Absorption Costing: Definition, Formula & Example

Lesson Transcript
Instructor: Brianna Whiting

Brianna has a masters of education in educational leadership, a DBA business management, and a BS in animal science.

Absorption costing is the process of summing up all the production costs and applying the total to the final cost of an individual product. Learn the definition of the variables considered in the absorption costing formula and see an example. Updated: 10/15/2021

Absorption Costing

Meet Jack! Jack has just recently went into business on his own. You see, Jack used to work for a company that made coffee pots. After a falling out with the manager about creative ideas, Jack decided to leave the company and start his own business producing coffee pots. However, when Jack produced coffee pots for his new business, he incorporated the creative ideas his previous manager disagreed with.

Jack knew his invention would be a hit and shortly after they hit the market, Jack was overwhelmed with success. That was until Jack realized he wasn't making the money he thought he would. After looking over his sales reports and doing some research, Jack uncovered the problem.

What was happening, was Jack was only charging $35.00 for each of his coffee pots. But, the cost of materials and labor was $45.00. This meant that Jack was not even covering his costs with each coffee pot sold. It was at that time Jack learned that he should consider applying absorption costing to his business.

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Definition of Absorption Costing

So, what is meant by the term absorption costing? Well, absorption costing is the method of gathering all of the manufacturing costs and assigning them to the actual individual product. In other words, absorption costing means that all costs associated with production, such as direct materials, direct labor, and all manufacturing overhead costs, are all included in the final cost of the product.

The following is a list of important costs that are applied using absorption costing:

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