Question: Briefly explain the concepts of Absorption costing and Activity Based Costing.

Expert answer

Absorption costing is a costing methodology that traces the costs of all products and services to the periods in which they are used. This approach is also known as full absorption costing. In contrast, activity-based costing (ABC) assigns costs to products and services based on the activities that are required to produce them. ABC can be more accurate than traditional absorption costing because it identifies the specific activities that are driving costs.

In traditional absorption costing, all manufacturing costs are assigned to products and services. These include direct materials, direct labor, and overhead costs such as rent, utilities, and property taxes. The thinking behind this approach is that all manufacturing costs must be covered by the selling price of the product or service. Otherwise, the company will have to sell at a loss or go out of business.

While this may seem like a straightforward way to determine the cost of products and services,