Calculating Inventoriable Cost Using Absorption Costing: An In-Depth Guide to Direct Materials, Labor, and Overhead Allocation in Production Processes

inventoriable cost using absorption costing

Direct materials + direct manufacturing labor + variable manufacturing costs + portion of fixed costs

Absorption costing is an accounting method that is used to calculate the cost of a product by taking into account all the direct and indirect costs that are incurred during the production process. Inventoriable cost is a key component of absorption costing. Here’s a detailed explanation of how inventoriable costs are calculated using absorption costing.

Inventoriable costs are the direct and indirect costs that are incurred during the production process and can be assigned to a product. These costs are capitalized as inventory until the product is sold, at which point they are recognized as cost of goods sold (COGS) on the Income Statement. Inventoriable costs are made up of direct materials, direct labor, and manufacturing overhead.

Direct materials are the raw materials and other components that are used to make the product. This includes the cost of purchasing and transporting the materials to the factory. The cost of these materials is usually easy to trace to a specific product.

Direct labor is the cost of the employees who are directly involved in the production process. This includes their wages, salaries, and benefits. This cost can also be traced to a specific product.

Manufacturing overhead is the indirect cost that is incurred during the production process. This includes the cost of rent, utilities, maintenance, depreciation on equipment, and other indirect costs that are not directly related to the production of a specific product. The overhead cost is allocated to a product using an overhead rate.

To calculate the inventory cost using absorption costing, follow these steps:

Step 1: Calculate the direct materials cost by adding the cost of all the raw materials and components that were used to produce the product.

Step 2: Calculate the direct labor cost by adding the cost of all the employees who worked directly on the product.

Step 3: Calculate the manufacturing overhead cost by adding up all the indirect costs that were incurred during the production process.

Step 4: Assign the overhead cost to the product using an overhead rate. This is calculated by dividing the total manufacturing overhead cost by the total amount of direct labor and direct materials used in production. For example, if the total overhead cost is $500,000 and the total direct labor and direct materials cost is $1,000,000, the overhead rate would be 50%.

Step 5: Add the direct materials cost, direct labor cost, and allocated overhead cost to calculate the total cost of the product. This is the inventoriable cost.

In summary, absorption costing takes into account all the costs incurred during the production process to arrive at an inventoriable cost for a product. This method is used to determine the true cost of a product and is useful for pricing decisions and determining profitability.

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