# Accounting Assignment Help With Understanding Absorption Costing And Direct Costing

## 5.8 Understanding Absorption Costing and Direct Costing

Absorption costing is a method that charges all costs to products. Under this approach product/service is charged with prime cost and all overheads. Overheads are of two types – fixed and variable. Overheads may be linked to product or they may be fixed in nature within a capacity range. In absorption costing this distinction is ignored. Overheads are analysed and charged to product/service on a suitable basis. This absorption costing is an ‘all-cost’ approach.

Direct costing on the other hand, means costs which are directly related to product/service. Prime cost and variable overheads constitute direct cost.

Let us see an example to explain the distinction between absorption costing and direct costing.

Eg. To produce 1000 units of A and 2000 units of B the following costs have been incurred.

 A \$ B \$ TOTAL \$ Direct Materials 50,000 70,000 1,20,000 Direct Labour 40,000 30,000 70,000 Production overheads Variable Fixed 10,000 5,000 15,000 30,000 Administrative overheads Fixed 40,000 Selling & Distribution Overheads Variable Fixed 5,000 4,000 9,000 20,000 Total 1,05,000 1,09,000 3,04,000

Direct cost of A is \$ 105 per unit and of B is \$ 54.50 per unit which are directly attributable to the respective product.

For absorption costing, Products A and B have to bear share of fixed cost over and above their respective direct cost. For allocation of fixed overheads you need to choose appropriate bases.

 Overheads Base A B Fixed Production overhead Production hours 2000 2000 Admn. overheads Time spent ratio 3 2 S & D OH Time spent ratio 1 1

Accordingly share of overhead of product A & B are as follows.

 A \$ B \$ Direct Cost 1,05,000 1,09,000 Fixed production overheads (1:1) 15,000 15,000 Fixed Admn OH (3:2) 24,000 16,000 Fixed S & D OH (1:1) 10,000 10,000 Total 1,54,000 1,50,000 Cost per unit (absorption costing method) 154 75 Cost pr unit (direct costing method) 105 54.50

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