs
 Fixed overheads are to be allocated ________
 Variable overheads are to be allocated ________________ (w.r.t. no of units)

Prepare the income statement of 3 products showing separately the profit contributed by them

Solution:
Income statement (Absorption costing)
Product A Product B Product C
Output (units)
Selling price (per unit)
Total Sales
Cost of production
Direct material (5/6/8)
Direct Labour (2/3/4.5)
Overheads
Fixed (18000)
Variable (21000)
Total cost
Profit
Total Profit of the firm

 Whether the product C should be discontinued?

 Whether the company will increase its profit from Rs __________ to Rs ___________ after
discontinuation of product C?
 Income statement (Absorption costing)
Product A Product B
Output (units)
Selling price (per unit)
Total Sales
Cost of production
Direct material (5/6/8)
Direct Labour (2/3/4.5)
Overheads
Fixed (18000)
Variable (21000)
Total cost
Profit
Total Profit of the firm
(note the change that has been brought in fixed cost, when C is discontinued. At the same time there is
no change in variable cost. Overall profit has been reduced to Rs ______________)
So what is the learning here ?

Next is how to estimate over/under absorption

Let us say that the about output is normal or standard output
Product A Product B Product C
Standard output
Fixed Overheads
Overhead absorption
rate (for standard
output)

 If actual output is different  there would be ____________________________

Product A Product B Product C

Actual Output (units)
Selling price (per unit)
Total Sales
Cost of production
Direct material (5/6/8)
Direct Labour (2/3/4.5)
Overheads
Fixed (1.2/1/0.60)
Variable (21000)
Total cost
Profit
Total Profit of the firm
 Total fixed cost charged = __________
 Allocated fixed cost = _____________
 So over absorption of fixed cost = _________

Product wise over / under absorption

Product A Product B Product C
Fixed cost allocated
Fixed cost absorbed
Over (under) absorption
Profit (as above)
Less: Over absorption
Add: Under absorption
Net Profit
Total Profit

So if fixed cost is expressed as per unit basis  then care must be taken for over or under absorption of
fixed cost

Learning points: In absorption costing