Absorption Costing

All the costs to make something. Yep, if you use this accounting method for creating financial statements, you include all the input costs, mostly materials and labor, but also fixed costs, like utilities and rent. That is, you are "absorbing" those costs into your figures when you produce metrics like "profit per unit."

So let’s say you have a blender-making company. It costs $70 to make the blender, which includes the parts (plastic, metal blades, etc.), plus the wage of the person putting it together. If we just stop there, it’s variable costing. But to get absorption costing, we need to include the fixed overhead costs, such as the salaried employees and plant utilities. So we take the wages of our sales and admin employees, and the electricity and utility costs, and divide it by the number of blenders we made. For our blender company, that’s $20 a blender, so now the cost of our blender inventory is $90 per, which includes the $70 in variable cost and the $20 in fixed overhead.