Question

A significant criticism of absorption costing is that it leads to inaccurate product costs. Is this true? Why would a traditional costing system lead to inaccurate product costs? And what could be done about it? In your response, discuss whether your company applies absorption costing in the decision-making process.

Answer 1

Yes, it is true .Absorption costing results in inaccurate product costs. When the firm produces multiple products absorption costing doesnot accurately represent the opportunity cost of different products.The cost drivers in absorption costing use a few input factors such as direct labour hours or machine hours to allocate overhead costs.the use of absorption costing generates a unique situation in which simply manufacturing more items that go unsold by the end of the period will increase net income, because fixed costs are spread across all units manufactured.

Since absorption costing has many advantages we can adopt certain methodologies to improve usages of absorption costing giving us a more accurate product cost.

For that we should use Efficiency based absorption costing methodology.Because it takes into account the different levels of overhead utilisation efficiency pf different products.this method highlights the problem with use of the single standard absorption rate to allocate fixed costs to products.