Question

Are the criticisms of absorption cost systems are valid or invalid and why?

Answer 1

ABSORPTION COSTING

Absorption costing is the method of costing in which firms choose to allocate all the costs to production. This is different from variable costing because in variable costing all only variable costa are considered for production. Both of these methods have its own advantages and disadvantages.

The main advantage of using absorption costing is that it complies with the generally accepted accounting principles (GAAP) which suggest to recognise all costs involved in production. Another advantage is that it accounts for all of the production costs incurred. This can help a company in determining better prices for the products produced. One of the major criticisms against absorption costing is that it can cause a company’s profits to appear better than it actually is. This is because of the fact that the fixed costs of production are not deducted from the revenue unless all of the products manufactured are sold. This can mislead both the company and potential investors. Since fixed costs are also accounted for in absorption costing companies may find it difficult to compare its different products because of the presence of major fixed costs. This can also make it difficult to determine the variations in cost that may occur at various production levels. These are some other criticisms against absorption costing. Thus one may conclude that the criticisms against absorption costing are valid but at the same time it also comes with its own advantages too.