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The advantages of absorption costing:
It provides a means of sharing the total overheads of a business in the manufacturing sector over the various production cost centres and the overheads for a particular production cost centre over the various products passing through it.
It allows production overheads to be allocated or apportioned to the cost centres on a fair basis and absorbed into the cost unit using an appropriate using an overhead absorption rate.
Non-production overheads are absorbed into the cost unit by adding a percentage based on the proportion of non-production overheads to the total production cost.
Disadvantages:
Not only is this cost accounting system is unsuitable for businesses in the service sector, but a major limitation of absorption costing is that it is based on arbitrary decisions about the basis for apportioning and absorbing the overheads.
Normally predetermined overhead absorption rates are used because the actual figures are not available until the end of the period, but if the predetermined overhead that has been absorbed is higher than the actual overhead, it will result in over absorption, which reduces expenses in the statement of comprehensive income.
If the business is miscalculating the cost of its products and basing its selling prices on this inaccurate information, it could have a dramatic impact on financial performance.
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