Absorption Costing

If we want to calculate the full cost of producing then we need to add in the fixed costs of production. However given that the total cost is fixed rather than variable, we need to absorb (or charge) the costs on a per unit basis. Given that the business might be producing different types of units that take different lengths of time to produce, the most common way is the calculate a cost per hour of labour (although, as I explain in my lectures, this is not the only way used). With regard to why some companies prefer to use absorption costing and others prefer to use marginal costing, I do again explain this in my free lectures.

Thanks John. What do you mean by "However given that the total cost is fixed" ? Does this mean we only carry out absoprtion costing on fixed overhead costs ?

Yes - it is the fixed production costs that are absorbed. Have you watched my free lectures on the absorption of overheads?