Absorption may be used to refer to absorption costing. This is a technique which ensures the documentation and accounting of all production costs of products or services. This is also called full costing.
Absorption costing allows companies to clearly and completely show information about their financial condition. It also allows companies to price more accurately, ensuring that the final price of a product or service takes into account the actual costs that went into them. This is particularly useful for small businesses which need to give more consideration to overhead expenses.
Absorption costing is taken in opposition to variable costing. Under variable costing, which may also be referred to as direct costing, only variable expenses are included in the computation. Therefore, fixed manufacturing costs are not included in the computation.
Since variable costing focuses more on expenses which can be modified or adjusted, it helps management plan and make decisions on how expenses can be minimized. Data taken from absorption costing shows the entire picture, together with fixed costs, so does not conveniently provide this information. On the other hand, since variable costing only shows part of the picture, it may not be taken by investors as reliable information. Also, since fixed costs are included in the computation of absorption costing, it might be more beneficial to use this information when sales change, since the figures won’t fluctuate too much.
Due to the huge differences between the two costing methods, it is important to specify which method is being used.