Absorb Cost in Business
In the business world, companies often face various costs that they have to bear. One such cost is the absorb cost. Absorb cost is that cost that a company incurs when it produces more units than what it sells. The cost can be absorbed by the company in various ways. For example, by increasing the price of the product or reducing the cost of production. Let’s discuss what absorb cost is, how it works, and the different ways in which it can be absorbed.
What is Absorb Cost?
Absorb cost is a term used in managerial accounting to refer to the cost that a company incurs when it produces more units than it sells. It’s also known as the fixed manufacturing overhead cost. The fixed manufacturing overhead cost is the cost of production that is not directly related to the number of units produced. For example, if a company produces 1000 units of a product and sells only 800 units, the cost of producing the remaining 200 units is the absorb cost.
How does Absorb Cost Work?
To understand how absorb cost works, let’s consider an example. Suppose a company produces a product that has a fixed manufacturing overhead cost of $100,000 per month. The company produces 10,000 units of the product in a month and sells only 8,000 units. The cost of production per unit is $10 ($100,000/10,000). And the cost of production of the 8,000 units sold is $80,000 (8,000 x $10). The cost of production of the remaining 2,000 units is the absorb cost, which is $20,000 (2,000 x $10).
The absorb cost should not be included in the cost of goods sold. This is simply because it is not related to the production of the units sold. The absorb cost is considered a period cost. Therefore, it should be included in the income statement under the heading of selling, general, and administrative expenses.
Absorbing the Cost:
There are various ways in which a company can absorb the absorb cost. Let’s discuss some of the common ways.
1. Increase the price of the product:
One way to absorb the absorb cost is to increase the price of the product. If the company increases the price of the product, it will increase the revenue per unit, and the absorb cost will be spread over a larger number of units. This will reduce the impact of the absorb cost on the profitability of the company.
However, increasing the price of the product may not always be feasible as it may result in a reduction in sales volume. If the price of the product is increased too much, customers may switch to a competitor’s product, resulting in a loss of market share.
2. Reduce the cost of production:
Another way to absorb the cost is to reduce the cost of production. The company can do this by renegotiating contracts with suppliers, reducing the cost of raw materials, or by finding ways to increase efficiency in the production process.
Reducing the cost of production will reduce the cost per unit, and the absorb cost will be spread over a larger number of units, reducing the impact of the absorb cost on the profitability of the company.
3. Increase the sales volume:
Increasing the sales volume is another way to absorb the cost. If the company can increase the sales volume, the absorb cost will be spread over a larger number of units, reducing the impact of the absorb cost on the profitability of the company.
Increasing the sales volume can be done by increasing marketing efforts, introducing new products, or by expanding into new markets.
Absorbed cost is a cost that a company has to bear when it produces more units than it sells. This cost can be absorbed in various ways, such as increasing the price of the product, reducing the cost
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