What is Absorption Costing?
Absorption costing, also called full costing, is a method of product costing in which all manufacturing costs — direct materials, direct labour, and both variable and fixed manufacturing overhead — are absorbed into the cost of each unit produced.
How It Works
- Identify direct material and direct labour costs per unit.
- Compute the overhead absorption rate from budgeted fixed and variable overhead.
- Apply the rate to each unit produced.
- Build up cost of goods manufactured, cost of goods sold, and ending inventory.
- Reconcile under- or over-absorbed overhead at period end.
Saudi Context
IAS 2 as adopted by SOCPA mandates absorption costing for external financial reporting in Saudi Arabia. ZATCA reviews the absorption base during VAT and zakat audits to confirm that inventory values reflect the full production cost.
Example
Per-unit direct materials SAR 20, direct labour SAR 10, variable overhead SAR 5, fixed overhead absorbed SAR 15 — total absorbed cost SAR 50 per unit. If 1,000 units are produced and 800 sold, ending inventory = 200 × 50 = SAR 10,000.