Advantages and Disadvantages of Absorption Costing

Absorption costing and marginal costing are different from each other as explained in the article “Differences between absorption costing and marginal costing”, but both have their own advantages and disadvantages.

Advantages and disadvantages of absorption costing are highlighted below:

Advantages of absorption costing

  • Absorption costing can be used internally as well as externally. In absorption costing, value of inventory includes fixed overheads. This treatment of inventory is consistent with the requirements of financial reporting.
  • Complete information about the cost of goods/ inventory being sold is useful. By comparing the full cost of inventory with its selling price, it may be possible to identify profit making products and loss making products.
  • Full cost of inventory calculated in absorption costing may be useful in determining the price of product, therefore helping the managers/ entrepreneurs in making decisions related to pricing.
  • Over/ under absorption of overheads calculated in absorption costing provides useful information which can be used to control fixed overheads.

Disadvantages of absorption costing

  • Absorption costing is more complex than marginal costing. Estimating and absorbing fixed overheads into the cost of inventory can be a tricky and difficult activity.
  • Absorption costing does not provide information in the manner in which marginal costing does in the context of decision making.