Introduction

  • 10 minutes

Absorption costing is one of many cost accounting methods that help ensure that indirect costs that originate in the manufacturing of finished goods are recognized and absorbed into the product cost.

Cost controllers can classify resources of the material and labor types into cost groups of the Direct materials or Direct manufacturing (labor) type. This classification lets cost controllers configure a cost composition with the level that is required for financial reporting and internal analysis. The aggregation also serves as the basis for calculating absorption of indirect cost.

Inventory is typically evaluated by the following parameters:

  • Standard cost - Cost composition can be tracked in Supply Chain Management, and the inventory value of a product can be reported by its cost composition.

  • Actual cost (FIFO, LIFO, LIFO date, Weighted avg., Weighted avg. date, or Moving average) - Cost composition cannot be tracked in Supply Chain Management, and the inventory value can only be reported as Direct material. Absorption of indirect cost is important for ensuring accurate product costing and valuation of inventory. In some industries, indirect cost represents a significant portion of the product cost.

Note

Supply Chain Management allows absorption of indirect costs when calculating the actual costs for an item by posting the indirect costs as a lump sum.

Accounting standards or Generally Accepted Accounting Principles (GAAP) might recommend or require that indirect cost is absorbed. Examples of indirect cost include:

  • Depreciations of manufacturing equipment.
  • Maintenance expenses that are related to manufacturing equipment.
  • Shop floor expenses for cleaning, rent, or insurance.

In this module, you will learn how to configure a costing sheet for your legal entity and be able to perform BOM/formula calculation from a sales quotation or sales order and analyze the costing sheet.

To configure the costing sheet, you must configure the following parameters:

  • Costing version
  • Cost groups
  • Calculation group