Accounting Dictionary

Absorption Costing

Absorption Costing is the method of preparing income statements based on GAAP.

GAAP requires that direct materials, direct labor, and both fixed and variable factory overhead be listed as product costs. All of these costs get included i.e. absorbed into inventory on the balance sheet, and do not hit the income statement until expensed as Cost of Goods Sold. In contrast Variable Costing requires that product costs be characterized as either variable or fixed, not as direct materials, direct labor or overhead, resulting in the key difference that fixed overhead, under Variable Costing, is expensed in the period incurred.

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