How do you account for fixed manufacturing overhead under absorption costing?
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Absorption costing is based on the idea that the cost of a product or service should reflect all the resources used to make or deliver it. This means that not only the direct materials and labor, but also the indirect costs such as rent, utilities, depreciation, and insurance are allocated to the units of output. Absorption costing is also known as full costing or full absorption costing.
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CONTINUED FROM PREVIOUS after arriving at the cost of the production departments , the total cost gets absorbed by the products. The rate at which it gets absorbed by the products various bases are used,like units , hours,volume etc . but in all this the point to be remembered is that "price is a fact & cost is only an estimate
To calculate the fixed manufacturing overhead per unit, you need to divide the total fixed manufacturing overhead by the number of units produced in a period. For example, if the total fixed manufacturing overhead for a month is $100,000 and the number of units produced is 10,000, then the fixed manufacturing overhead per unit is $10. This amount is added to the variable manufacturing costs per unit to get the total manufacturing cost per unit under absorption costing.
Under absorption costing, fixed manufacturing overhead is recorded as part of the inventory cost when the units are produced. This means that fixed manufacturing overhead is not expensed until the units are sold. When the units are sold, the cost of goods sold includes both the variable and fixed manufacturing costs of the units sold. The difference between the sales revenue and the cost of goods sold is the gross profit.
Absorption costing affects the income statement by changing the amount of cost of goods sold and gross profit. Under absorption costing, cost of goods sold depends on the number of units sold, not on the number of units produced. This means that if the number of units sold is less than the number of units produced, some of the fixed manufacturing overhead will remain in the inventory and will not be expensed. This will increase the gross profit and the net income. On the other hand, if the number of units sold is more than the number of units produced, some of the fixed manufacturing overhead from the previous periods will be expensed. This will decrease the gross profit and the net income.
Absorption costing affects the balance sheet by changing the amount of inventory and retained earnings. Under absorption costing, inventory includes both the variable and fixed manufacturing costs of the units in stock. This means that if the number of units produced is more than the number of units sold, the inventory will increase and so will the assets. This will also increase the retained earnings, which is part of the equity. On the other hand, if the number of units produced is less than the number of units sold, the inventory will decrease and so will the assets. This will also decrease the retained earnings, which is part of the equity.
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The important things here is whether you want all foh to be recovered by production of the period sales of the period . In the later case you can avoid carryover of one period FOH to next period
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