Running head: ABSORBTION COST
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Absorption Cost Systems
David Schwarz
California Southern University
MGT 86512
Dr. Mark Pugatch
December 30, 2015
Running head: ABSORBTION COST
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Global Issue: Absorption Cost Systems
Absorption cost systems sees to it that all manufacturing costs are either traced or
allocated to the different products made, meaning that the cost objects are the products.
An example would be if it costs 32 million dollars to run a factory that produced 620,000
cell phones, including phones till in inventory, it would be then that an absorption cost
system would either trace or allocate 32 million dollars amongst the 620,000 cell phones
(Albright, 2015). Absorption cost systems illustrates the trade off between making
decisions and control. Absorption cost systems are used predominately in financial
reporting for calculating the value of inventory and the cost of goods that are being
manufactured. These types of systems were developed in manufacturing organizations.
However, it is the same applications that have been applied to the service sector, which
includes financial institutions and service firms like law firms, hospitals, and advertising
agencies (Kerzner, 2006). In contrast, nonmanufacturing account systems are much easier
as they do not have inventories for the “work in process” and “finished products”.
Frequently there are many types of production processes that are used in plants.
An example of this would be that parts might be manufactured in batches in an individual
department and than put together in its final stages in a different department. These
different production processes require different accounting systems in order to
accumulate the costs and assign them to the products (Beauchamp, 2009). There are two
types of absorption systems; job order systems and process cost systems. Job order
costing is used in different aspects of business that product output in specific jobs. Job
order costing is used in the assembly processes. A job might include that of a single unit,
such as the construction of a building, or a batch of units. In a service organization, a job
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might entail the handling of a customer’s lawsuit or the processing of any type of loan at
the bank. The cost of each job is tracked individually, and job order cost systems
accumulate costs by jobs. On the other hand, sine assembly processes and the
continuation of flow production process utilize process costing. Production in these types
of environments is continuous and individual batches or groups do not exist. Costs are
assigned to the production processes but also to the products that are progress through
various processes (Albright, 2015). With either of the systems, all of the manufacturing
costs are assigned to the products being produced.
In putting these systems into motion, there is a good amount of diversity in how
organizations’ accounting systems assign costs to products and services. Even within two
departments that are batch processing, there are no two systems that are alike. Many
firms use hybrid of orders and process costing. Each accounting system is developed
specifically for the department or organization (Albright, 2015). The interesting thing
about job costing is its treatment of overheads due to the fact that it entails the
organization’s managements’ judgment and offers the managers discretion in the cost of
products and income determination. If all the resources and factory costs were utilized
directly for the products then cost accounting would be nothing more than basic math.
The dynamic part of job order costing is the build up of indirect costs in the overhead
account and the distribution of the costs to the individual jobs per the use of an overhead
rate. The overhead allocation base is chosen to allocate the indirect cost to the jobs. As
work is being done on the job, the overhead is being charged to the job based on the total
hours that the machines are being used (Kerzner, 2006). If a prospective overhead rate is
established at the beginning of the year, it will enable the jobs to establish a price as they
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are being made. The input measure that is selected by the company is typically the one
that has the best relationship of cause-and-effect towards the overhead. Further, the
allocation base is the factor input most associated with overhead. Overhead includes both
fixed and variable costs. In the long term, fixed costs can be adjusted in terms of the
differences in the volume. In the event that the overhead rate is less than or equal to the
marginal cost on the firm when the output expands by one or more units, then allocating
is a much better option then not allocating at all (Albright, 2015). Traditionally,
management would like to tax the input that is impressed externalities on various parts of
the organization. In an ideal situation, the overhead rate will provide an estimate of the
opportunity cost using at least one unit of the allocation base.
Absorption cost systems ensures that all manufacturing costs are traced or
allocated to the different products made, meaning that the cost objects are the products. It
shows the trade off between making decisions and control. These types of systems were
developed in manufacturing organizations. It is the same applications that have been
applied to the service sector, which includes service firms like law firms and hospitals. In
contrast, nonmanufacturing account systems are simpler as they do not have inventories
for the “work in process” and “finished products”. There are two types of absorption
systems; job order systems and process cost systems. Job order costing is used in
different aspects of business that product output in specific jobs, which is used in the
assembly process. Job orders cost systems accumulate costs by jobs (Albright, 2015).
Production in these types of environments is continuous and individual batches or groups
do not exist. Each accounting system is developed specifically for the department or
organization. What is intriguing about job costing is its handling of overheads due to the
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fact that it entails the organization’s managements’ judgment and offers the leadership of
the company discretion in the cost of products and income determination. It is the
overhead rate that will provide the management team with an estimate as to the
opportunity cost of utilizing a minimum of one unit of the allocation base.
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References
Albright, Christian S & Winston, Wayne L.(2015). Business Analytics Data
Analysis and Decision Making (5 th ed). Cengage.
Kerzner, H. (2006). Project management case studies (2nd ed.). Wiley, John & Sons, Inc.
Kerzner, H. (2006). Project management: A system approach to planning, scheduling,
and controlling. (9th ed.). Wiley, John & Sons, Inc.
Beauchamp, T., Bowie, N., & Arnold, D. (2009). Ethical theory and business. (8th ed.).
Upper Saddle River, New Jersey: Pearson Prentice Hall.
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